The main reason many utilities are now playing catch-up while first-mover challenger businesses are thriving is a failure to ask themselves what is actually in demand. As a result, they are now losing valuable customers, offering outdated products and operating in the wrong markets, write Ben Warren and Klair White of EY
Simply generating and selling electricity or gas at a regulated rate is no longer enough of a proposition, with consumers increasingly demanding more tangible and integrated value creation across their energy consumption needs.
This means utilities and others need to do more than optimize power sales – they must create greater revenue security through product diversification, emulating the rapid deployment of renewable electricity, distributed generation and demand-side management to capture opportunities and low-hanging fruit in the heat and transport sectors, energy efficiency, smart infrastructure and in more holistic integrated resource management solutions.
The post-COP21 focus on emissions reduction is also likely to spur a broader energy focus given that achieving country-level targets will require a range of measures beyond renewable generation alone.
However, this does not mean abandoning the more traditional power markets either – cost-effective large-scale generation will remain critical in many markets where rapid economic growth and industrialization are putting pressure on power demand or where significant volumes of conventional generating capacity are being retired.
Nor does it mean utilities can rest on their laurels, though, as competition intensifies to more effectively and flexibly integrate an increasing volume of renewable energy into the system in parallel with recalibrating output from conventional assets.
Any reassessment of the products and services on offer therefore requires both new thinking and efficient thinking.
Beyond power: the triple line
The words energy and electricity are frequently used interchangeably, masking the fact that energy – often the basis for national or state level targets – actually comprises heat and transport as well as electricity. In Europe, for example, most markets are well on their way to meeting their 2020 renewable electricity goals, but have been less successful in implementing heat and cooling and transport solutions to contribute to the overarching 20 per cent renewable energy target.
Potential heat efficiency solutions are widespread from replacing fossil fuels with renewable sources such as biomass, solar and geothermal for immediate use or stored heat generation, to air- and ground-source heat pumps, industrial process heat capture and recycling, or solar water heaters replacing often hazardous kerosene-based cooking. Technology innovations are even setting the stage for electricity to be the primary fuel source for heating systems, enabling power providers to bundle offerings or go after revenue streams traditionally dominated by gas and residential oil companies.
In transport, electric vehicles present the most obvious clean energy solution, and while the market is arguably taking longer than expected to gain critical mass, it is still experiencing steady growth, with most manufacturers now offering hybrid or all-electric cars and significant prospects for further cost and efficiency gains. This is creating opportunities to partner with automakers to develop, implement and manage the required charging infrastructure, with a number of different business models emerging and some utilities already starting to include chargers as part of their base rate.
Other opportunities include shifting to low-carbon fuels such as biogas and compressed natural gas or air, fuel efficiency from lighter components, and automation technology solutions that can, for example, use data mapping to analyze traffic congestion and identify the most fuel-efficient route or closest charging station.
Such data mapping could even help early autonomous technologies such as platooning: linking pairs of vehicles to cut drag, which can reduce fuel consumption by up to 7 per cent according to Bloomberg New Energy Finance. The scalability potential for transport efficiency solutions is also compelling and could create opportunities that feel more like long term infrastructure investments, from national bus fleets to large-scale marine vessels.
Energy efficiency applications are growing in importance as consumers seek to achieve both reduced energy costs and sustainable consumption. Solutions today vary from increasingly intelligent smart meters and thermostats that can be managed and monitored by smartphones to more holistic software systems that collect and analyze millions of data transactions from sensors tracking various energy-consuming applications to diagnose patterns and determine inefficiencies.
This far-reaching potential is also spurring demand for more integrated and intelligent resource management systems that can incorporate efficient water usage, air quality and waste management in addition to sustainable power and heat. Such systems can be embedded into infrastructure, from a single home or factory to an entire city, generating cost and energy savings through a more efficient allocation of resources, as well as the potential for self-reliant and/or net-zero emissions energy ecosystems.
An increasing focus on resource optimization could also see more heat capture and recycling from industrial processes, and large-scale on-site renewable energy projects being used to run desalination and wastewater recycling plants to produce clean water, or power enhanced oil recovery processes to avoid using potentially more costly and polluting energy sources for commodity extraction.
Technology or affordability is rarely the barrier to achieving this. Being able to design, fund and implement an integrated rather than a piecemeal solution often requires strong sponsorship, leadership, a commitment to invest and the ability to navigate all the necessary regulatory, social, procurement and implementation challenges.
Though the smart cities agenda, like electric vehicles, has arguably produced more hype than results to date, as is the nature of any transformative process, the economic and societal case is strong for intelligent and integrated energy and resource optimization solutions across a city’s infrastructure – from smart street lighting and rooftop solar energy to congestion management sensors and wireless IT systems.
This presents significant potential for technology innovators, utilities as service providers and investors willing to fund major infrastructure projects in return for stable long-term returns. City and municipal governments, often with budgets that can be more easily deployed at a local level and with fewer political barriers, have the potential to be catalysts for change if they are able to harness, manage and co-ordinate the visions and ambitions of innovators, investors and technology promoters. COP21 discussions around the need for more climate-resilient infrastructure should also accelerate the imperative for smarter and decentralized resource management systems.
At the same time, however, utilities should also be at the forefront of determining the most economic ways of balancing the growing penetration of variable renewable power. Initially viewed as a challenge to be overcome, such integration is now becoming an opportunity to enhance resilience and efficiencies across the energy system, as well as representing a major new business opportunity for incumbent utilities.
Storage is, of course, widely hailed as one of the most promising ways to achieve this, with broad application potential at grid level, alongside specific assets and behind the meter. Despite the significant long-term ambitions for energy storage, in the first instance its major value is likely to be in providing system-critical ancillary services such as frequency regulation, voltage support and reactive power – albeit prompting the need for appropriate regulatory frameworks and remuneration models that accurately value such services – and then, increasingly, to bridge gaps between renewable power production and demand. The International Energy Agency (IEA) estimates 475 GW of energy storage system capacity by 2030, and costs are expected to fall with a similar trajectory to solar PV over the next few years, if not even more dramatically.
|Credit: European Commission|
However, with these costs still relatively high – around $350/kWh for lithium-ion battery packs in late 2015 according to BNEF – and varying significantly between applications, electricity generators should also be looking to improve supply and demand balancing through better resource forecasting, more geographically diverse assets to mitigate localized resource intermittency, increased interconnections between grids, smart infrastructure and demand response applications.
This balancing act becomes even more critical given the increasingly vocal divestment campaign gathering speed as a growing number of corporations and financial institutions pledge to exit or avoid investments in fossil fuels such as coal. However, it’s likely that the most economically inflexible baseload power will be driven out of the market first anyway, with the cost of such plants tending to increase once they are taken offline, even for small periods, to make use of cheaper renewables with almost zero marginal cost.
However, caution is still advised to avoid draconian quick wins in the carbon battle that blindly lumps all fossil fuels together or artificially accelerates peak demand to the point of destabilizing baseload power supplies. There are no silver bullets, and all generation has a role to play, initially at least. Further, a forced divestment campaign risks simply passing around the financial risk associated with emissions rather than reducing the total amount of risk within the system, potentially calling for investors to put pressure on dividends rather than divestment. This forces fossil fuel asset owners to produce value for money, and even more so if carbon pricing is introduced in multiple markets as expected. The gradual redeployment of oil and gas sector skills to offshore or extraction-based renewable energy or unconventional oil and gas technologies is also potentially preferable to forcing them out of business altogether.
There is also scope to enhance the performance and efficiency of both current and future generating capacity. Decisions around repowering and life extensions of maturing assets will play an important role in determining the value of operating portfolios, and identifying and maximizing technology innovations will also be key. Such innovations run from larger wind turbines and floating solar installations to more revolutionary technology shifts such as transparent solar panels on windows and skyscrapers or Makani’s Google-sponsored wind kite, which claims to generate up to 50 per cent more energy than conventional turbines. There is also a growing opportunity to tailor technology solutions to specific markets – for example, turbines suitable for low wind yield sites in Europe now that many high-resource sites have been saturated, mega-scale solar projects in India to consolidate infrastructure and logistical efforts, or siting multiple projects on sites with existing grid network access where transmission systems are relatively weak.
However, even if utilities work hard to innovate with new services and to better integrate clean power assets into the world’s energy systems, what about the lost generation of customers?
While many utilities were continuing to view their customers agnostically, as just account numbers to be billed periodically for electricity sold at the highest price from existing generation assets, the challenger businesses were realizing that what energy consumers want is different from what they are often given. The result has been more tailored or segmented products and services for specific types of energy users or even individual offtakers of sufficient scale, as small becomes the new big.
It’s unsurprising, then, that the rapid growth, availability and affordability of decentralized generation solutions such as rooftop solar, microturbines, storage, smart energy management devices and microgrids has enabled competitors to create significant customer churn for utilities’ core product of grid-connected generation by empowering and incentivizing many to take control of their own energy supply and demand. Navigant forecasts that around 346 GW of distributed solar PV alone will be installed in 2015-2024, producing $670 billion in revenue for the industry. This compares to an additional 290 GW of utility-scale solar expected to come online in the same time frame.
The question is therefore whether utilities themselves are now also ready to become more granular in their focus on customer needs, to either regain these lost customers or at least learn lessons going forward. After all, this is not a trend that looks set to abate any time soon.
Project Sunroof, for example, uses Google Earth’s high-resolution aerial mapping to help homeowners calculate their own roof’s solar energy potential and the potential energy bill savings. Launched in the US in 2015, the tool also matches homeowners with local solar providers. Companies are also finding new ways to target customers, such as NRG Energy providing discounts on residential solar systems to people who list their homes on Airbnb.
Community-scale projects are also becoming more economically attractive for customers and growing in scale – e.g., TriGlobal’s 500 MW South Plains Wind Farm in Texas – as well as creating new service model opportunities for utilities, project developers and investment conduits. The Clean Energy Collective, for example, is installing shared solar arrays across rooftops in New York City that will be administered by facilities and financed by local homeowners making an up-front investment in a portion of the system in return for net metering credits on their energy bills.
Utilities face a balancing act says EY
A growing number of commercial and industrial corporations are bypassing utilities and seeking out project development and financing parters for direct power purchase agreements (PPAs), whether to meet specific clean energy targets or as part of a broader energy optimization strategy. This can involve direct consumption of on-site renewable energy (particularly for energy-intensive operations such as data centres or industrial processes) or virtual and back-to-back power PPAs for electricity generated off-site.
Utilities also shouldn’t underestimate the needs of the public sector as a critical segment of any customer base – typically the largest energy consumer in any market and with the ability to create critical mass for the implementation of new technologies or solutions spanning the entire energy infrastructure spectrum.
In particular, many governments are now setting themselves specific clean energy efficiency targets. For example, all US federal agencies must achieve a 20 per cent renewable energy generation target by 2020, while Bangladesh has mandated rooftop solar on all government buildings within two years.
In addition to thinking more strategically about customers and products, another dimension to the shifting energy landscape is the creation of a more global market and the opening up of new frontiers as market economics take over, the role of policy shifts and competition intensifies.
A more global market undoubtedly brings energy companies and investors greater choice and opportunities, but also greater competition.
While some utilities have already spread their wings beyond their domestic markets, including former state-owned utilities such as Enel, EDP, EDF and Iberdrola, many are still relatively confined to specific jurisdictions and sectors. With most countries now facing some kind of energy imperative and COP21 in particular creating greater transparency, scrutiny and accountability for the transition to low carbon economics, finding ways to compete in new markets, or else gain visibility for alternative business models or solutions that could be applied in domestic markets, will be critical for utilities seeking to compete with more geographically diverse energy service providers.
Back to basics
Even utilities or major energy companies that currently enjoy de facto monopolies in their own markets are unlikely to be shielded from competition long-term as global energy challengers become ever more confident to go after their customers. Governments will also likely come under increasing pressure to liberalize energy markets still under heavy state control, prompting the unbundling of generation, distribution and transmission assets in a controlled manner as a precursor to privatization that further drives competition and cost efficiencies.
However, in some developing markets, the lack of a creditworthy utility offtaker is stalling investment and growth, despite the opportunity. This necessitates a period of restructuring and tailored credit enhancement solutions to make often debt-crippled utilities cash positive and provide investors with more tangible assurances around project payment terms and risks. A tradition of heavily subsidized energy prices in some markets also makes it nearly impossible for utilities to charge cost-reflective tariffs that enable them to break even – never mind operate profitably. While such restructurings can be complex and politically sensitive, policymakers must try to prioritize the creation of long-term sustainable, affordable and investor-friendly energy markets, leveraging support from donor organizations and the private sector where possible.
The new energy horizons cannot be exploited in isolation of policy at a national and regional level, however. Reflection on the often distorting impact of energy policies in recent decades creates a call to action on governments to shift the focus from intervention to enablement, creating conditions for competition and innovation.
This is something that utilities can and should be leading the charge on, instead of lobbying for protection. It will necessitate breaking down entrenched regulatory frameworks and rethinking standards, protocols and relationships as new asset classes and business models are incorporated to create more efficient and resilient energy systems. This includes designing energy systems that will attract the cheapest long-term capital – capital that will have certain requirements but that will also be there for the lifetime of the related infrastructure, in turn having a direct benefit on consumer pricing and removing inefficiencies from the process.
Critically, this shift will also require measures to enable a level playing field and determine the true cost of energy – including removing all types of energy subsidies and enabling the market to price externalities, such as the right to pollute via carbon pricing.
More clearly defined goals around value for money and affordability should also facilitate the use of public-private partnership models to manage major capital and infrastructure programmes that may not otherwise be developed.
Ben Warren is Energy Corporate Finance Leader and Klair White is RECAI editor at EY