The road ahead: gaining momentum from energy transformation

April 22nd, 2015, Published in Articles: EE Publishers, Articles: Energize

 

Energy transformation is being driven by five global megatrends interacting with and amplified by a set of shifts taking place within the power sector. These five megatrends – technological breakthroughs; climate change and resource scarcity; demographic and social change; a shift in global economic power and rapid urbanisation – are challenges for all businesses.

Schwieters-Norbert_Dr-PwC_4c-240x300

Dr. Norbert Schwieters

But in the power sector their impact is made all the greater by a number of simultaneous disruptions, involving customer behaviour, competition, the production service model, distribution channels, government policy and regulation. The extent and nature of these disruptions varies from market to market. But, in many markets, their intensity is making their impact transformational rather than incremental.

Some of the changes arise from the megatrends – for example the regulatory encouragement of renewables in response to climate change concerns – while others heighten the impact of particular megatrends – for example the potential for rapid urbanisation to accelerate the roll-out of distributed energy and micro-grids.

Together these megatrends and the changes taking place in and around the sector have profound implications for the strategies and future role of companies all along the power utility value chain. They are combining to have a disruptive impact which will lead to the development of new market models and require companies to pursue new business models (Fig. 1).

PWC Fig 1

Fig. 1: PWC’s energy transformation framework.

 

Technological breakthroughs

Technological innovation is at the heart of the shifts that are occurring in the power sector. Advances are happening in many parts of the sector – for example, in large-scale technologies such as offshore wind and high voltage DC transmission, in distributed and smaller-scale customer based energy systems and on the load side. Power is being transformed from a top down centralised system to one that is much more interactive but also decentralised and fragmented. Elements of the old centralised system are becoming stranded and there’s a need to find an alternative investment model that recognises technological advances.

In many jurisdictions, renewable power is replacing or has the potential to replace fossil fuel generation. Smart grids are delivering the potential for greater interactivity with customers. And the scope for even more transformative technological breakthroughs is being taken more and more seriously all the time. A breakthrough in the cost and practicality of battery storage technology could be a quantum leap enabler, opening up the possibility of off-grid customer self-sufficiency when used in combination with “own generation”.

Power to gas is also a potential transformative technology. All bring opportunities for incumbent power companies but many also have the effect of eating away at a utility company’s traditional revenues and undermining the traditional utility business model.

Other technologies, notably the combination of the internet, mobile devices, data analytics and cloud computing with smart grids and smart metering, present opportunities for utility companies to get closer to the customer, play an enhanced “energy partner” role and exploit data opportunities. Analytics capabilities, which today are generally of a low to moderate standard within utilities, will need to be a core strength in the future if companies are to fend off competition from new entrants who already have these capabilities at the heart of their business.

Climate change and resource scarcity

The energy sector is on the frontline of concerns about climate change. The sector as a whole accounts for more than two-thirds of global greenhouse-gas emissions with just over 40% of this stemming from power generation. Resource scarcity or availability, and the associated geopolitics and economics of gas, oil and coal supply, are key factors shaping power market policy. A growing emphasis on renewables is a response to both climate change and security of supply concerns.

In the US alone, over 30% of new electricity generation capacity added in 2010 to 2013 involved solar and wind power, up from less than 2% in 2000 to 2003. Solar photovoltaic (PV) is now present on more than 1,2 million Australian homes and producing over 3,3 GW per annum.

In Germany, renewables accounted for 24% of gross electricity consumption in 2013, placing the country slightly above the growth trajectory needed to reach its 2025 target of 40 to 45%. Energy efficiency has also risen up the policy and customer agenda. Together, renewable technologies, energy saving and a different customer outlook are leading to a transformation of the electricity environment.

They are causing the value chain to shift, away from large conventional power plants towards local power generation and a greater focus on distributed energy and demand management. Transformation is also very relevant to developing countries, many of which face the triple challenge of being unable to meet existing demand for electricity while also facing huge demand growth and the need to extend access to those who don’t have electricity. The need for good demand management is already very familiar in countries such as South Africa where managed outages and demand restrictions are commonplace. Technological advances will enhance this response as well as present the opportunity for expansion of power in ways that may leapfrog the traditional grid evolution route.

Demographic changes

Within the next minute the global population will rise by 145. By 2025, world population will reach about eight billion. Explosive population growth in some areas set against declines in others makes for very different power market growth potential in different parts of the world. Africa’s population is projected to double by 2050 while Europe’s is expected to shrink.

The growth prize for power companies of serving expanding populations is a big one. For example, Nigeria’s population is expected to exceed America’s by 2045. But the infrastructure challenge in many countries is immense and not all growth markets are readily open to international expansion. Companies seeking to reposition their geographic footprints towards faster growth countries will also need to have a clear view on the impact of energy transformation on these countries. The prospect of bypassing the grid and leapfrogging to new local distributed technologies and market models is not unrealistic if the pace of technological advances and cost reductions continues.

Shift in economic power

The focus of global growth has shifted. As fast growth economies become exporters of capital, talent and innovation, the direction of capital flows is being adjusted in a way that is quite different from the traditional routes from developed-to emerging and developed-to-developed countries. We are already seeing significant east-west and east-south investment flows in power markets, involving both financial investors and power sector corporate investors. For example, Chinese state-owned power and utilities companies have been active in their search for suitable international power utility and grid investment opportunities. Europe, South America, Australia and other parts of Asia have all been targets for expansion. Sovereign wealth funds and pension fund investments in the sector have also become multi-directional. The challenge for many power companies is access to scarce capital from this global flow of capital, minimising the risk of stranded investments and seeking innovative ways of securing investment in replacement assets.

Accelerating urbanisation

Over the next two decades, nearly all of the world’s net population growth is expected to occur in urban areas, with about 1,4-million people added each week. By 2050, the urban population will increase by at least 2,5-billion, reaching two-thirds of the global population.

Fast urban expansion presents a major challenge and an opportunity for power utility companies. The speed of urban growth puts a big strain on infrastructure development. In Africa, already large cities such as Lagos, Kinshasha and Cairo are going to become megacities, with more than 15-million people.

The population in Nairobi is set to more than double between now and 2025. Power companies can play a pivotal role in ensuring future cities become “urban smart” rather than “urban sprawl”. They have the potential to be lead players at the heart of future city infrastructure but it will require a new mindset and the development of new partnerships. In the west, rural urbanisation is a trend alongside big city growth.

PWC Fig 2

Fig. 2: The power sector has reached an inflection point where its future direction is much less predictable.

 

Customer behaviour

We’re already seeing a gradual erosion of power utility company revenues as distributed energy gains an increasing foothold. Some commentators go so far as to predict that customers will be saying “goodbye to the grid” in the future. In some places, it’s already happening. Significant changes in the economics and practicalities of self-generation and storage are needed for such a scenario to occur on any kind of scale. But even if customers don’t literally say goodbye to the grid, power utility companies face the prospect of playing the role of being providers of secondary or back-up power to customers. Instead, they could become part of the change by being more active participants in the self-generation market, providing advice on equipment, metering and using the opportunity to secure more of the home and business services space.

Competition

Energy transformation is shifting the opportunity for good margins into new parts of the value chain. But lower barriers to entry in these areas of the value chain and the need for new capabilities mean there is the prospect of existing companies being outflanked and outpaced as more nimble and able competitors seize key revenue segments.

The production service model

The production service model of centralised generation and grids is being joined by a much more disintermediated and distributed model. New supply sources requiring centralised infrastructure, such as offshore wind, are coming onstream but the danger for utilities is that other assets and infrastructure are left stranded. The centralised infrastructure that has long been a source of strength of the industry can be a source of weakness vulnerable to market, policy or disaster risk.

Distribution channels

In a digital-based smart energy era, the expectation is that the main distribution channel will be online and the energy retailing prize will hinge on innovative digital platforms to secure the energy automation, own generation and energy efficiency customer space. Already, many companies are shifting their positioning to cluster energy management offerings around a central energy efficiency and energy saving proposition and using new channels such as social media to engage with customers.

Government and regulation

Energy is by its nature a key economic and political issue. More than in many other sectors, firms in the power sector depend on the political context for their license to operate and public trust in their activities is a big factor. The cost of power is an important element in household budgets as well as business and industrial competitiveness. The availability of power is a “make or break” matter for everyone. And its infrastructure is the centre of often controversial planning debates. So it’s inevitable that the activities of power utility companies are never far from the centre of the public and political spotlight.

Future market designs

Unlike markets for many other products and services, the role of governments is significant given the importance of power to everyday life and economic activity. So the exact market shape for individual countries will depend on policy direction as well as on other local factors such as the extent of competition and customer choice, access to fuel, the nature of existing infrastructure, the degree of electrification and degrees of interconnectedness or isolation from neighbouring territories. And, of course, a crucial factor will be the pace of global technological change.   Over the last two decades or so, many countries have moved away from a classic model and, through a combination of regulator-led and market-led innovation, have created markets characterised by different ownership structures with varying degrees of market liberalisation, customer choice and technology adoption.

Green command and control

The green command and control market scenario represents a market in which government owns and operates the energy sector and mandates the adoption of renewable generation and digital technology. In this scenario, we see vertical integration as the norm (particularly between generation and retail), and investment decisions made as a response to regulatory direction. It is a market in which renewables may be cost-competitive or supported under renewable policy initiatives, while stranded thermal assets may remain operational even when private sector owners would have taken closure decisions. Ongoing capital investment would be subject to policy approval and would feed into regulated tariffs.

Ultra distributed generation

The ultra distributed generation (DG) market scenario represents a market in which generators have invested in distributed renewable generation, with investment decisions based on policy incentives and/or economic business cases. It is a market with full unbundling and strong customer engagement, both in retail and as micro-generators. Market operation becomes more complex for both transmission and distribution operators given the increased volume of distributed and renewable generation and the continued operation of large-scale thermal generation, but remains centrally operated and does not fragment. Regulatory oversight and revenue price controls are likely to address efficiency of system operation and equitable treatment of generation in dispatch and system support. In particular, determining which market participants pay for the central transmission grid becomes a critical regulatory question.

Local energy systems

The local energy systems market scenario represents a market in which we see significant fragmentation of the existing transmission and distribution grids and local communities demand greater control over their energy supply, or a market in which a local approach is adopted for serving remote communities. The market is likely to have undergone full unbundling and experienced strong customer engagement, both as consumers and micro-generators, but recognises the benefits of vertical integration for off grid solutions. Financial viability of distributed generation and distributed grids is a pre-requisite. Strong policy support for fragmentation is required, either to allow local initiatives or to encourage and incentivise local communities and businesses to take control and build and operate their own local energy systems. In its purest form, there would be a limited role for large-scale generation connected to a central transmission grid. It would continue to support industrial customers with large, secure, long-term loads and would be able to provide back-up for security of supply reasons.

Regional supergrid

The regional supergrid market scenario represents a market which is pan-national and designed to transmit renewable energy over long distances. It is likely to embrace some degree of unbundling and customer choice. It requires large-scale renewable generation, interconnectors, large-scale storage and significant levels of transmission capacity. The main challenge that will need to be overcome is regional regulation that applies across borders. National regulators will have limited responsibilities and will be required to oversee national markets within the regional context. In some situations, geopolitical risk will also be a major factor, for example if supply relies on generation located in neighbouring but politically sensitive regions.

Combined models

Each of the four potential market scenarios outlined above represent a transformative move away from current markets. There are common themes across the models and we can see how, in practice, countries might adopt certain components from more than one model. The seeds are in place for transformative change but there is still a lot of inertia in the system. The pace of change will vary from territory to territory. Some will see a gradual evolution while others will see parts of the sector undergoing faster transformative change. Such transformative change might be defined by locality or by the part of the value chain.

Future utility business models

Companies need to determine the future direction of their own markets, how these markets are affected by technological advancement and what this means for their business strategies. While the urgency of their responses may vary by location and value chain presence, we believe companies can’t afford to wait as the next decade is crucial.  Within the next decade we anticipate that step-change milestones will be reached in at least some of the key disruptive technologies – grid parity of solar distributed generation, lower cost and mass-scale storage solutions, vibrant and secure micro-grids, attractive electric vehicle options and ubiquitous behind-the-meter devices. In this new technology-enabled, customer-engaged marketplace, companies need to define their desired purpose.

The range of future business models

Much comment has been directed to the business model of the future. We do not believe there will be a single winning business model but rather that there will be a range of business models that will deliver success in the new market environments. Just as we see a number of transformational market models, we see a range of business models that build on existing models or fill new service or product needs. We outline eight business models which we believe will emerge individually or in combination (see Fig. 3). These individual business models cover the full power sector value chain; each has individual characteristics and several are based on integration and/or collaboration with non-traditional partners.   Some market participants – incumbents or new entrants – may be prevented from playing in all segments, while others may seek to specialise in selected segments or integrate into broader market areas. Whatever the case, the adopted business model(s) needs to be tailored to enable companies to succeed in three key ways – strategically, financially and competitively.

 

PWC Fig 3

Fig. 3: Business model choices.

 

Where do we go from here?

Utilities may choose from a range of paths to move forward from where they are today. But frankly, business model clarity may be difficult to achieve as a lot of uncertainty exists on how future markets may develop and mature. And multiple models may need to be deployed to meet diverse market needs or specific regulatory structures in various countries, or even jurisdictions. Companies will need to be agile in designing their future business model and recognise that an imperfect view of the future will likely lead to an unfinished product that evolves through time.

The full report can be read here.

Send your comments to: energize@ee.co.za

 

 

 

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