Last fall I was asked to speak to a group of institutional investors about the future of the electricity sector given the rapid technological and business model changes that are occurring in the utility sector. My remarks focused on the intersection of falling energy costs, technological advances, the rise in sustainable investing and business practices and the digitalization of the electricity sector that is allowing businesses and consumers unprecedented choice in how they meet their energy needs and allowing for new business models. And how change is gathering speed, like a giant snowball rolling down a mountain.
This article is based on my speaking notes, and includes the PowerPoint slides that I used in my presentation
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Good morning. On one hand one could say that the power sector has not changed much since edison invented his lightbulb and designed a system of large central power stations. We still use his light bulb, we still have the same hub and spoke system.
On the other hand, i just renovated my house in Maine with LED lights and i am considering solar panels and a tesla power wall. Google is now in the home automation business and E.On has transferred its historic conventional German power assets and trading business into Uniper, sometimes referred to as its “bad bank,” because of the negative or low profitability of those units. It is seeking a new future as a customer-led renewable energy developer and operator and supply business. RWE is doing the same.
These contradictions led me to think about two North American energy conferences that i have attended for the last several years and which have been held within a few weeks of each other. The Bloomberg new energy finance conference and a private energy seminar hosted by a leading private equity investor.
I made a point of attending both as a chance to get my head outside of the European renewable energy ivory tower. It often felt to me that the differences between the two could not be more stark, and I was left feeling as if we were suspended between two competing futures for the electricity sector.
Sort of like standing on the uncompleted golden gate bridge in 1936.
Each conference has its own biases. For Bloomberg, an unshakable belief in a new energy paradigm driven by renewables, distributed generation and disruptive business models. For the private conference, an equally unshakeable faith in large central gas fired generation, a tinge of climate change scepticism, that renewable penetration will be limited and electricity sector business model will remain largely unchanged.
My work colleagues know that I have been pondering these contradictions for some time. At i have been sceptical about major changes to the electric sector given the political and market dominance of large utilities and that in the past technological changes have been achingly slow.
But then I thought about one of the examples that al gore uses in his talks on climate change and technology.
In 1980 AT&T, which invented mobile cellular technology, asked McKinsey to forecast the us mobile market in 2000. In an epic fail, McKinsey predicted 900,000 subscribers. Based on McKinsey’s forecast AT&T decided that there was not much future in the mobile telephony market and did not pursue it. AT&T later spent $11.5 billion to acquire McGraw cellular and get into the business that they invented. And just for the record the actual number of users in 2000 was 109 million and by 2011 there were 5 billion subscribers worldwide. Today over 1 billion iPhones have been sold.
The mobile phone growth line, the ubiquity of the app store, demonstrates a snowball effect of new technology and new business models. Thus, for me the question is whether electric sector headed down the same path?
I believe that it is, based on at the interaction of three trends:
- Digitalization and technology
By cost, I really refer to the technological advances and ensuing cost reductions that are upending the energy sector and challenging long-held assumptions.
For the last 60 years, and certainly since the 1973 oil embargo, we lived in a world of rising energy costs. Cheap oil and gas were over, and we would have to move to more expensive tar sands and offshore fields. Ever rising costs, meant that investments in lower cost technologies would benefit from higher oil costs; a rising tide that would lift all boats.
Rising conventional costs would eventually make renewable energy competitive. Radical and rapid falls in renewable energy costs were simply not forecast.
Well, technology changed all of that.
Renewable costs have fallen and continue to fall from step changes in technology and economies of scale. The costs are expected to fall further. In many places in the world, Solar PV is now the least cost generation option.
The same thing is happening in oil and gas, driven by fracking. Five to six years ago frackers could drill 1,000 feet horizontally, and it would take 2-3 months to frack a field. Today they go 5,000 feet horizontally in 2-3 weeks. The results can be seen above, with greater production per well and with fewer rigs, lowering unit costs. And fracking is still relatively new technology.
Falling cost means greater choice in how we as a society, and individuals, meet our energy needs. In recent years that choice focused on relative costs between conventional technology – either oil or power – and new technology, renewables and fracking. But now cost and technology advances are allowing business model choices – do i buy from a utility, or an independent, or do I generate my own power?
Cost is driving the renewed corporate interest and action on sustainability. In the past, being green or sustainable was seen as less profitable or unprofitable. Falling costs have changed that, as have consumer attitudes. There are still some corporate climate deniers, such as the Koch brothers, but that is pretty bad company to be in.
These are some of the 154 large us corporates that signed on to the Obama white house pledge to reduce co2 emissions as part of the 2015 Paris climate accord.
- Because the costs of avoidance are falling;
- Because institutional investors, whether through the fossil fuel divestiture movement, carbon disclosure project or stronger advocacy of ESG principles are demanding action from the c-level suite; and
- Consumers are demanding it
That corporate political support is backed by action on the ground.
In 2014 US corporates signed power purchase agreements to buy power directly from over 1200wind farms, solar projects and biomass projects, bypassing the traditional utilities. These PPAs accounted for 52% of new United States wind and 23% of new United States solar projects in 2014.
Silicon Valley has been particularly active, with Google, Facebook and Amazon purchasing green electricity for their power hungry data centres. Several of these companies are pursuing a target of 100% renewable power for all of their data centres.
The sustainability drive is not going away. In October the European Union ratified the Paris Climate Accord that was agreed by 100% of World Governments. To become binding it required the approval of a certain number of countries accounting for more than half of global CO2 emissions. The EU put it over the top. So the drive for sustainable investments will only increase.
Digitalization may not the right term. Maybe it is creative destruction, or innovation, but something is happening. Cost is
enabling greater choice. Sustainability is driving the choice towards renewables. The digital providers are getting into the sector, and as we will see in a moment may change the business model.
The question is who will drive the change? I am not sure it will be the utilities.
This is a pacific gas and electric smart meter. Maybe it works for a utility, but how appealing is that to a customer, or a millennial?
Compared to this – Google’s nest learning thermostat
Or to this – which is my iPad control for my home heating system, courtesy of Honeywell and the App Store. From my iPad I can control my home heat from anywhere in the world, at any time.
These are relative modest changes. Others are setting out to change the utility business model.
Vandebron is a start-up utility in The Netherlands. It is matching local renewable electricity generators with local consumers, bypassing the traditional utilities.
Matching diverse suppliers and users. Isn’t that what Uber and Airbnb do?
It used to be that utilities did things like help large energy users industrial consumers manager their energy demand. But maybe not any more. Facebook is leading a charge to 100% renewables for data centres, coupled with electric system designs that are more efficient – and they are sharing the results in open platforms for all to use.
The above slide is a bit unfair the digital world R&D spend encompasses far more than the electricity sector. However, I see R&D spend as a barometer from where innovation is likely to come.
Even Facebook’s relatively paltry $3.8 billion 2015 R&D spend is two and one half times greater than the $1.6 billion spent by the 15 largest European electric utilities – combined.
The utilities say that their world is changing, and they need to innovate, but their investments don’t seem to match their rhetoric.
Which comes back the snowball. Is it gathering? I think it is.
This is a graphically challenged attempt to show how cost, sustainability and digitalization are now beginning to feed and sustain each other.
Cost is driving choice, enabling greater sustainability which drives more demand creating a feedback loop. Digitalization is starting to feed into that loop, lowering costs and increasing choice and competition and the opportunity for new business models.
When i flew back to the USA from Europe in September, i had the jet lag curse. I was awake at 4:00 am. So i turned on the BBC World Service. There was a fascinating program on business models and disruption.
It focused around a thesis discussed a great deal in the Harvard Review of business; that there are four basic business models, which attract four very different valuations:
Asset builders, service providers, technology creators and network orchestrators. Some companies, like Apple field more than one business model.
For some time, I have been asking myself and colleagues, “Why not an Uber for electricity? Why can’t I plug my energy usage data into a website and get bids on who wants to supply my electricity for the next hour, day, week, month or year?”
Vandebron is trying, and others are asking the question, including Navigant Consulting. In a recently published paper. “From Grid to cloud, a Network of Networks in Search of an Orchestrator.” Navigant squarely posits a new business model for the electricity sector.
This is the historic electric utility model, which still dominates the sector, and which many do not see as changing.
And this is the future, or rather the present, as this already exists, it is not yet ubiquitous, but it will be.
Navigant concludes that there is no orchestrator yet, and there are obstacles, both physical, intellectual property and regulatory. But firms like vandebron are starting to test the thesis.
So what does this mean for renewable energy sustainable real asset investment?
First, there will be substantial global growth in sustainable real assets. They will require vast amounts of capital, which increasingly sustainable orientated investors will supply.
Second, regulation and regulators will lag technology developments. We see how they lag in the taxi industry with Uber, and in the hospitality industry with Airbnb. Why should it be any different in the electric sector, which is more complex.
Past renewable regulation was designed to drive technology advancement and lower cost. But now technology is poised to drive regulation. So regulatory engagement by market participants and investors will be critical in allowing new business models to develop and to create value for companies, investors and consumers.
Third, the number of players and market interactions will increase. More and more corporates will follow the Silicon Valley lead and source clean energy from their own plants or directly from independent generators. More homes will become generators and export excess power to the grid. Storage companies will emerge. Commodity houses will offer power sales arrangements.
In my 25 years of energy investing, the fundamental thesis underpinning my teams’ investment strategy has been quality. Borrowing from real estate, we termed this investing in platforms of “A Grade” assets. For us this meant the best equipment, the best resource and the best deal structures.
We would tell clients that in renewable energy projects you make money by generating electricity. The more electricity you generate, the more money you make. A decade ago this seemed a novel idea to some. With better equipment projects generate more and have less downtime. The better the wind, solar or water resource, the more electricity projects generate. It takes the same capital expenditure to build a wind farm in a windy place than a less windy place. Good equipment and good resource makes projects lower cost producers. Layered on top of it all were good deal structures. Allocating and insuring construction and operation risk to those best able to manage and bear them. Avoiding excess gearing that looks attractive on paper, until you have a bad wind year. Working with strong counterparties.
Looking forward, this three-part definition of A Grade remains the core, but to capture more value and compete in the new world will mean that A Grade assets will need more attributes.
First, a grade assets will have more and deeper relationships with customers. This is an expansion of the structure element. The traditional utility can be seen as a middleman, skimming off their share of value from generator to customer. Generators that get closer to their customers may be able to secure more value.
Second, a grade assets will need more relationships with other service providers, or providing services from the same asset platform. It is one thing to build to a feed in tariff. Winning renewable auctions another. But both of those are very different from the energy cloud – where there may be multiple interfaces to support a project – several power buyers, balancing providers, back-up power arrangement, microgrid transmission network interfaces and ancillary service agreements with high or low voltage grids.
Third, a grade will require a more integrated approach to infrastructure, particularly storage and microgrids. The penetration of intermittent renewables is driving a demand for storage and grid response. In many electric networks these services are divorced. generators are generators and storage providers are storage providers, but we are seeing emerging integration, such as in combined island wind, solar and battery systems, and aes corporation installing batteries on their fossil fuel sites which allows them to provide enhanced grid systems. So projects need to consider how they can today, or in the future install storage and ancillary service infrastructure on their sites to offer more services and to capture more of the energy value chain.
At the outset of this article, I said that at times it feels like the electric industry is suspended between two futures; one forward looking and one backward looking. I think many utilities and investors are looking back, ignoring the cost, sustainability and business model changes that are already underway,
Navigant’s energy cloud will not be here tomorrow, or even next year, but it is on its way. To mix cheesy idioms and metaphors, Elvis has left the building, the train has left the station, we have lift-off.
It is not a time to be looking back, but a time to be on board.