The business model of the electric companies: new actors, new roles, new rules

For a while now, we are experiencing changes of great relevance in the electricity sector. Slowly but unstoppably the big electric companies are working hard to reinvent themselves.

The boom in innovation has led to the corporate venture capital funds of large electricity, oil and gas companies, tripling their investments in the last six years, as a way to prepare themselves with technologies and new business models that will enable them to undertake the challenges that arise.

The relatively low barriers to entry have allowed the massive arrival of new competitors without much need for large margins. The business model based on the sale of kWh is no longer enough to sustain these large energy corporations.

The struggles of recent years to win large market shares have reduced margins and what was taken for granted, is no longer the case.

But what is changing? It has been the golden years of the industry, where demand has been growing and absorbing large investments, while costs fell by the miracle of economies of scale (despite the more than discussed government energy policies). Large investments could be distributed among the growing volume of sales, which meant lower prices per unit for the average consumer, which, in turn, encouraged to increase consumption. A spiral that seemed to have no end.

However, these premises have been reversed. The demand falls and the only maintenance of the current system is increasingly expensive. Electricity suppliers face annual budgets with sales stagnating or even falling, with margins increasingly reduced. To this we add a wholesale market that, in addition to facing the challenges of the generation mix, has to absorb the inability of the system to maintain its fixed costs. The result is an electric bill difficult to sustain / accept by the consumer.

All this coincides in time with great technological advances in renewable energies that are encouraging the traditional consumer to consider alternative solutions such as self-consumption and total or partial disconnection of the grid as an increasingly attractive alternative.

However, self-consumption is not a panacea, it is not without challenges. To date, the evolution of generation through renewable energies (cogeneration, photovoltaic, wind, etc.) has been established through government support policies through subsidies. This system has proved unsustainable and we are at a time when renewable generation begins to be competitive against traditional generation without the need for a premium system.

However, what is the mass boom of self-consumption? Technological advances, especially in storage, micro-grids and domestic energy management, allow more consumers to become practically self-sufficient, in the sense that they no longer need to depend 100% on the grid to obtain energy. However, they remain partially dependent on the network for reliability, load balancing and a variety of other valuable services. The concept of having the network as a back up of our own self-consumption system, faces great challenges.

Regulators in many parts of the world go through great difficulties. They have to decide how to regulate and how much to pay for that intermittent self-generation of consumers. Self-consumption erodes the current revenues of the public electricity system without a proportional reduction in its fixed costs, which are significant. That is why we see so much resistance on the part of the governments to the withdrawal of the so-called “tax to the sun” in Spain. Who will finance this transition? How will we face the costs of the current electrical system?

The businesses of traditional energy companies have never been glamorous or exciting, but the line of maxims has been vertically integrated companies that could count on predictable sales and sustainable revenue growth. The arrival of new competitors, the advances in efficiency (in all areas) and the fact that mature economies are slowly moving away from the electro-intensive industries, makes the growth of electricity demand slow down or decrease, which, if everything else remains constant, decreases income. (This phenomenon applies virtually to all mature OECD economies).

The net charge in many networks is flat or decreasing. However, the most important thing is that, as the volume of sales is reduced, the significant fixed costs of the industry will be extended, which will generate higher regulated costs.

As we have already explained, the growth rates of electricity demand are rapidly approaching zero, in a number of advanced economies.

The reasons vary from one country to another, but, in general terms, the advanced economies are becoming deindustrialized gradually, as they move away from the electricity-intensive segments towards services and high-value-added manufacturing. These economies can generate enormous wealth using relatively little energy.

The evidence, although fragmentary, is nevertheless instructive. For example, Germany’s demand for primary energy (not electricity) decreased by 4.8% in 2014, compared to 2013. Furthermore, this was not a one-year anomaly. Germany’s economy continues to grow while using less energy since 2006. The same applies to electricity in almost all mature economies.

The most extreme case of falling energy demand – compounded by the increase in renewable shares – can be seen in Denmark, a country that is deciding to phase out its dependence on fossil fuels by 2050.

These and other examples, although not conclusive (and at the expense of the evolution of the electric vehicle and batteries in the coming years), suggest that the days of growth in demand in the energy sector have already passed, at least in the mature economies of the world.

It is, of course, a different story in fast-growing economies, but they will also reach stagnation, followed by economic growth that consumes less energy. The backward evidence from China, for example, shows a significant drop in the growth of electricity demand in recent years.

In this scenario, large electric companies must decide whether they should fight against the rapid adoption of self-generation systems or, failing that, join the competition to help more consumers become prosumers.

For regulators, the challenge is how to regulate better (if they are going to regulate), since the traditionally predictable and boring industry is going through a total redefinition.

For prosumers, however, the future is filled with new and exciting opportunities that, for the first time, allow them to do things that were barely imaginable a decade ago. More importantly, the possibility of generating clean, sustainable and non-polluting energy on the roof, at prices that meet or in some cases are lower of those of the public network. And they have more options to control their consumption and manage their use.

If the cost of energy storage falls as fast as the cost of solar panels did, the connection to the grid can be a good option for backup, reliability and load balancing. It will no longer be necessary to buy a large number of kilowatt-hours from generators or pay distributors for the delivery of electrons.

The business of the electricity companies is becoming something else. The way in which the interested parties and regulators respond to these changes will matter a lot. Prosumers, however, will increasingly do what is best for them, bypassing both the services of energy Suppliers and regulation, if they get in the way of what is technically possible and economically advantageous.

Skeptics dismiss such discourse as pure speculation and hyperbole. They argue that traditional energy companies have existed for more than a century and will be able to overcome the challenges they face today, either by overcoming or joining their competitors. But we know of large corporations that did not know how to adapt to the changes and disappeared (Kodak, Yellow Pages, etc …)

While some may, in fact, survive and possibly prosper, many will be too slow to change or, perhaps, be hampered by the same regulations that have protected them from competition for so long.

But what future awaits us? There is much speculation about the longer-term implications of these trends, and what that means. To this day, I do not think anyone knows, but there is a lot of money and very capable people working to find it. You just have to see amount of headlines of the media that is published in relation to new lines of business and technology.

However, there are key and certain aspects that will mark that future:

• Renewable. There are very few experts who would disagree that the future is renewable; it is only a question of time and scale, since the costs of renewable energies continue to fall, while restrictions on the use of fossil fuels increase, partly to limit carbon emissions to the atmosphere.
• Decentralized. That future will be increasingly distributed and decentralized with many consumers / prosumers who operate totally or partially outside the public network, where individuals or groups of them will live in a zero net energy environment with distributed generation, storage and / or relying on microgrids semi-autonomous. Will a distributed / self-sufficient future work for all? Probably not. But for a certain type of customer you can very well find a model that is not only adequate, but also profitable and reliable.
• Integrated. While the future of traditional power companies can be unpredictable, the future of the integrated network is bright. The growth of distributed generation, blockchain, and renewable energy will significantly increase the value of the integrated network, which is quite different from simply being connected to the network, like most customers currently are. Beyond this, there are those who predict that passive consumers will not only become active prosumers, but will be able to interact with each other using the distribution and possibly the transmission network to make transactions through technology such as blockchain.
• Storage. The future, no doubt, depends on the cost and practicality of energy storage. The future can certainly be more distributed if prosumers could store their generation of opportunities for use at other times.
• Regulation. It should be remembered that given the political nature of the electricity service that is considered a public good, despite the advances, regulators and energy policies will decide what they want it to be. Politicians tend to interfere not only in the price of electricity service, but also in its composition, how it is acquired, delivered and who subsidizes who in the process. While technology and the economy will continue to play a role, so will regulations and policies, whether we like it or not.
• Connected or not connected. The future of the energy business can be increasingly divided between those who have and those who do not, with the growing disparity of service needs and network dependence. Much of the current debate about solar versus non-solar customers focuses on equity, and who is subsidizing who. As some clients move away from the total dependence on the grid, those who remain totally dependent must assume higher costs, since their number is reduced.
• Aggregated. The aggregation of individual customer consumption, which is traditionally an arduous task, is becoming easier every day, as are the ways of encouraging aggregate cargo to respond to prices or incentives. Through aggregation, customers can not only respond better to prices, but can group and bid in wholesale markets, something that only very large industrial customers can manage today.

Depending on the point of view and the assumptions of one or more of these futures or a combination of them may arise, and it is unlikely to be the same future for all regions / countries.

Executives from large corporations and power companies are already beginning to make assumptions about what they think the future entails and are devising strategies accordingly. Diversification, investment in start-ups, or technology are the order of the day.

Without a doubt, technology is the most critical driver of change. The emergence of platforms and technologies that support the management of large amounts of data, proliferation of smart meters, smart devices, home energy management systems, wireless sensors, automation and artificial intelligence. Customers can now get better information about who offers what services in a certain area, just as they do when looking for low cost airline seats. The electrical equivalent of Kayak / logitravel / expedia / Skyscanner is coming, even if it is not widely used.

It is already happening, the electric power sector, historically protected from competition for a long time, and the last to adopt the largest communication and information technologies, is undergoing great changes. The answer of “what future” or, perhaps “if there is a future” for the electric companies will depend on how they react to the incumbents and how quickly.

All this invites me to presage the entrance in the sector of technological companies or the proliferation of mergers between energy and telecommunications / technological corporations. Be attentive to the headlines of the media.

Alejandro De Roca | Energy Consultant