Deep Dive: New Business Models in the Solar Sector (Part 2)

Good day, everyone, and welcome to this international
Solar Alliance expert training course. This is the second part in a two-part series
looking at new business models in the solar sector. This training series is supported by the International
Solar Alliance, which is a group of solar resource-rich countries from
around the world. The International Solar
Alliance is partnered with the Clean Energy Solution Center to deliver these expert
training series. The focus of these trainings is to provide
global overview of some of the cutting-edge topics in the solar sector.

And the Clean Energy Solution Center is one
of the leading agencies around the world in providing no-cost technical assistance and
capacity-building support to governments around the world on clean energy policy. So, a quick overview of the training series. As I
said, this is part two of this particular segment. The entire training module course is
shown here, and you can see the eight different module components, racing from policies
for distributed PV to the technical integration of solar socioeconomic aspects, as well as
off-grid solar and new emerging sectors in solar, such as the solar heating and cooling
sector. This module is found – this particular training
is found as part of module one, and we saw last time, in part one of this training module,
an overview of the different solar business models that have emerged in recent years to
make it easier for customers and communities and individuals around the world
to participate in developing their own solar projects, or owning their own solar
projects. Part two of this particular training
focuses specifically on how these new business models and these new changes in the
electricity market are impacting the traditional utility business.

So, we’ll take a slightly broader view than
in the last – than in part one, where part one
was really focused on the business models themselves, part two really takes a step back
and looks at the bigger picture, and some of the bigger picture changes that are re-shaping
the power sector, specifically with a focus on these new business models. So, here’s a
quick overview of the presentation. We’ll look quickly at the overall learning
objective. Part two looks at the history, provides a
little bit more historical context so that all of you
can understand where we’re coming from and hopefully in an aim to get you to better
understand where we’re fundamentally going in the utility sector and in the solar sector
more broadly.

The third component looks at – is essentially
the core of the presentation, and then I’ll have a few concluding remarks followed by
a few suggestions for some additional reading, if you’re interested in this topic. And the sixth component will be a quick
knowledge check that has five multiple choice questions for you to answer as a bit of an
assessment of your understanding of the training material. So, without further ado, let’s
dive in. So, the core aim here is to really understand
the broader, historical context for the development of the electricity market, the
opening up of the electricity market that has
led to these new business models being possible.

This is part of a process that’s
sometimes called liberalization, or sometimes de-regulation. We’ll look at a little bit
more about what that meant in practice, and why it’s been so instrumental in enabling
new business models to emerge. We’ll look at some those, and how, specifically,
these new business models and other trends that
are reshaping the power sector are impacting different aspects of the system, and are ultimately
changing the way that utilities provide electricity to customers, and also changing,
fundamentally, the way that customers interact with utilities themselves. And there’s a lot of innovation happening
in the space. It is impossible to capture all of
the different trends and technologies that are emerging, as things are changing very
quickly.

But the aim of this presentation is to really
give you a firm grasp of the magnitude of these changes, essentially what
the main drivers are, and put you in a better position to help you understand how the solar
sector is fundamentally reshaping, redefining, along with other technologies,
the future of the utility sector. And we’ll look
at some key challenges going forward. So first, some history. As we often say, in order to
know where you’re going, you need to know where you’re coming from. And it’s always helpful to take a historical
perspective, to take a step back and look, okay, where did the power sector come from,
and how did we get to where we are today? So, the traditional utility business model
of selling essentially electrons to customers from large centralized power plants has effectively
defined the 20th century.

For most of
the 20th century, customers were what we called captive. This means that customers did
not have a choice. They had whichever region they happened to
live in, there was one utility that was actually providing power. You would have to connect with that utility,
and that was effectively it. Captive
customers connected to one monopoly utility had some advantages. They provided the
utilities themselves with fairly strong balance sheets, and made them very reliable, low-
risk investments. And because they were seen broadly as low-risk
investments, they were able to mobilize very large amounts of capital
in order to support the further development of the electricity sector. So, as that need for capital was recognized
for low-risk, low-cost capital in particular, regulators effectively established a regulatory
formula that varied between different jurisdictions, but broadly shared a lot of
key characteristics. And the core characteristics
enabled the essentially monopoly utilities to provide power to captive customers at
regulated rates, and those rates were designed to allow for a specific, targeted rate of
return.

So, if utilities said, “Well, we spent this
many billion on the transmission assets or distribution sector assets or generation assets,
regulators would essentially approve whatever rate increases were needed in order
to recover those investments. So, the utility business was a good place
to be. It was fairly low-risk, fairly predictable,
fairly stable, and played a key role, ultimately, in driving the broader economic and social
development of the second half, in particular, in the second half of the 20th century. So,
utilities very rightly are proud of that history. And many utilities are uncomfortable with
the changes that are taking place across the sector and all the technologies and the
disruption taking place, because they see a lot of this change and this rapid particularly
technological change and business model evolution disrupting their particular business
model, and undermining their ability to continue to do what they’ve always done, which
is provide power to customers at a reasonable price.

So, as the market has changed, so, too, have
the technologies and the business models, as
we’ll see. This diagram provides a quick overview of
the key characteristics of the utility business model. You can see generation into transmission lines,
through transformers; transmissions lines delivering up to distribution
wires, and all the way to customers. This
fairly linear model of power flow really was and in many countries remains the dominant
mode of operation for the electricity sector. And as I pointed out, utilities perception
as a low-risk investment was a critical ingredient in this story. The fact that they could – that they were
given the right, by regulators, to set electricity rates for customers that allowed
them to recover their costs meant that they were effectively protected investments. They were almost providing a guaranteed rate
of return. And investors, unsurprisingly, were willing,
even glad, throughout the second half of the 20th century, to provide very large
volumes of capital to the power sector to enable
its growth and further development.

So, it’s important to understand how critically
the inter-relationship between the – fundamentally between utility regulation and
investment is. In order to mobilize the kinds
of investments, the scale of investment that was needed, we needed stable regulatory
conditions. And that’s one of the things that some analysts
in this debate argue that we are currently losing. We are making the market in many ways riskier. We are making it
more complex. And that complexity combined with that risk
is making it harder to mobilize the kind of capital, the level of capital that we need,
in particular, to achieve broader objectives like
reducing emissions, increasing the share of renewables, improving grid integration, and,
where necessary, building out transmission and distribution lines.

So, there’s a deeper
question in the backdrop of this presentation that I encourage you to keep in mind as we
go through. And that debate is there are no easy answers. There are no simple solutions. But I encourage you to engage actively with
that debate and keep that in mind as we go through the presentation. So, this started to change around the 1970s. What I’ve been describing, essentially,
as the agreement between regulators and utilities
and, broadly, the politicians and the public at
large, of providing stable, regulatory conditions so that utilities could mobilize capital to
build out transmission and generation is what is sometimes called the utility consensus,
or sometimes called even the regulatory compact. This is the idea that there was, essentially,
a stable, relatively consensus-based agreement that the regulations should continue to
enable monopoly utilities to operation in their current form. So, the regulation effectively defined and
supported, in some ways buttressed, the business model. It was a core part of the business model to
have a regulatory framework that essentially was based around it.

But this started to change, and we started
to see some cracks in the foundation of the utility consensus
in the 1970s, driven by a range of factors. So, I list a few here. One of these was rising fuel prices, which
drove up electricity rates. As you no doubt know, there was the major
oil crisis in the early 1970s that drove up the price of oil and the price
of gas. And this led to rising electricity rates. In some cases, very rapid increases in electricity
rates, and started to change attitudes and research focus across the utility sector.

People
started looking more at things like energy efficiency. People started looking more at
diversification, you know? Essentially starting to reduce reliance on
fossil fuels, and we saw a lot of national policies emerge for
the first time around this time in the 1970s against the backdrop of rising fuel prices. And a core focus of national energy policy
was, at the time, on the one hand to improve energy efficiency, and on the other, to diversify
in order to diversity the mix, in order to improve energy security.

The second key component here is the rise
of distributed energy technologies. In the 1910s or 1920s, it wasn’t possible
for most people to – or most companies, even, to produce their own power. There were, of course, exceptions for
larger industries and some manufacturing facilities, but for most customers, that remained
out of reach, partly due to economies of scale and the state of technology. This started to change around the 1970s and
into the 1980s and the ‘90s as new technologies emerged that enabled, for the
first time, power to be produced in a smaller, distributed way at a price that was competitive
or roughly competitive with the cost of power provided by traditional utilities. And that started shifting the balance of power
effectively, slowly away from utilities and more towards new technologies and new
companies active in the sector.

So, this change has taken time. The third key point here is changing financial
market conditions. In the 1970s and early
1980s, interest rates rose very rapidly, which led to several bankruptcies of major utilities
and a lot of issues in the utilities sector, because they had borrowed too much, had taken
on too much debt, and were unable in a short period of time to recover the cost from rates
in order to enable them to pay back those debts, and led to a range of wrenching changes
throughout the power sector, as well as a range of other sectors at the time. The fourth component here that’s sometimes
underappreciated in the whole debate is there were clear cases of utility mismanagement,
where utilities, as some argue, effectively abused their monopoly position,
and made investments that were deemed in regulatory speak as imprudent. They were investments that were not arguably
in the public interest, or that incurred a higher
cost than were justified, or they built excess capacity.

In other words, the forecasts on which those
new generation projects, in particular, were based proved to be over optimistic. And because they were over
optimistic, it led to essentially excess generation capacity at a period in time where
electricity demand growth was actually slowing. And that meant that effectively they had
over invested, and needed to, then, scale things back. And the final point here is precisely the
impact of lower electricity demand growth, which was driven, in part, by improvements
in energy efficiency, but catalyzed critically here by the first point, or the first bullet
on this list, namely by rising fuel prices. As price
went up, customers started to become more fuel conscious or price-conscious, and that
led to greater efforts to conserve energy.

So, this
flux of different factors led to what’s sometimes called the perfect storm. And
this perfect storm drove a number of shifts in the way that utilities are regulated. Regulators started to want to favor more competition
to encourage more actors to participate in the market, and fundamentally
driven by the desire to create a more open and ideally cost-effective electricity system,
where a greater number of investors and actors could participate. Now, the challenge with the perfect storm,
that the perfect storm effectively responds to is all these factors
in the 1970s and early 1980s that were taking place at the time. A key part of this, as we saw in the last
slide, is that small-scale generation became increasingly cost effective. Not only wind turbines in countries like Denmark
and in parts of California, but also the natural gas turbine,
which really had a significant role to play in the redefining economics of the utility
business, and transforming, essentially, the traditional logic of economies of scale, that
it was always cheaper to build ever-larger power plants.

And the emergence of these new technologies
subverted that traditional wisdom, that it was always more economic to
build larger and larger plants. We started to
see technologies that for the first time were actually at a fairly small scale comparatively,
but could still provide cost-effective power to customers. So there were a few regulatory steps that
helped drive this change. We had – not all of
them are listed here. This is – the aim is to provide a highlight
of some of the changes that took place. First, electricity markets were opened up
to competition, in particular to retail competition.

So, that enabled customers to choose their
supplier. If you were based
in a geographic area, you were no longer forced to buy power from a particular utility. You were, for the first time, given choice. This choice was first opened up for industrial
customers, some of whom had maintained that privilege, even before the utility
consensus was consolidated, and then eventually for commercial and residential
customers. And we’re still seeing this shift underway
now, particularly in the US and in certain parts
of Europe, gradually are opening up the potential for residential customers also to get
retail choice. So, retail choice is a critical part of this
because it enables customers, for the first time, to actually make an informed
decision about who’s going to supply their power. And that further helps fuel competition in
the sector and innovation in the sector, because it means there are – that companies
with a different business model or with a different approach to the market, or with
a leaner overall capital structure can provide a
cheaper service for customers, and ultimately gain market share.

The second point is that regulators helped
drive what’s sometimes called fund bundling of transmission, distribution, generation,
and customer service. So, a number of utilities
in this de-regulatory drive or liberalization drive unbundled the ownership of the different
components of the power system. So, it was no longer possible, in certain
cases, to own both transmission and generation. Those two had to be split up into separate
entities. And, again, these changes are underway, continue
to unfold in a number of different markets, in just about every market in the
world. So, different, although the drive to liberalization
that we’re essentially providing a crash course view of here started in countries like
the UK and the US and spread out gradually to other jurisdictions around the world, to
continental Europe, to parts of Asia, to parts of
the Americas, and even parts of Africa. But again, it’s important not to forget
that many utility markets around the world remain under
effectively the utility consensus. They
remain regulated as essentially monopoly suppliers.

So, different jurisdictions are at
different points of this evolution. And that’s one of the reasons why we see
more innovation in business models, more innovation in dumb technology into the business
in certain jurisdictions, precisely because these rules opening up the market
have enabled these innovations to emerge there. They’ve created new opportunities, new niches
that actors in the market could capitalize on. So, again, you see the critical role played
by regulation in opening up these new niches, and driving innovation and change
in the sector. This understanding of regulation is different
from what many people and many of you no doubt think when you think regulation. In many cases, it’s about protecting the
status quo or preserving the status quo or enforcing
certain standards. But it’s also important not to
forget that regulation can also play a very – have a very catalytic role in driving
technological and business model evolution. And the power sector is a terrific case of
precisely that.

A third component here is the role of independent
power producers. Regulation started to
introduce rules that allowed independent producers to participate, and one of the
signature initiatives to do this was launched in the US in the late 1970s under what is
called PURPA, the Public Utilities Regulatory Policies Act. And und PURPA, the
specific mandate was introduced that utilities had to consider and in some cases were
required to purchase power from independent producers at their avoided costs. So, in other words, if another business out
there, another business model, another investor, could produce power for cheaper
than the utility could itself, the utility effectively was required to purchase it at
their avoided cost. And that really drove,
effectively, cracked open the previously-monopolized generation business, and the
previously-monopolized utility business. And, again, opened the door to all of these
different business models to emerge in the decades that would follow. So, a few examples here, solar leasing, which
we saw in part one, peer-to-peer operators, which are starting to emerge in places like
Australia and the UK where power can be exchanged between different users, different
customers.

Pure retailers that buy,
effectively power on a wholesale market and own no generation themselves, they’re just
intermediators, and in some cases pure play transmission operators that just own
transmission. So, all of these and other business models
started to emerge in the decades that would follow after these reforms were
introduced. So, you can see here the traditional model
of the vertically-integrated utility broken into
its four constituent parts. Unbundling or sometimes called liberalization
led to a legal separation between these different entities. There are many nuances to the way this was
implanted in different jurisdictions, but this is the core differentiation. One of the key
challenges, however, was that although the market was opened up to all these new
business models and triggered a whole range of changes to electricity markets, it left
the utilities, traditional utilities that had
dominated the power sector for much of the 20th
century, with a fundamental question – which path to take? And in many cases, even to this day, many
utilities are still trying to answer that fundamental question. How do I go forward? How do I diversity? What are the right
strategic pathways to restructure our business in this new environment? And the
challenge is, as with many things in life, there are often far more than two paths to
follow.

Life would be easy if it was only a matter
of binary choices. Do I go left or do I
go right? If I take this option or that option, the
truth is, there is if not an infinite number certainly a very large number of different
pathways that utilities can follow in adapting to
this new landscape. And that’s one of the aspects that we’re
going to cover in more depth in this presentation. So, if liberalization, previously, from the
1970s, ‘80s, and ‘90s was about unbundling the
power sector, now we’re looking beyond the 2010s into the 2020s at a potentially much
more decentralized power system, similar to the one you see sketched out here.

You can
see at the bottom right corner, that’s the role of centralized power plants, which remain
one important node in the system, but by no means the only one. And you can see the role of smarter networks,
the role of renewable technologies, the role of pro-sumers, or customers that are both
consuming from the power grid as well as injecting power back into the grid. So, a much more dynamic and much more interactive
and much more complex and multi-layered business environment than was the case
throughout much of the 20th century. And this, many would argue, is fundamentally
where things are trending. So, let’s shift now to taking a closer look
at how these new utility business models are changing the sector. Simply put, there’s a deeper transition
underway between the traditional or the old utility model and these
emerging utility models. There’s no utility
that embodies all of these changes, but all utilities that are in these new environments,
in these new regulatory and business model environments
are adopting some of these changes. So, under the old utility model, customers
were charged effectively on a per kilowatt hour
basis for their supply.

Customers owned everything behind the meter,
so all of their appliances effectively belonged to the customer. The utility relationship started at the
meter. The customer has little visibility under the
old model over their costs. They
effectively just get a bill, sometimes one that’s broken down into different components,
and they have to pay that bill. The only choice the customers basically have
is which appliances they buy, and which rate category
they fall into, if they’re eligible to apply for
different rate categories. And utilities effectively own all the transmission
and distribution infrastructure under this traditional model own and operate all generation. Now, in the emerging business models,
in the emerging utility models, we’re starting to see a number of shifts.

Customers are
being charged on the basis of their service level rather than just on the bulk amount
of kilowatt hours they consume. In some cases, utilities are starting to own
or even finance a portion of customers’ own on-site equipment. So, we’re seeing utilities in some cases
directly owning hot water heaters, in some cases air conditioning units, major cooling
units, different energy management analytics software and analytics tools, data gathering
tools on the customers’ premises. This is particularly the case for commercial
and industrial customers, but it’s possible now for utilities to own some of those things,
even though those technologies and those services are actually found on the users’
premises. And in some cases the appliances can
even be controlled by the utility. It’s no longer the case that the customer
is the only one who can flick on their air conditioning unit,
their cooler, their heater. The utility can
remotely control certain appliances. Like, of course, with the customer’s permission,
often by the use of algorithms and different smart technologies.

So, you’re seeing a shift, essentially a
blurring of the lines between what belongs to the
customer and what belongs, fundamentally, to the utility as these new business models
penetrate more deeply into the home and business of their customers. Customers also
have more transparency, increasingly, over the costs of the system, and also are provided
with a much wider range of choices. They can choose which utility they want to
buy their power from. They can choose often a range of different
rate categories, a range of different functionalities. They can join different programs that are
available by the utility or by other third parties. They also have transparency through the use
of apps an online energy data or energy management software.

So, households can now and businesses can
now see in real time their power consumption and essentially manage
their demand and manage their real- time use in response to things like price
signals and then other factors. This is a very
different world than the traditional utility world of the 1950s, ‘60s, and ’70. And we’re seeing more ownership structures
for – in some cases for transmission and distribution. We’re also seeing a much wider range of
actors participating, almost at every node within the utility system, including,
most notably, on the customer end. So,
that’s a quick synthesis of some of the big changes and some of the big differences
between traditional utility business models and what we’re now starting to see happen. As a result of this and of these ongoing changes,
we’re seeing a whole taxonomy of different utility business models emerging. Some of these terms may not be familiar to
me, and they are, some of them have only recently been coined.

They outline and refer to
different kinds of utilities that are either in existence or that are in the process of
emerging in different jurisdictions in the world. We won’t get into all of these here. The
goal is really to provide you with a quick overview of these different business models,
and particularly in this presentation to focus on the changes that are taking place and
driving all of this innovation. If you are, however, interested in learning
more about these, you can click on the link at
the bottom, and read up in more detail about what each of these business models entails. Critically, it’s unclear which of these
business models will ultimately thrive, and which
will fail. Now, as with any market with a lot of innovation,
it is unclear what the – who the winners and losers will ultimately be. In the end, it’s hoped, of course, that
the customers will be the winners, and the companies
that are the most adaptive and responsive to customer needs shape and changing
technology are going to be the ones that succeed. And you can see here how these different actors
and these new business models are laid out on a spectrum from more heavy asset-based
models on the left to more service-based on the right.

And you see on the top left the shift from
the more generation-focused components of the value chain towards the
more retail customer-focused end of the value chain. As was put clearly by the head of ENBW here
in Germany, a large utility in the southern part of the country, one of Germany’s
traditional big four utilities, conventional business models of larger power supply companies
simply no longer work. And ENBW
has been at the forefront of a lot of change and innovation in this space, and they’ve
been trying to adapt intelligently to these ongoing
technological and business model changes. These trends are pushing many utilities away
from – increasingly away from these low margin parts of the business – for example,
trading electricity – and towards higher- margin areas of the business, with a much
higher focus on better customer service, more automation, improved software offerings to
allow better energy management, as well as looking at smarter appliances and smarter
technologies, including smart meters, and the
possibility of linking things together in what is sometimes called the Internet of Things,
the linking different appliances and smart, responsive adaptive networks.

Broadly speaking, if we look at the way that
different utilities are adapting to this rapidly- changing landscape, it’s possible to observe
a what’s sometimes called a barbell strategy. This term refers effectively to movement towards
the extremes, or towards the poles of the market. On the left-hand side we have some utilities
that are focusing more on the regulated end of the business. So, that’s particularly the transmission
and in some cases the distribution end, where returns on investment
are still relatively protected, and are still fairly secure.

While others are focusing much more on the
customer end of the business, where it’s much more deregulated, much more open market. And according to some analysts, much
more like the wild, wild west. There’s a lot more happening, a lot more
innovation, but also at the same time, a lot more risk. So, as you can see here, if we look at this
simple characterization of the vertically-integrated
utility broken into its four key different components, some are becoming more aligned
with, or more transforming themselves more into a traditional transmission company,
what’s sometimes called a transco. Others are moving more, again, on the retail
end of the market, and focusing more on providing better services to customers, and
earning fees on those services rather than just
by selling bulk kilowatt hours.

And the market that’s really being squeeze
and that’s really facing considerable challenges in the
years ahead is the really the generation side of the business and the trading side of the
business. It’s kind of between these two
extremes. We could get into more why this particular
shift is underway and why it’s particularly difficult for generators to compete and to
survive and to thrive in this new environment. We’ll touch on that a little bit in some
of the slides ahead. But as utilities devise their new
strategies, and they’re trying to adapt to this new landscape, as utilities like ENBW
here in Germany and as some of the big utilities
in the US, like PG&E and SCE in California, we see different approaches emerging.

And it’s always helpful to keep in mind
the wise words of Sir Winston Churchill who said, “However
brilliant the strategy, you should, however, occasionally look at the results.” And if we look at some of the results, you
can see we still have some progress to make. So, I’ve laid out here a few snapshots of
what’s happening across the utility sector in
terms of financials, in terms of utility performance, and just to give you an idea of how
these changes are impacting the sector as a whole. So, you can see here, this slide
prepared by the IEA, that the aggregate earnings of the top 20 European utilities are
declining, and fairly dramatically. You can see here over the last five years
the decline of over 40 percent in the aggregate earnings
of those top 20 utilities.

You can see in the meantime, however, that
capital expenditures in the orange line as a
share of their earnings before interest, taxation, depreciation, and amortization [inaudible]
are actually going up. So, utilities are spending a lot, and yet
their aggregate revenues or aggregate earnings continue to go down. So, this is a bit of a – if this is a forecast
of things to come, it doesn’t necessarily look
very bright for some of the larger utilities in
this picture. Fundamentally, the revenues that are enabled
by the utility’s business model need to enable the utility to cover its fundamental
cost of operation, and its fundamental costs of
financing. And as utilities get riskier and are perceived
as a riskier investment, their cost of capital will go up, which will further
squeeze their ability to operate the business cost
effectively, further undermine their ability potentially to compete, particularly against
new start-up companies, newer business models, who may not have as much debt, who
may not have as many liabilities on their balance sheet, pension-related or otherwise,
and who may be able to fundamentally outcompete
them in this new environment.

So, there are some very real and very substantial
changes taking place across the European power sector. This is in particular when you look at the
European. The US
market looks markedly different in many ways, even more complex, but this gives you an
idea. The net income of these utilities drawn from
– this is again European utilities – are also not looking particularly rosy. You can see in some cases actually quite dramatically
negative. This chart shows the number of hours that
we’ve seen in three key countries here in Europe with negative prices.

And you can see that the number of hours on
the spot market with negative prices was almost zero
in 2011, so just seven short years ago, almost eight short years ago, and how that
number has risen on a quarter-by-quarter basis since then. And most analysts anticipate that the number
of negative hours will continue to go up. So, that means for anyone who’s operating
a traditional, say, fossil fuel power plant will find it difficult to recover their
costs on the wholesale market during those times, because they’ll be selling into a
market where the prices are negative.

They’ll effectively be being penalized to
produce power for the power they are providing. So, these changes are driven by a host of
factors, arguably by overcapacity in the system, by the growing shares of renewable energy
in the system. They’re essentially driving
very large amounts of wind and solar during certain hours of the day and certain days
of the month. And that surplus in the system combined with
fairly stagnant electricity demand growth is leading to periods of oversupply. And when there’s oversupply, there is – we
see the tendency towards negative prices. Now, some argue we could solve all of this
if we just phased out some old baseload power plants, phased out some coal in the
system, phased out some nuclear. We could
make out more room for more renewables, and we could also ensure that there are fewer
periods of negative prices. But, again, those reforms are very difficult
to implement, and they would further squeeze a lot of the existing
utilities, and hence the difficulties of implementing a sound transition strategy for
phasing out assets in the power system, regardless whether they are nuclear or coal,
or even gas-based. So, it’s a very challenging – as I pointed
out a few moments ago, there really are no easy
answers.

You can see here by looking at the shift in
the German power market, you can see quite a clear correlation. Each dot here refers to a day of supply in
2018. And you can
see the amount of renewable energy supply on the right axis and the bottom horizontal
axis over time, for that day. So, the days with the most, with nearing up
to 1,000 megawatt hours in that one day. You have renewable power supply from wind
and solar. Those are the days with the lowest average
daily wholesale market prices. So, a fairly clear correlation there showing
that the more wind and solar you have in the system, the more – the lower the wholesale
market prices are. Now, on the one hand, this
is something to celebrate.

Rate payers should be thankful, business should
be thankful for lower wholesale market prices, because lower
prices have to translate somewhere down the line into lower power prices, provided
that lower costs are being passed on to customers at some stage in the chain. Now, on the other hand, for any business,
any traditional utility, this is a very worrisome sign, because it means the more renewables,
the more solar and wind we have in the system, the more daily average spot prices
are going to converge to, or closer to zero. And there is still an ongoing debate about
what this means for the electricity market as a
whole, for bigger picture questions of where we’re fundamentally – where we’re going,
and how to reform this energy-only market into something that’s a bit more financially
sustainable, both for utilities as well as for other independent generators in the system.

So, these shifts are having significant impacts
on, again, the traditional, conventional utilities in this space. We’re seeing that new business models are
competing for different components or different parts, at different
parts of the utility business. As I pointed out,
we’re seeing completion driving new innovation, particularly on the customer end of the
business. We’re also seeing that equipment providers
are starting to get into the game, and are starting to take an active interest
in smart technology, smart meters, more service- oriented offerings, specifically for customers
– commercial, industrial, and residential customers.

So, essentially chipping away at what were
traditionally utility revenues that used to
belong, effectively, under the monopoly model to utilities. And that competition, as one
might expect, is eroding utility revenues as the number of new actors continues to grow,
and as the number of new companies competing for this market share, so to speak, the
broader share of total electricity market demand and as a result that has to have negative
impact on the utilities, because there are more – the pie is not growing that rapidly
in most jurisdictions. In other words, the total electricity demand
is not growing that rapidly. So, the more actors there are, you have to
split that pie into and ever-greater number of
pieces. And that simple fact alone means that there
are fewer revenues left for the traditional, established utilities. And you can see that in context of the slides
that I showed previously showing the aggregate earnings
of the utilities going down over time. That’s very much a reflection of this broader
shift. Now, interestingly, there are very
much some positive elements to this as well, particularly for customers. Customers are
tapping into new ways of better managing their power demand.

Better customer analytics, better data analytics
are enabling commercial and industrial customers to more intelligently manage their
power demand, in some cases, shaving their demand charges by reducing their demand peak. For residential customers, they can be
smarter about which appliances they use when in order to avoid, for example, peak
pricing or evening pricing. And you can see how these different changes
ultimately are leading to smarter customers, and in the long
run, will lead to better outcomes for the overall efficiency of the power system as
we see a greater correspondence between the responsiveness of power demand and the availability
of power supply. And as demand gets more flexible through these
new data management and energy management technologies and software, we’re
going to see a greater ability to ensure that supply and demand are constantly in sync over
the course of the day, and in the process also help shave electricity demand peaks and
shift load around to times in the day when there’s more wind and solar, in particular,
available, so that we can increase the share of
renewable energy in the power system as a whole.

As we’re starting to see as well, there
are a number of positive changes happening on the
company end of the spectrum. Large companies are starting to supply their
own electricity in ever-greater numbers. Many large companies in countries like Germany
and France supply their own – have their own
generators on-site, often from fossil sources, for historic reasons. But a growing number, both in Europe and in
North America, as well as parts of Asia and Latin America are starting
to sign long-term renewable energy contracts. So, we’re seeing a growing number of companies
and corporates getting in the game and starting to become more self-sufficient
in their power supply. Now, that means, effectively, that all else
being equal, they are consuming less power from utilities, because they’re producing
more of it themselves.

So, that’s another major
shift here that’s shaking up the sector and further eroding utility revenues. And the same
is happening on the residential end of the spectrum with the rise of self-consumption,
the rise of net metering and net billing, and
other policies like that, particularly to govern
rooftop solar. So, the more that customers become pro-sumers,
the more you see the emergence of a – the more utility revenues
decline, on the one hand, if they’re not changing anything, and the more you see the
rise of smarter and more interactive customers, and more two-way power flow between
the customer and the utility. So, it’s not just the utility providing
power to captive customers anymore. Customers are
becoming a very real and a very critical part of this transformation. Now as I’ve been
pointing out throughout the result of all these changes – and there are more – is
that utilities are fundamentally losing out on
their traditional sources of revenues.

This is
forcing utilities in the process to get creative in how they generate value for their existing
value, how not to lose existing customers, how to continue gaining new ones, but also
how to continue to provide value for shareholders. And that is proving to be particularly
tricky. Against this backdrop, if we look at the way
the markets – the financial markets – are unfolding in relation to these changes, the
recent analysis of 50 major utilities, not just
from Europe, not just from North America, but from Asia as well, reveal that cumulative
returns to shareholders were about one percent between 2007 and 2017. This means very,
very low, almost negative returns over that period. That’s compared to a 55 percent return
over that period in the overall MSCI world index. You can see that shareholders who own
significant shares in utilities in these 50 major utilities, in particular, must not be
too happy about the performance of these traditional
utilities.

So, there’s clearly a need for a new approach
and a new strategy. Many utilities are
already investing considerably in trying to diversity, trying to adapt their business
model. We are arguably at the beginning of that process
in many jurisdictions. Some are more
advanced than others. But it’s clear that if utilities are going
to go back to anywhere near their previous historic position as providers
of reliable, low-risk dividend, almost annuity-like returns to investors, they’re
going to need to strengthen their business model
and improve the service offering, because in a lot of cases, it isn’t clear that the
existing utility model is going to be able to mobilize
capital at anything like the scale that it used
to in order to meet the challenges and the transformation ahead.

Another example here from a recent article
in the Financial Times is Centrica in the UK
that’s seen its share price fall 50 percent over the past five – over the past four
years. In
France, EDF has lost 65 percent of its value since 2005. And, despite some recent
recovery, the German utility, RWE – it’s a large heavily coal-based utility here in
Germany – is worth little more than a fifth, so a little more than 20 percent of its peak
value ten years ago. So, you can see, this is really – these
are deep and wrenching changes that are taking place in the utility
sector, and that are effectively leading to the –
if not the demise, certainly the decline of what were previously giants in the corporate
and utility world. Now these shifts, as we’ve seen, are driven
by a whole range of factors, and each utility has a different story to tell, because each
utility has different exposure to these different risks. And each utility operates in a unique, regulatory
environment.

But broadly, we are
seeing weakened price signals from the energy-only markets. As we saw a few moments
ago, there are more and more hours in the year with negative wholesale market prices,
prices below zero. So, nobody’s earning any money. We are seeing fairly low, if not flat,
electricity demand growth. Some countries, like Spain, have even seen
periods of negative electricity demand growth due in part to the financial crisis and to
the effects of the economic crisis that followed. We are seeing low to negative profitability
on existing generation assets. And all of these
factors, when you combine with digitalization, virtual power plants, the increasing role
of pro-sumers in the utilities sector and the
electricity sector, the emergence of these new
peer-to-peer power sharing platforms that allow customers, essentially one household
or business, to share their power, their excess
power, with others.

And we’re seeing more and more third parties,
more and more new businesses, competing for the supply of energy capacity
as well as flexibility in the traditional, again,
the model of business that was traditionally dominated by these large utilities. So, these
factors, all of this competition, is in the process of fundamentally re-designing,
fundamentally re-shaping the power sector in markets that have been – particularly
the ones that have been more heavily liberalized,
that have been more opened up. The recent fall of some of these major, major
companies in other sectors, which I’ve flagged, too, here – Kodak and Blockbuster
Video – is a reminder that nothing is forever, and that no businesses are fundamentally immune
to the changes that are taking place in their sector.

The deeper shifts that are taking place across
the utility sector in that sense are a wake-up call for many in the utilities
sector that nowhere is it written in stone that
the utilities that are currently dominating or that used to dominate the landscape are
going to continue to do so in the future. And all businesses fundamentally, even the
largest or even particularly the large ones in
the utility space are vulnerable to rapidly-changing markets, and rapidly-changing
technologies. These risks that the large utilities are facing
really underscore the, increasingly, thin margins on which many traditional
utilities are currently operating. Where the utility business used to be a fairly
– as we saw at the beginning – it was a
fairly profitable, fairly stable, fairly low-risk business that, in many places and in many
jurisdictions, in many parts of the electricity sector, is no longer the case.

Now, the deeper question that’s looming
behind all of these transformations is how are
we going to mobilize the kind of capital that we need in the decades ahead if utilities
aren’t there to do the job, if utilities aren’t there to mobilize those investments? According to the IEA, they estimate that we’ll
need somewhere in the order of $3 trillion for transmission and distribution alone worldwide
between 2016 and 2025. And with $3
trillion of investment, utilities or whoever’s making those investments is going to need
to be in a market in a jurisdiction where the
risks and the costs of doing business are low
enough for them to be able to mobilize those investments at a reasonable cost of capital. And currently, on the transmission and distribution
end, that’s arguably less of a problem, because the transmission and distribution
sectors remain more heavily regulated than, particularly with the generation side of the
market, or the customer end of the market, but
concerns remain.

The critical question here as well is if we
keep in mind the fact that the world is collectively trying to reduce its
emissions and significantly scale up new, cleaner
technologies, like wind and solar and geothermal and hydro around the world, we are
going to need massive amounts of new investments in generation as well. And the riskier the market gets on – particularly
on the wholesale market and on the fundamentally for any generator who’s in
that market, the harder it becomes to mobilize the kind of capital that’s necessary to
actually drive that transformation. So, at the very
moment when we arguably need the stability of revenues, the reliability of fundamental
revenue profitability in the sector to drive the kinds of changes that – to drive the
kinds of investments that are going to help us transform
the power sector into a cleaner, more sustainable system in the years ahead.

Precisely at that moment, we are entering
into a phase when the generation, particularly on the generation side, the market is riskier,
arguably, than it’s even been. And how we
reconcile those – that contradiction or that challenge is – remains unclear. So, a few
concluding remarks before we open up, and before you get some questions on this
module. Globally, almost regardless of where you’re
based and where you’re living, the key priorities for the electricity sector
remain the security of supply, providing low prices
to customers, and ensuring that there is a transition to a clean generation mix.

Those are really the three core guiding principles,
if I can call them that, underpinning the utility – the electricity business more
broadly. And as utilities try to balance these
different priorities while remaining profitable, it’s getting increasingly difficult for
them to make sound investment decisions. Now, some will say, “Oh, this is all fine. This is a
good thing,” because they are, increasingly, not the ones making the decisions anymore. We are seeing new businesses emerge, new companies
competing, entirely new actors emerging, providing data management software,
providing new tools and new technologies that are enabling smarter management
of energy demand for customers, that are providing better solutions to problems
that utilities have struggled to solve.

And maybe it’s not a big deal that the utilities
aren’t the ones making the decisions, or that they’ve become a smaller part of the
market. Maybe we see power shift more and
more to a wider – either a wider number of competing smaller businesses, or the market
starts to become more significantly influenced by other larger – even larger players. For
example, in the larger tech companies who get involved – who may get involved in this
sector in order to attempt to adapt their business model into this rapidly-changing
landscape, and to try to provide a better deal for customers than the current utilities
are able to, given, again, the traditional utilities
often have large debts, often have significant liabilities, and are often less able to adapt
less quickly, or less able to adapt quickly to the
changes that are taking place across the market.

In that regard, having a long history in the
sector and having large debts and having large assets can be a significant disadvantage in
trying to adapt to these rapidly-changing environments. And that’s why a growing number of analysts,
myself included, anticipate that a growing number of utilities are going
to be offloading assets in order to try to thin
down the business to enable them to be more adaptable, more nimble, more flexible in
these rapidly-changing environments. In the process, there seems to be a consensus
emerging, if there is a consensus at all in this, again, this rapidly-changing sector,
is that we’re going to see more focus on the customer
end of the market. More customer to utility relationships, utilities
starting to provide, either directly or on contract with new businesses, new business
models, real-time mobile and digital services, services like energy audits, in order to provide
more information to customers, how they can better manage their energy costs. We’re going to see utilities partnering
more as – in providing energy management solutions, either
directly or via S-goes, energy service companies who can essentially engage with
the customer in order to reduce overall energy costs, and potentially take over some
of the investments that those customers want to make, but they don’t have enough disposable
income or free cash flow to do themselves.

And we’re going to see much more two-way
power flows. The power system in the
future is no longer going to be based around the – essentially the linear supply of power
from one large utility to millions of captive customers. We’re going to see much more
dynamic, two-way power flow, not only between – or even multi-directional power flow,
not only between the customer and the utility, but also between customers and other
customers.

And all of these changes are going to re-define,
fundamentally, what the power sector looks like in the years and decades
to come. One aspect that remains clear, despite all
of the complexity and all of the pace at which these changes are taking place, is that the
business as usual – in other words, the traditional monopolized utility sector is
not an option, and utilities are going to have to
get smarter on how they adapt to these changes so that they can fundamentally also
benefit from them, potentially even profit from them, and potentially even thrive in
the midst of them.

So, with that, I’d like to thank you for
your attention for this part two of the training module on new business models
in the solar sector. In this presentation, we’ve gone somewhat
beyond the solar sector alone to look at the –
how these broader changes within the power sector are reshaping the utility sector in
particular. And I’ve provided here at the end a list
of a few key reports that outline some of these trends and have provided some insight
as well as a recent book that was published. The last one here on the bottom, The Future
of Utilities and Utilities of the Future. And that provides a deeper look at a lot of
these trends that are reshaping the sector.

So, with that, thank you very much for your
attention, and you will be presented shortly with the questionnaire. It’s been a pleasure being with you, and
I look forward to seeing you during the next training session. Thank you..

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