TODAY’S STUDY: THE UTILITY PARADIGM SHIFT TO NEW ENERGY FROM THE INSIDE

Energy transformation; The impact on the power sector business model

October 2013 (Pricewaterhouse Coopers)

Executive Summary

The PwC Annual Global Power & Utilities Survey goes to the heart of boardroom thinking in utility companies across the globe. In this, our 13th edition, we look at the pressures building up on the traditional power utility business model and the industry’s viewpoint on the transformative changes that lie ahead.

Disruption and transformation

Many in the industry expect the existing power utility business model in their market to transform or even be unrecognisable in the period between now and 2030. 94% predict complete transformation or important changes to the power utility business model. But there are big regional differences and the industry is split on the extent of change and transformation ahead. The prospect of transformation of the industry business model arises from a number of potentially disruptive changes. Decentralised generation is already eating into revenues and partly marginalising conventional generation. Ultimately it could shrink the role of unwary power utility companies to operators of back-up infrastructure. Across the main markets of Asia, Europe and North America, only a minority of our survey participants expect centralized generation and transmission to play the lead role in meeting future demand growth.

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Changes in technology and cost

The growth of distributed generation and its threat to the power utility business model depends on technological developments and cost. Its rise in Europe has been subsidy-driven. Cost barriers remain in the way of it being truly market-driven. But, if these barriers can be overcome, they could set the scene for widespread global industry transformation. Many believe that point is within reach. Energy efficiency, falling solar prices, demand-side management and smart grid technology head the list of technological developments that the industry believes will have the biggest impact on their power markets. But new sources of fossil fuel supply will also have a major impact on the power market. The advent of shale gas and tight oil are changing the economics of the energy landscape. Peak oil forecasts are fast being revised. The prospect of North American energy independence is within reach and the geopolitics of world energy flows are in flux. Industry opinion is far from ruling out the possibility that a new abundant energy era might open up. But alongside this, there is a significant degree of societal concern about extractive activities and a feeling that renewable energy can bring benefits and is here to stay.

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How should companies respond?

How companies respond to these changes will determine whether they will be part of the future or join the ranks of companies from other industries whose business models have been eclipsed by technological and market change. Strategies are needed that identify the best revenue opportunities in a changed and, potentially, transformed future market landscape.

Key elements in this will be a strategic view on just how far and at what pace distributed generation will take hold in their markets, together with a view on the role and opportunity afforded by gas. The impact of shale gas will be heavily determined by how the environmental and community concerns about it are played out in different territories. Vast amounts of distributed power generation will change the nature of the distribution network, making it much more complex. The roles of transmission system operators and distribution system operators will need to be re-designed in an era of self- generation, smart grids and demand-side management.

Efficiency savings and performance improvements can buy power utility companies considerable defensive headroom in responding to the changing industry environment. Nearly a third (31%) of all survey participants worldwide say there is scope for power and utility companies to achieve cost base and efficiency improvements of more than 20%. Nearly three-quarters (73%) see big scope for improvement in asset performance management.

But also critical will be how companies respond to the rise of the ‘energy saving’, ‘energy generating’ active consumers. A significant proportion (41%) of our global survey participants see their market in one or more of these terms in ten years’ time compared to just 9% today. This includes 60% of survey participants in Europe, 50% of those in North America and 46% of those in Asia

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How can regulators respond?

Governments and policy-makers have the difficult task of grappling with the big issues of supply availability, affordability and environmental impact. The tensions between these goals are coming to the fore more and more. Affordability has risen up the agenda in many countries. Concerns about blackouts are increasing as reserve capacity gets stretched. And the advent of shale gas is introducing a new environmental battleground which governments will need to police.

The sentiment from many of the participants in our survey suggests that regulation is facing something of a crisis. On balance, the industry viewpoint is that, in many places, current developments in companies’ power markets are increasing rather than decreasing the risk of blackouts. There is a feeling that regulation is at a crossroads, with the era of liberalisation fading and a new era of greater certainty needed.

The issue of what policy design features are needed to enable system operators to balance a system with high levels of intermittent generation is an urgent one for regulators. Capacity schemes are one answer to this. Together with

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Big Issues

Transformation

Many in the industry expect the existing power utility business model in their market to transform or even be unrecognisable in the period between now and 2030. But there are big regional differences and the industry is split on the extent of change and transformation ahead…

Business model change

In most contexts, this demand growth would present a rosy picture for companies already established in the market and well positioned to profit from further expansion. But the industry is increasingly coming to recognise that to stay profitable and to succeed in the period ahead, companies will need to adapt their business models to respond to a power environment that could be transformed by changes such as decentralised power, technological changes and a very different customer outlook…

Industry sights set on transformation

In such a context, nearly half of the industry expecting transformation is significant. And perhaps more significant is that, although Europe is where the current environment for power utilities is proving most disruptive, the anticipation of transformation is more widely felt (figure 1). Indeed, the strongest anticipation of transformation is from power utility companies in Asia. It’s a significant indicator of the extent to which the industry is set to change radically, given that Asia is not as fully electrified and renewables are not as subsidised as Europe. Asian change and technology development could reinforce and quicken the pace of change elsewhere…

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Disruption

The prospect of transformation of the industry business model arises from a number of potentially disruptive changes. Decentralised generation is already eating into revenues and partly marginalizing conventional generation. Ultimately it could shrink the role of unwary power utility companies to operators of back-up infrastructure…

The impact of distributed power generation

Across the Atlantic, a paper produced for the Edison Electric Institute, an association that represents all US investor-owned electric companies, notes: “Today, a variety of disruptive technologies are emerging that may compete with utility-provided services. Such technologies include solar photovoltaics (PV), battery storage, fuel cells, geothermal energy systems, wind, micro turbines, and electric vehicle (EV) enhanced storage. As the cost curve for these technologies improves, they could directly threaten the centralised utility model.”…

Physical and revenue impacts

On a technical level, the intermittent nature of distributed generation increases the difficulty of physically balancing the system and ensuring adequate power supply. On a revenue level, managing these extra challenges pushes more costs back onto the system. There is the danger of increased centralized costs to be borne by those customers who are more grid-dependent.The cost impact is further exacerbated by any cross-subsidisation mechanisms to recover payments used to promote renewable sources and demand side measures, as these are also typically borne by the wider customer base…

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Technology

The growth of distributed generation and its threat to the power utility business model depends on technological developments and cost. Its rise in Europe has been subsidy-driven. Cost barriers remain in the way of it being truly market-driven. But if these barriers can be overcome they could set the scene for widespread global industry transformation…

Fast-changing economics

The UBS research estimates 43GW of unsubsidised solar in these markets by 2020, reducing demand for grid- supplied power by 6–9%, on top of shrinking demand due to energy efficiency and subsidised renewables. It talks about “a vast opportunity for unsubsidised solar, even though certain financial and technical limitations will leave some potential untapped.”…

A technology-driven future

The impact of the changing economics of solar power, as well as the potential of energy efficiency and other demand-side management innovations, is reflected in our survey participants’ views on which technological development they expect to have the most impact in their power markets. Energy efficiency, falling solar prices, demand-side management and smart grid technology head the impact list…

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Supply

New sources of fossil fuel supply will have a major impact on the power market. The advent of shale gas and tight oil are changing the economics of the energy landscape. Peak oil forecasts are fast being revised. The prospect of North American energy independence is within reach and the geopolitics of world energy flows are in flux…

Shale gas impact

The impact of shale gas on the power market is scored highest by survey participants in the Americas (figure 5). Of course, the US is now well advanced down the shale gas road. But South America is also set to be a major producing region. Argentina holds the third largest technically recoverable shale gas reserves in the world after the US and China. Brazil and Mexico are also in the world top ten for shale gas reserves…

Big Responses

Companies

How companies respond to these changes will determine whether they will be part of the future or join the ranks of companies from other industries whose business models have been eclipsed by technological and market change. They will need to be clear-sighted about where their best revenue opportunities lie, act fast to reduce costs or exit unprofitable areas, improve customer service and appeal to a new type of actively engaged customer…

Efficiency and performance improvement

In the opinion of our survey participants, the industry as a whole has the potential to deliver substantial cost base and efficiency improvement (figure 6). Nearly a third (31%) of all participants worldwide say there is scope for power and utility companies to achieve cost base and efficiency improvements of more than 20%. In Europe, 58% and, in Asia, 31% say this level of cost saving is possible. In North America and South America, 22% and 20% view this as possible and 11% say the same in the Middle East and Africa…

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Strategy

Efficiency savings and performance improvements can buy power utility companies considerable defensive headroom in responding to the changing industry environment. But defense needs to be accompanied by offense. Strategies are needed that identify the best revenue opportunities in a changed and, potentially, transformed future market landscape…

Customers

Companies are likely to face stiff competition with each other as they seek to ensure distributed power generation becomes an opportunity rather than a threat. Becoming a provider of distributed generation services to customers tops the list of strategies that our survey participants identify as most likely to succeed in a more decentralised power landscape…

Regulators

Policy-makers have the difficult task of grappling with the big issues of supply availability, affordability and environmental impact. The tensions between these goals are coming to the fore more and more…

Keeping the lights on

On balance, the industry viewpoint is that, in many places, current developments in companies’ power markets are increasing rather than decreasing the risk of blackouts (37% increasing versus 26% decreasing globally) (figure 11). Many survey participants are neutral on this topic. But, of those expressing a view, the worry that current developments are tilting the balance towards blackouts is particularly felt in South America (67% versus 0%), North America (30% versus 0%) and the Middle East and Africa (50% versus 30%). In Europe, opinion is much less likely to be neutral but is divided with 40% feeling the risk of blackouts is increasing and 40% saying it is decreasing…

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Meeting and balancing demand

Asked what the most important policy levers are to help meet demand in the coming decades, it is a regulatory environment that encourages network investment (scored strongly by 81% of survey participants), increased interconnection (also 81%) and fast-track planning and permitting for strategic infrastructure (67%) that tops the list. Things like market liberalisation (40%) and unbundling (35%) come at the bottom of the list…

Regional survey highlights

Power markets around the world differ in many ways, not least the stage of their development and their natural resource context. Different energy policies have also played a key role with the result that the inroads made by new forms of renewable and distributed power generation vary considerably…

Business model transformation

Although Europe is where the current environment for power utilities is proving most disruptive, the anticipation of transformation is more widely felt. Indeed, the strongest anticipation of transformation is from power utility companies in Asia. It is weakest in South America, the Middle East and Africa (see main figure 1 at front of report). Some of the factors at work in explaining these difference are the strong role of hydropower and the potential of shale gas in South America, the fossil-fuel-rich context of the Middle East and the importance of widening access to grid power in Africa…

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The impact of distributed power generation

Across the main markets of Asia, Europe and North America, only a minority of our survey participants expect centralized generation and transmission to play the lead role in meeting future demand growth (figure 2). Indeed, in all regions at least half of our survey expect the rise of distributed generation to be such that it plays a role alongside centralized generation…

Companies

We reported earlier on the widespread view in the industry that the sector has the potential to deliver substantial cost base and efficiency improvement (figure 6). There are some variations in opinion across regions about just how far the cost base can be reduced…

Regulators

On the generation side, regulatory barriers are reinforcing the problem of access to finance for new generation. Consistently, in every region, companies report the ‘inability to recover the cost of new generation via regulated energy tariffs’ as a disincentive to developing new generation…

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