Utility businesses models across the world are increasingly under pressure from three forces: Decarbonisation, Decentralisation and Digitalisation. These changes are so profound that they are calling into question the very existence of many utilities. No more is this so than in Europe where utilities have made, in recent years, asset writedowns totalling over $100 billion and destroyed billions of $’s of shareholder value. That said some utilities such as the Italian utility Enel are now embracing these changes as opportunities rather than as challenges and this has lessons for all utility executives and investors across the world.
The biggest change we are seeing in Europe is how money is made in the utility business. In the past, it was all about large scale generation but now profit pools are moving from conventional generation to renewables, from upstream operations to downstream, from products to services, from units of energy to comfort, and from wires to digital. This has huge implications for the business models of traditional utilities, which have been used to controlling the whole electricity value chain from power generation to transmission and distribution to the retailing of that power.
Large scale generation be that nuclear or fossil fuel has been under pressure for a while. Concerns around the growing costs of decommissioning existing nuclear plants as well as the spiralling costs of new build mean that nuclear’s importance in a large part of the world will decline. This is also true for large fossil fuel plants which are under pressure from the weather which is becoming the major determinant of the wholesale power price. When there is a lots of wind or sun, power prices tend to fall and when there is not much, power prices go up . This is having a very negative impact on the amount of time that conventional generators are actually used which in turn is impacting the profitability of these plants. But let’s be clear it is not just large scale conventional generation that is under pressure, profit margins around large scale renewables have been under pressure in recent years as the market for new installations slows and competition increases. Going forward with governments moving from feed-in-tariff support mechanisms towards reverse auctions (lowest priced bidders wins) the competition and thus margin pressure is only going to intensify. This can be clearly seen in the recent results of the German offshore wind auction under which Dong Energy won two tenders with a zero bid which means that they will only receive the wholesale price for those projects going forward.
In the grid area, which is a highly regulated business, we are already seeing returns under pressure. Regulations are reducing the returns that grid operators can make and we will see competition intensify as grid builds outs are opened up to tender. And with concerns mounting over spiralling end user power costs across Europe there will be pressure for grid operators to optimise and digitalise the grid with storage and sensors as opposed to just investing in new and expensive cables and hardware.
Then we have the retail business which in many cases is the core business of a utility. These businesses are increasingly under pressure thanks in large part to the internet and price comparison sites like Verivox in Germany and Switch in the UK, which are making it very easy for customers to switch energy provider. Going forward as low cost digital players enter the market, we will see increasing competition. To compete in this digital world, the traditional utility needs to reduce their costs of servicing and acquiring customers. They must also look at adding services such as security for homes onto their product offerings and this is not easy. And above all utilities must stop selling kWh’s which is fast becoming a zero margin business.
In between the retail and energy generation is the world of trading. Fuel has to be bought and power has to be sold and it has been a highly profitable area for most utilities and still is in certain places like Great Britain. However, most of the rest of Europe has liquid and highly transparent power markets in place, which is good for the buyer as well as a whole range of new generators who have entered the market. The result is that trading is not as profitable for the utility as it once was.
This begs the question where the profit pools will be in the future? The answer is downstream in the customer focussed area and in particular around decentralised solutions. There will be a need to install and finance and charging stations, decentralised power solutions such as solar, batteries, heat-pumps, smart home systems and micro-CHP plants, and there will be a whole range of services that can be added once this equipment is in place. Such customers will also tend to be “sticky”.
The good news is that the retail utility is well positioned to take advantage of this growth opportunity given their large customers bases, and in many cases loyal following. But they oftentimes do not even have the email address of their customers let alone the ability to gain insight from the customer data they have. Add to that a whole range of new players coming into the power world, a corporate culture which is used to making investments in large centralised generation stations for 40 years, not to mention the lack of a customer facing approach and you see the challenges facing the utility. But those challenges are also an opportunity especially for the fast moving utility or even new entrants to the market.