Are utilities ready for energy system 2.0?

By

Matt Rennie

EY Energy Transition Lead Partner & EY Parthenon Partner

Passionate about helping clients navigate Australia’s energy transition.

4 minute read 7 Jun 2018

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In energy system 2.0, changing conditions are reshaping the value of assets and creating complex conditions for investment.

Transactional activity still dominated by network deals. It’s often said that if you want to know how a sector is moving, follow the money. In power and utilities, multi-billion deals dominate the headlines, with 2017’s transactions focused on big-ticket networks sales (US$100.3b of a total US$200.2b). These assets remain in high demand by investors seeking long-term, stable returns.

But beneath the megadeals, an emergence of smaller energy investments signal a new direction for the sector. These investments, often in the form of series A and B funding, demonstrate a repositioning of utilities – and the entrance of newcomers – in readiness for a new energy system.

Key factors shaping system 2.0

While the fast pace of technology and consumer-led change makes it difficult to predict exactly how this new energy system will look, it’s clear that key factors shaping it include:

A new paradigm for generation

Baseload and peaking generation, with conventional and renewable generation augmented by storage and open-cycle gas generators, will manage the peak. The era of power-purchase-agreements (PPAs) for renewable developments, already endangered as the pipeline of permitted projects without funding grows, will be a thing of the past. Just as conventional generation competes on heat rates, placement of projects in good solar areas, and on conveniently dispatched parts of the grid will determine the winners from the losers. Large-scale storage enabled by short-term settlement in electricity wholesale markets will complement open-cycle gas turbines and better ramp rates for conventionals to meet peaks. Availability and pricing of gas will be an increasingly critical factor in determining electricity prices.

An enhanced role for electricity networks

Networks will be the providers of high-voltage direct current (HVDC) transportation between markets, as well as existing AC and connection asset technologies. Within 10 years, we’ll see different approaches to how these companies are valued, as they increasingly compete with – and are enabled by – battery storage.

A new life and model for distribution systems

Discussions around household beyond-the-meter storage will soon be replaced by those around investment cases for storage within transformers and substations. This would allow for load flow management across the network and, in time, the disappearance of the peak. The subsequent reduced need for capital expenditure will place pressure on current models for valuing these assets, and require utilities to investment more in the technologies and practices that will increase revenue and profit yield from the network. 

New digitally enabled retail models

We’ll see the emergence of digitally enabled retailers that strive to reach a scale of five million customers, while managing wholesale risk through financial or physical integration with open-cycle, storage or baseload generation assets. Those retail companies that are used to competing with small-scale, electricity or dual fuel retailers will face new competition from tech-enabled, large-customer-base entrants hungry to deploy scale investments through existing platforms to new users. Margin-selling retailing will largely cease and barriers to entry will rise, with new entry retailers facing pressure to lease digital platforms to compete effectively, and to gain customers from a higher relative cost platform.

The creation of new secondary markets and technologies

Cyber security, market modeling and load flow, frequency response, ramp rate technologies and system planning using data analytics will enter mainstream electricity markets. New regulatory arrangements will be driven by stakeholders keen to push for lower prices through greater innovation and competition. In generation, settlement intervals will shorten. In networks, regulatory asset values, pricing arrangements, cost allocation and service classifications will change. Retail protections will embrace privacy in a digital age. In short, the system will change, and the way utilities view their parts within it will change too.

Boosted investment in energy services and storage

Investment in these new areas has been focused on energy services, technologies such as batteries, and trading. We expect this to increase over the next 12 months as the market benefits of early investment in large-scale storage (to support frequency response) become clearer.

In retail, start-ups and digital platforms have emerged on the fringes, raising US$746m of series A and B funding over the past two years. We expect to see an increased focus on digital in retail, with companies looking to acquire small innovative start-ups in this space.

As the sector reshapes itself, regulators and network operators will move to address market design issues, including reducing settlement periods to support increased investment in this space. 

Complex conditions reward vigilant energy investors

The characteristics of system 2.0 ensure its complexity for investors. Finding value will require vigilance and knowledge beyond where the markets are going.

It will become critical to consider how trends are evolving, how companies are adapting and which new technologies will become essential, and who will buy them in the energy system.

Returns will be contingent, not only on technologies and roles, but on regulatory arrangements, revenue recovery, price signaling and counterparties. 

Financial engineering will become less important than deep sector expertise and system understanding: knowing which buttons to press, which levers to pull, and the most likely mix of policy instruments necessary to enable them will be essential.

In energy system 2.0, successful investment will depend upon the ability to think holistically about the convergence of sectors, technologies and social drivers that will determine the winners and losers. Are utilities ready?

Summary

To win in a new energy future, power and utilities companies need to consider the whole picture and prepare for System 2.0.

About this article

By

Matt Rennie

EY Energy Transition Lead Partner & EY Parthenon Partner

Passionate about helping clients navigate Australia’s energy transition.