3 minute read 3 Jul 2018
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How enabling and disruptive technologies are impacting the electricity system

By

Matt Rennie

EY Energy Transition Lead Partner & EY Parthenon Partner

Passionate about helping clients navigate Australia’s energy transition.

3 minute read 3 Jul 2018

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As a new energy system approaches, who will be the winners and losers? Energy companies need to prepare now.

As Fernando Suarez found in his Harvard study on first mover advantage, it is more than a myth but far less than a sure thing. 

Those investing in new energy over the past five years would no doubt agree. Indeed, every utility magazine, seminar, conference agenda and boardroom discussion since 2012 has focused on the transformation of the sector, my own articles included. And even in the two years since I wrote my first piece cautioning against irrational over exuberance in the sector: “Uber Electricity, not so fast”, a great deal of technological progress has occurred. 

Virtual power plant trials abound, targeting the ever present arbitrage presented by the enormous amount of capital expenditure invested each year in the distribution network peak. Andcustomers are starting to view choice, partnership and electricity as a private good. 

Yet despite so much progress, we are still surprisingly without unicorns. There have been no Google's or Facebook's in electricity and no one company setting the scene and defining the market. 

Despite this, over the last two years, around USD$750M has been invested into series A and B investments in new energy (primary EY research), all of it looking for returns now impossible in conventional poles, wires and generation. When will the rubber hit the road?

Do early birds always get the worm?

There is no doubt the industry is transforming, and that much value will be gained and lost over the next 15 years. As I wrote in Towards System 2.0, we see a 2030 grid dominated by renewables with battery and gas turbine reliability support, a new era for point to point transmission services, a peakless network supported by batteries in transformers and substations, and new retail models enabled by 7m plus customer scale competing on digital platforms rather than risk management and margin. 

The implications of this model are clear and well understood by most in the industry. The time for asset based thinking is coming to an end, as system solutions become the only way for companies to understand where they fit in the new market. 

It is of course, easy to hypothesize and far more difficult to invest ahead of a curve which has not yet drawn itself. This is the dilemma in which utilities currently find themselves, a double edged sword of moving too slowly or too fast.

Enabling versus disrupting – different sports

The technologies impacting the new electricity system of the future come in two categories – enabling technologies and disruptive technologies. The distinction between them is curiously slim. 

  • Enabling technologies are those that enable the current participants in the system to execute their core functions with greater efficiency and lower costs; for example robots which inspect transmission lines or augmented reality glasses which aid generation maintenance. 
  • Disruptive technologies, by contrast, are such because they have all of the process improvement possibility of enabling technologies but do so in a way which disrupts current commercial models. Virtual power plants, for example, discharge electricity into the system in a manner which could be extremely helpful for distribution systems to manage the peak at lower cost. Introducing them when owned by a third party, however, would see the savings reduced and capital expenditure transferred away from the network companies, impacting the mechanisms which provide return on asset growth in the regulated environment. 

It is a fact however that both disruptive and enabling technologies require contractual counterparties to earn revenue, and scale level sales are required to see the types of cost reductions that typified the rise of solar between 2006 and 2012. 

While the runway is somewhat clear for enabling technologies to enter the tightly held electricity system – network companies have much incentive to introduce innovative methods by which to reduce opex and to pass these savings to customers – it is less clear for those technologies which have been designed to disrupt. 

When to invest in disruption?

Technology rarely rewards first movers – early gains are rarely captured and new entrants swarm once the ground is more sure footed. Yet waiting presents risk for incumbents in a fast moving market. 

To navigate such a risk, the creation of watchtowers is one method which allows companies that are in danger of disruption to scan horizons, and to look at the direction of the wind, rather than the movement of the trees. 

Understanding the likelihood of change occurring, and the range of possible timing, is the secret to defending a patch, and as Sun Tzu said “the supreme art of war is to subdue the enemy without fighting”. Watchtowers allow companies to both better understand the nature of preconditions to change, and to map the range and timing of likely outcomes for, in this case, those technologies and services which are aiming to disrupt the market.

There are two preconditions to the success of disruptive technologies:

  1. The preconditions for counterparty relationships: Without utility counterparties, disruptive investments will be forced to engage directly with customers; a slow, organic and expensive route to market based on individual decisions. Having a utility counterparty matters; it provides security of revenue, a platform for the next sales, and reputation in the field. 
  2. The preconditions for scale: Without scale, unit costs remain high, slowing roll-out and sales. Scale allows for changes in manufacturing to occur which step change production costs and introduce new ways of thinking. When both preconditions are met, new technologies become business as usual.  

There are three drivers that we observe, which we believe would have a marked impact on the likelihood of counterparty relationships being executed:

  1. The introduction of kVA distribution network tariffs for small load customers, which would price the peak effectively and give rise to the valuation of the arbitrage.
  2. Regulatory changes to allow either the ability for network companies to include disruptive technologies within the regulated asset base; or alternatively, to allow third parties to arbitrage the peak reductions through some sort of regulatory intervention which bring about a counterparty relationship.
  3. A technological or manufacturing advancement that would bring the cost of new energy down to a point which would nullify scale advantages.

There are three drivers that we observe, which we believe would have a marked impact on the likelihood of scale production being accelerated:

  1. Increases in the take-up of other technologies at consumer level which use similar componentry – for example, a change in the cost curve for electric vehicles would lead to scale production of batteries, which may in turn provide scale for cost decreases in new energy products.
  2. Investments ahead of the curve by large multi-nationals, which would accelerate scale despite the economics not being proven.
  3. Government policy changes to mandate technologies, or services which use these technologies, which would lead to increases in manufacturing scale. To this point, in New York City local government and authorities have worked together to release a comprehensive list of guidelines for the installation of energy storage projects, in an effort to help storage move to scale, for example.

These drivers will naturally differ in every market, but provide a platform to understand the likelihood of disruption. Solar energy, for example, achieved its dominance through scale, driven by policy change, which in turn allowed counterparty relationships to be achieved at reasonable cost.

There is little doubt that the electricity industry is in a period of transformation. Whether true disruption occurs in the electricity market, however, remains consequent to a number of decisions and market events that have not yet occurred. 

Until these happen, all we can do is wait, watch and understand. Disruption is meant to be a surprise, but only for the unprepared.

Summary

New technologies are disrupting and enabling energy companies. Those who prepare now to take advantage later will win the market race.

About this article

By

Matt Rennie

EY Energy Transition Lead Partner & EY Parthenon Partner

Passionate about helping clients navigate Australia’s energy transition.