CONTRIBUTION TO SERVICE ENERGY SAFETY PROGRAM
The past decade has been difficult for many service companies. Services of companies around the world in the last decade were like a slide ride, not so often painful. Despite the sharp increase in global demand for electricity, many utility companies have lost value or recorded under-performance. An analysis of 50 major public utilities from Asia, Europe and North America showed an average overall cumulative yield of shareholders of about 1% from 2008 to 2018 compared to 55% for the MSCI World Index.
Services with high exposure to commercial income are in an even worse situation. There are two reasons. First, the collapse of a conventional generation of traders reduced profits in Europe and the United States, and growth in other sectors, such as renewable energy and transmission and distribution (T & D), was not sufficient to compensate. Secondly, service companies worldwide are losing market share in new sectors, such as the financial and oil and gas industries.
Over the next decade, we expect that demand for electricity will increase faster than any other type of energy, due to economic growth in Africa, Asia and Latin America and electrification of final energy consumption, especially in transport and heating. To keep pace, huge new investments will be needed.
The International Energy Agency (IEA) estimates that $ 7.2 billion will be invested in the electricity sector between 2016 and 2025 (Figure 2), which is almost $ 1.0 trillion more than in the previous decade.
READING FUTURE: IMPLICATIONS OF INDUSTRY
In order for the future to be different, and better, the energy strategy must be more efficient. Conditions change fundamentally and quickly. Services, too, have to change – faster and more skillful than many have proved capable.
In order to discuss this territory, it is useful to have a sense of trends that are likely to shape certain sectors.
The revenue model for all manufacturing technologies will come close to long-term contracts, but the profit margin will not necessarily increase. Over the past five years, excess capacity and low wholesale prices in energy markets have led to serious pressure and in some cases on market collapse, in purely commercial electricity production. The amount of thermal energy savings in Europe reached just 12 billion Euros in 2015. The new production capacities will be difficult to fund according to the net profit model of traders, in which prices are determined by the variable cost of marginal technology. Recent bloodshed in commercial production, higher regulatory risk and the growth of renewable energy sources, which do not have marginal costs, mean that future prices are uncertain. Long-term fixed prices, either through an agreement on the purchase of electricity or capacity mechanisms, are most likely new revenue models. In fact, the share of new production capacities that carry a full price risk has already fallen, and we believe that it will continue to do so.
How can service services progress?
Services are facing another decade of major changes, characterized by significant risks and significant opportunities. In order to turn growth in the volume of industry into profit growth, there are four principles for success.
Get scale. Digitization, industrial convergence, market liberalization and new entrants mean that barriers to entry are lower than ever. In this context, the scale becomes a competitive advantage. Renewable energy and retail outlets, with their fixed costs structure, are two areas in which size and competitiveness went hand in hand. And in the T & D area, the scale will be increasingly important, as regulators will become more demanding in terms of efficiency, and ownership of the infrastructure will be auctioned. Scale will mean different things for different players. Local or regional leadership can be enough to create a competitive advantage. In order to get the scale, utility companies will have to re-examine their capital deployment and be ready to make significant disinvestments. Consolidation can be another approach.
In the end, geographic diversification could become a better option for obtaining a level in relation to vertical integration, in order to protect regulatory risks.
Accept new technologies. Good economic use of technology will be important in determining winners and losers. The application of advanced asset management analytics can mean significant improvements in cost-efficiency in business; there is a significant potential for increasing efficiency through technology. In fact, this has already happened: we saw 15 to 25% savings in maintenance costs and replacement for transformers and switches and 10 to 20% savings in maintenance costs and replacement for overhead lines and underground cables. Services should adopt similar technologies as soon as possible, as they could become mainstream in just a few years.
Focus on regulatory management. In the past, a large portion of retailer revenue required service companies to understand future commodity prices. In the future, the dominance of the regulation from the top downwards means that the prediction of regulation and, eventually, assistance in its design will become the name of the game. An effective regulatory strategy implies asking broad questions: What is the cheapest mix of supply? Are tariffs and incentives sustainable and fair? It will also be necessary to communicate with key actors. Efficient regulatory management will therefore be a priority and will require the development of new skills, such as the active advocacy of institutions.
The service industry has never faced so many disruptions at once. The consequence is, therefore, that this is the right moment to launch new business models. For example, developers may decide to sell an increasing share of ownership to financial players who can offer lower cost of capital. This is already happening in the renewable energy sector and can be extended to the infrastructure. In the second case, T & D players can decide to extend their role in telecommunication infrastructure, based on operational synergies. In order to gain a significant share in the value set that comes from electrification of transport and new downstream capabilities, utility companies could also consider new areas, such as insurance and consumer loans.
The service industry enters a period of uncertainty mixed with the possibility – a value that is waiting to be caught, and significant competition for it. In order to prosper, service companies must act decisively or face significant and possible existences the risks.