The power of ten

Mark Hughes tells Power & Energy how the global utility scene has changed since PricewaterhouseCoopers conducted its first industry survey 10 years ago.

When we first launched our global utilities survey, in the late 1990s, governments and energy utilities were focusing on regulation and liberalization. The markets were slowly realizing that competition was feasible in a variety of ways, and companies wanted to know what impact of wholesale and retail market liberalization would have on them and what marketplaces were going to emerge around the world. Would it be a case of a pooling wholesale market or a balancing market? What would be the impact on some of the vertically integrated utilities if wholesale market prices were to fall fast and they were left with stranded assets?

Concerns about commodity shortages, high prices, security, renewables or climate change certainly did not feature as major themes. And of course, these are key now. There’s been a complete shift in the focus of people’s analysis and concerns reflecting where the world has moved to.

Shifting patterns
The other big change over time is that there has been the significant amount of growth in the emerging economies. Ten years ago China’s economy was a fraction of its size today. Similarly, India, together with places like Russia and Brazil, now represents significant demands on global resources for energy, which has pushed up commodity prices around the world.

The energy industry is a barometer of the balance of supply and demand for energy resources. There’s been a significant shift over the last decade in energy trade flows: where coal is coming from and going to, and where gas is coming from and going to. Ten years ago, for example, there may have been a trickle of a liquid natural gas supply route from Southeast Asia up into Japan, whereas now LNG is a major supplier of gas over vast distances.

During the late 1980s and the 1990s and the beginning of the current century independent power businesses from the US began to come into Europe, Asia and South America. Some big NS-based IPP companies, like AES and Intergen and Enron, exported their business models and expanded their international footprints substantially in that time period.

Just after the current century began there was a substantial wholesale energy price drop in both Europe and North America. This was partly a consequence of the competition in the generation and wholesale markets, and also reflecting relatively low and benign oil and gas prices. Wholesale prices fell and a lot of the international investments that these original pioneering companies had made started losing money at a time when domestic markets were proving difficult. As a consequence, a lot of US power businesses exited the European market. It’s been a pretty volatile ride from when we started doing our reports to where we are now.

Partly as a consequence perhaps of both market opening and concerns on market volatility, energy utility businesses now are also much bigger than they were a decade ago. There’s been a lot of merger and acquisition activity and many companies have built big and robust balance sheets, enabling significant investments and long term procurement strategies in a challenging energy security environment.

Alternative sources
In terms of alternative energy sources, what people are anticipating as their contribution to total energy would have been unheard of as little ago as five years ago. Over in the UK, the government is currently going through a renewable consultation exercise, and is talking about 32 percent of electricity production coming from renewable energy by 2020, and looking for a reduction in greenhouse gas output by 2050 of something like 80 percent. These are phenomenal targets and have enormous implications for alternative energy sources.

In the US there are obviously some big changes afoot, and we may see the government adopting a more globally coherent stance in line with Kyoto. As a consequence, we should see within North America a much more concerted attempt at reducing carbon emissions, and the place to start, as all the big countries have found out, is in renewables. In North America this includes hydro electric power.

Another place to look for more environmental efficiencies is in carbon capture and storage – CCS. CCS, for the coal-rich countries in the world, like Australia and North America, is going be key to meeting continued demand growth whilst at the same time meeting targets for carbon reduction.

Globally, people’s attitudes to carbon and the future of carbon trading and carbon emissions caps have matured. In the European Union, for example, when people talk about carbon trading and the ETS, the Emissions Trading Systems, they only do so in terms of what the latest extension will be and how long those extension periods should last. It is no longer being argued with or second guessed except in the details of its application. Emissions trading is now a done deal, and I believe the cap and collar or the cap and trade systems that exist in Europe are likely to be replicated and rolled out elsewhere.

Carbon emissions trading
In our latest global utilities survey, the respondents now believe that a cap and trade policy will emerge on a connected but related regional basis rather than on a single global basis, pretty much everywhere. There’s also been a realization that the people who’ve got to take leadership action on this are the first-world economies. They have to lead the way in developing renewable technologies and in charging people a bit more for their energy so that they reduce their consumption, and in finding energy efficiency targets and making them stick.

Whilst the US has yet to put in place a carbon emissions framework at a federal level, if you go down into individual states, like California, you’ll find that some states have an aggressive line on encouraging efficiency and meeting carbon reduction targets. Likewise, if you look at what individual states are doing on the carbon capture and storage front there’s been a very big change in various parts of the country on the ground, and if you look at how nuclear is being taken up, some individual states are pushing harder than others.

For new nuclear to be successful, you need to have strong transmission systems to move the power around from where it’s generated to where it’s going to be used. You need to have access to both nuclear fuel sources and a plan around decommissioning, dismantling and long-term waste. Some states have got that pretty well sorted out because they’ve got a history of doing that, and other states are farther behind.

Another option is super critical coal plants, which produce the same electricity for less coal so you get less emissions for the same amount of megawatt hours produced, and that can be quite a significant change on what the status quo is. Currently you get nearly a ton of carbon for a megawatt hour of electricity, and some of the super critical plants go down to 0.6 tons per megawatt hour. That’s a big change. It’s not halving carbon output but it’s not far from it, simply because the new technology is more efficient in its consumption of coal.

Rising costs
Whenever energy becomes expensive there is increased focus on effective procurement and improving control up the supply chain. The companies who are consuming it want to have more say about or more access to the production process rather than just taking a market price.

I was at a big conference called Where Are Energy Prices Going recently, and the audience was pretty much split 50/50 between people who were producers or suppliers and people who were consumers. That was coincident with the time when oil prices leapt up to over $130 per barrel. This fed through into wholesale gas and electricity market prices. The industrial and commercial consumers essentially got a reflected wholesale price plus a little bit of a margin to cover supplier transaction costs such as billing.

When they went out trying to find an alternative price from one of their local suppliers, they all came back with the same number. That tends to be the way the market works for them, and that is true for industrial and commercial cusomers around the world ­– it was true, for example, for the big industrial commercial producers in France despite the fact that EDF is predominantly a nuclear generator, and so its cost base should not be affected by wholesale price movements. Of course the reality is that the opportunity cost for EDF on the European energy market is pretty big, and to the extent that it’s got discretionary sales it wants to get those discretionary sales at market prices rather than be locked into historic levels.

In the UK, there’s a drive from the likes of the big supermarket chains Sainsbury’s, Tesco and Asda (owned by Walmart) to show some responsibility in terms of what they’re doing energy-wise. Asda is a case in point. They’ve tried to show their customer base that they are a clean provider of energy and user of energy on their sites and as much as possible in the products on their shelves. When you get that type of pressure coming through from the retailers it reflects on what the producers and industrials do.

We are increasingly finding people moving into particular generation businesses and combined heat and power businesses when they weren’t previously part of their core chain. That’s not just from the bottom up, it’s also from people who operate oil refineries, people who previously were part of a gas cycle chain wanting to get into the power market so they can start influencing and having more of a controlling position on what’s going on.

Thinking global
Utility companies are now combining a global focus in a green and efficient brand with local action. They’ve got to be on the ground in their local area and in their local marketplace looking at energy efficiency via improved insulation and glazing; looking at green distributed generation – for example, via a domestic CHP plant. It’s the idea of corporate responsibility and being serious about the problems that the sector currently faces in how to face up to or interplay with the regulators and the politicians.

As a specific example, we’re doing some work for an energy business in Australia that is being pushed to un-bundle, disintegrate, introduce retail competition, open up the wholesale market for new entrants, and have competition in its procurement processes. This is all very well in a marketplace where there’s quite a lot of stability: you don’t need to contract the very long periods, and there is not a lot of questioning about volatility or contract duration or creditworthiness.

But as soon as you start undermining businesses’ balance sheets, introducing competition, reducing their ability to enter into long-term contracts, and reducing their creditworthiness as a consequence of all those changes, you undermine their ability to secure long-term supplies and you undermine what many energy utility businesses need by way of energy security and long-term stability.

Mark Hughes is European Utilities Leader at PricewaterhouseCoopers. He is an in-depth client service adviser with significant experience in advising energy and utility companies getting to grip with the challenges of liberalisation and competition. Hughes leads a London-based team of 30 professionals with specialist industry capability in the gas and electricity sectors covering the full range of market, valuation and corporate finance advisory capability.

Mark Hughes of PricewaterhouseCoopers answers our questions about the smart grid role in increasing energy efficiency.

P&E.One key effort in the attempt to encourage energy efficiency among consumers has been the introduction of the ‘smart grid’. What advantages does it offer?
MH. In the household you’ve got a smart meter, which should help people in the household be aware of their energy usage and hence enable more informed choice. A smart grid operator able to control consumption with a smart meter might be better able to manage significant variation of supplies by turning discretionary loads off when supply in short and loads on when you’ve got some cheap energy to play with.

P&E: Who will be the primary beneficiary: the consumer, the utility, or both?
MH. I suppose the question that people always have in this area is who’s in charge, who’s in control, and if there is value to be taken out of the supply chain in this way to whose benefit will it be applied?

I’ve heard of companies fitting solar panels to roofs and giving rent to the person who owns the house, but not significantly reducing his tariffs for the value of the renewable energy that he’s housing on his roof. That’s an example of a new opportunity where the value is being divided up between the households and the owner of the panels in a particular way, and there’s obviously also a risk and reward type of balance being struck there.

P&E: How will we ensure that this risk and reward balance is fair?
MH. As you develop smart grids and smart meters, where you’ve got local generation being attached to a house, then that question will be asked repeatedly, and one would anticipate there being some different risk reward models being tried out, and at some point the one that should win is the one that’s fair for both producers and consumers.