Renewables revolution – what should utilities do? Part 1: The dilemma
Across the globe, renewables are entering into their second phase: no longer driven by subsidies or even climate concerns, they directly compete with existing fossil fuel based power. So far, few utilities have been able to manage even the first phase successfully. And they seem to be struggling to strategize the second. Why is that the case? Should they oppose or embrace renewables? This is Part 1 of a three part series on utilities and renewables, looking at their dilemma. The second part will look at the choice of obstructing vs. embracing change (Read here). The third looks at how utilities can successfully re-invent themselves (Read here).
- Traditional utilities are still the backbone of energy systems
- Many face rapidly falling market capitalization and profitability in electricity generation
- They have no real strategy of their own for redesigning the future of energy and thus are constantly driven by other stakeholders
Over the course of the 20th century, the generation and distribution of power had become an increasingly centralized affair. Grids grew in size and linked up with one another. Ever larger power plants, fired by coal or nuclear reactions, fed power through them. Often, generators and distributors were the same. Often, these were public sector monopolies. The future seemed predictable and investments safe. Then, new regulations lead to tectonic shifts in the world of utilities. First, competition was encouraged through unbundling and privatization. Then, new distributed, smaller power plants, based mostly on renewable energy technologies began to emerge. These were initially belittled, as their contribution to the power supply was still tiny and their infirm nature gave them an air of fundamental impracticality. However, as the costs of fossil fuels rose and climate concerns grew in the 90s and early 2000s, their development was rapid and suddenly they changed the game. Utilities – out of arrogance or ignorance or inertia – were left wrong footed. They had bet on the traditional model of power generation and sale and seemed quite incapable of adapting to the new business models that emerged. While new, often profitable energy companies popped up across the globe, many traditional utilities began to lose money.
In Germany, a pioneer in the field of renewables, this development was particularly pronounced. Generators of solar, wind or biomass power were given preferred access to the grid. They did not have to worry about balancing fluctuating power, but could supply power whenever available. At times, this could lead to oversupply of power. On June 16th 2013, Germany had to sell power at a price of minus (!) 100 Euro per MWh to get rid of excess generation and keep the grid stable. Wind and solar made up over 60% of the power at that point in time. Coal and gas fired power plants reduced their generation to just 10%. While the renewable power generators were still paid through the FiT, the coal and gas fired plants made heavy losses.
Utilities are still the backbone of the electricity system, providing base-load power, spinning reserves and managing the grid. However, a deep structural shift is taking place in this highly conservative industry. Utilities are not driving the debate; they are driven by it. That might be their main failing: a lack of imagination, innovation and strategy. As a result, industry developments are not going in their direction.
While renewable energy generators have the privilege of stable framework conditions, fossil fuel plants are increasingly denied long-term visibility. In Germany this had lead to the phenomenon of high and rising consumer power prices (driven among other things by a renewable energy surcharge) while at the same time, power prices at the power exchange have dropped to a long time low, making it unviable for utilities to sell power. By now, and this is the second phase of their development, renewable power is increasingly competitive and will be bought by consumers even without government support, exponentially creating a more complex web of generation and distribution to which the traditional infrastructure seems increasingly ill-fitted. As their core business is threatened and unrelated strategic mistakes have piled up, utilities have so far failed to sufficiently tap into the new opportunities. Markets are skeptical about their prospects to do so in the future. Germany’s largest utilities E.On and RWE have lost over 60% of their market value in the past five years. Their very survival is called into question.
Refer to part 2 of the blog series here.
Refer to part 3 of the blog series here.
Tobias Engelmeier is the Managing Director at BRIDGE TO INDIA.