E.ON is among the top multi-utility player of Germany with diversified business in power generation, natural gas, energy trading, retail and distribution operations. It has decided to spin off the fossil fuel business (together with some other businesses, such as energy trading and exploration) and focus on renewables, on grid management and on “customer services”. This is a drastic step as it would lead to shrinking the company to half its size. Indian utilities should take note: there are important lessons for them.
- E.On, like the other large German utilities, fatally slept through Germany’s tectonic energy changes
- It is the first large utility anywhere to completely transition its business model to renewables
- E.On’s move is at once a validation and a critique of Germany’s energy politics
Image source: Greenpeaceblogs.org
The announcement shocked the market: At the end of another loss making year, Germany’s largest utility has decided that the old game is up and has flung itself headlong into a new game. For a typically risk-averse utility this is the final card to play. The term that comes to mind is “creative destruction”. The economist Schumpeter applied it to the market’s capacity to overturn the status quo and thereby produce innovation.
What used to be a straightforward, often monopolistic, very stable industry is now challenged by rapid technological progress and new regulations, massively lowering barriers to entry and creating a plethora of new players. Many of these have skill-sets that traditional utilities lack: flexibility, speed, customer orientation. In all developed countries, where new power sources tend to replace old ones, this has put utilities under huge pressure. Their reaction in Japan, the US, Germany, or elsewhere, has been to fight back. This was usually done through the policy process (access to grids, treatment of renewables, etc.). E.On’s case is so interesting, because it is the first large utility that has given up the struggle to protect its old business model and instead now wants to jump to the other side and become a “new” player. It is a rare case of corporate “creative self-destruction”.
Energy giant, E.On has decided to divest of all fossil and nuclear assets and focus on renewables. The reason, according to E.On’s CEO Johannes Teyssen, is that the renewables and the conventional power business are “completely different”. He says, “The future is in renewables”. (A second reason, observers suspect, might be that E.On wants to extract itself from the costs and risks associated with shutting down its nuclear plants.) It is a big gamble. Whether or not the new E.On will succeed will, in my view, depend ultimately on whether it can change its corporate culture towards a much more innovative, fast-paced and customer oriented entity.
Whether or not the old energy business can be spun off successfully will depend on whether conventional power plants in Germany can still earn money. They have been in trouble, because renewables have preferential access to the grid and have taken up a large share of the generation capacity. As a result, there was oversupply and the trading prices for power dropped (even as the consumer prices rose). It became increasingly difficult to earn money with conventional plants and investments into new conventional plants came to a standstill. Now the utilities are lobbying the government for so-called “capacity markets” that pay conventional plants to be on stand-by as spinning reserves whenever demand peaks or renewable generation is low.
Germany has three more large utilities. Of these, the second largest, RWE, plans to stay on its traditional course. Its CEO, Peter Terium, seems to still be at an earlier stage of thought development, recognizing “the situation is serious”. The other two, EnWB and Vattenfall, are now making serious efforts to grow their renewables portfolios and reduce their fleet of conventional plants. Yet, E.On has conducted the most substantial strategy change by far. According to Mr Teyssen, “we live in an age when energy utilities need to reinvent themselves”, but he admits that he has “no blueprint of what E.On will look like in ten years”.
Amongst large, industrialized countries, Germany has paced ahead with what it calls the “energy transition”. Through large-scale subsidies for solar, wind and biomass (amounting to more than EUR 20 bn per year), it has changed its energy mix. In 2013, renewables contributed 23% to Germany’s power generation. On peak days this number rises to well over 60%. The goal is to achieve an annual average of 80% from renewables by 2050. In addition, after the Fukushima catastrophe (2009), Germany decided to exit nuclear power, which until then contributed about 20% of its power, much more rapidly.
The way, in which the energy transition in Germany is handled, is closely watched, sometimes praised, sometimes criticized and often observed with puzzlement across the world. Currently the country is half way through the transition, neither here, nor there, incurring all the pains of transition without yet getting many of the benefits: Power prices are amongst the highest in the world, carbon emissions of the power sector are not falling as much as desired, and there are big, unanswered questions around how to create supply security in the future and integrate Germany’s plans into the wider European context. The German energy minister Sigmar Gabriel recently said: “It is an open heart surgery”. And added: “the fact that we are broadly alright has more to do with the good constitution of the patient than with the skill of the doctors”.
The context in India differs from the German one in crucial ways. First of all, India needs much more power and hence will grow all power sources rather than replace one with the other. Secondly, India is not willing to pay more for power just because it is green. It simply needs all the power it can get, as cheaply and as quickly as possible. Thirdly, India’s grids are less reliable and capable. Also, they don’t supply power to everyone yet (a third of the population is un- or undersupplied). However, despite these differences, Indian utilities should take note and read the writing on the wall.
The technological change, lowering the barriers of entry in the industry is global. Renewables are becoming ever more competitive. Soon, local and centralized storage will become widely economically viable. Digitization (metering, internet, software) makes energy management very simple and available to local providers and end consumers. The result is a much more flexible, diverse and crowded marketplace. Utilities anywhere, including in India, cannot afford to sleep through this monumental shift.
I believe there are three key lessons the E.On case holds for Indian utilities. Firstly, there is no time to lose. Utilities need to prepare for a different future now, while their traditional businesses are still intact. Secondly, what is required is not only a strategy shift, but also a cultural shift: to be successful in energy in the future, utilities will need people that can develop a customer focus (rather than the prevailing infrastructure focus). A third is that utilities quickly need to stop being part of the problem (seeking to stall change) and instead become part of the solution (working with all stakeholders to best manage the energy transition).
Tobias Engelmeier is the Founder and Director of BRIDGE TO INDIA