Seb Beloe, Head of Research and Partner, WHEB Listed Equities and Michael Pearson, WHEB Infrastructure
The traditional utility business model is wobbling. The market capitalisation of European electricity utilities has fallen from an approximate €1 trillion peak in 2008 to roughly half that today.
Even during the last 12 months, RWE and E.ON’s share prices are both down more than 20% while the German index is up more than 20% over the same period i. The 13th PwC Annual Global Power & Utilities Survey, published in October 2013 found that 94% of global power and utility executives predict a ‘complete transformation of, or important changes to, the power utility business model’. 67% also expect technology and new supply sources to dramatically reduce dependence on oil and gas-rich countries ii.
It is perhaps no wonder that RWE’s Supervisory Board is reported to be considering a radical departure from its traditional business model by focusing instead on being ‘a service company applying energy supply capabilities and information technologies intelligently’iii. In our view, the electricity utility model has been caught out by a combination of the scale and pace of technological change, and shifts in the underpinning economics and politics of electricity production and distribution. Like industries as diverse as publishing, music and film, executive recruitment, communications and estate agency before them, they are seeing their traditional business models and structures torn apart by new technologies.
The changes facing electric utilities are underpinned by a revolution in renewable technology, especially solar photovoltaic “PV” technology. Deployment of solar PV has now reached such a scale that it has helped reduce prices of solar panels by 80% in the last five years iv. In Germany, renewables are now generating electricity at such volumes that they are overwhelming the traditional dynamics of electricity market pricing to the point that electricity prices have actually turned negative at certain timesv. At midday on a sunny day in Germany, when power consumption and prices are traditionally at their peak, solar PV accounts for approximately 50% of electricity generation. As a result, peak power prices have been slashed from €14 per MWh above base-load prices in 2008 to a premium of just €3 in 2013 and are obliterating the peak pricing model of traditional utilitiesvi. Other markets with growing renewables penetration such as California look set to follow suit.
The situation though is much worse for the utilities. Efforts to improve the efficiency with which energy is used mean that growth in demand for electricity, already weakened by recession, looks lacklustre at best. HSBC estimate that the EU’s Energy Efficiency Directive, combined with other measures, will cause heating and electricity demand to fall by 14% and 8% respectively from 2012-2020vii. While worrying for utilities, this is clearly good news for consumers (and the environment). In fact, because German households are already so well-insulated, electricity bills are actually lower in Germany than they are in Texas even though the price of electricity per Kwh is more than three times as muchviii.
Worst of all though, renewable generating capacity is overwhelmingly owned by householders, farmers and small businesses and not by utilitiesix . This makes the policies that support renewable energies like solar PV very popular. This is as true in the USAx as it is in Germanyxi. Owning generation equipment helps mitigate higher energy prices and shifts revenue away from utilities to individuals and communities, driving what some have called a ‘utility death spiral’. As more people install solar, the more attractive the technology becomes, thus accelerating the process. In a recent research note entitled ‘Energy Darwinism’xii, Citigroup concluded that ‘combining the declining size of the electricity market in terms of volumes with the declining market share for conventional generation, could see [developed market] utilities in their current form suffer a 50%+ decline in their market’.
Traditional energy utilities will not of course disappear entirely, and in some regions are likely to remain dominant. Very large scale, highly capital intensive offshore wind, for example, is ideally suited to utilities with the balance sheet strength and capital allocation models that support these developments. Elsewhere, back-up generation will be required for intermittent renewables – at least until large scale energy storage becomes more commercially viable – and transmission and distribution as well as wider energy services will become increasingly important. However, the danger for traditional utilities is that rather like the role of copper-line landlines in contemporary telephone networks, they will remain, but progressively become static, low margin businesses, while the real action moves elsewhere.
i Bloomberg data, 30 October 2013
ii Energy transformation: The impact of the power sector business model, PwC, October 2013
iii RWE sheds old business model, embraces transition, Karel Beckman, Energy Post, 21 October 2013
vi How to lose half a trillion euros, The Economist, 12 October 2013
vii German Utilities, HSBC Global Research, 9 September 2013
viii ‘Why we need the energy transition’, Heinrich Böll Foundation, (www.pl.boell.org/downloads/Boell_Energy_change_in_Germany.pptx)
ix Citizens own half of German renewable energy, Craig Morris, Energy Transition, 29 October 2013
x Middle Class Homeowners Flock to Rooftop Solar, Anne Mulkern and Climatewire, 22 October 2013
xii Citi, ‘Energy Darwinism: The Evolution of the Energy Industry’, October 2013