NJA Consulting

The global energy industry has been sailing some pretty rough seas for the last 10 years, dramatically changing market environments have forced energy companies to reduce scale, increase flexibility and get ever closer to the customer. In the past it has been stable market conditions that have shaped the industry and it is estimated that the required £500bn of investment needed in the last 10 years in Europe has been massively under delivered, a clear indication of the volatility in the market. Renewables and increasing climate change policies across Europe will drive EU targets as energy companies struggle to not only keep up but also fund massive change required in the generation and supply infrastructure. Add to this cyclical commodities and issues over security of supply and we can see that operating in this space is increasingly difficult for organisations like Europe’s big 6. With energy companies continuing to be scrutinised in the public arena and political and regulatory pressures mounting the view ahead is not a good one, add to this the continued volatility in price levels only ensures shifting market conditions for some time to come.

Competition and liberalisation has completely changed the face of the energy industry in Europe. 10 years ago the UK was split roughly between British Gas, npower, E.on, EDF, SSE and Scottish Power. Now we have many more with OVO, Co-op, First Utility, Utilita, Utility Warehouse to name but a few. The vast amount of smaller operators that have appeared in the last 5 years now command something like 8-9% of the UK electricity market. Increased competition on all levels from upstream to retail has changed the behaviour of the customer, causing regional power and gas markets to converge, ensuring the continued consolidation of the top players in Europe for the foreseeable future , watch this space as i predict some off loading of assets and liabilities will continue over the next few years.

Rising CO2 emissions are gaining ever more leverage in the political arena, and this is a good thing as we all appreciate it cannot continue. However when we look at the global emissions issues i am afraid it becomes pretty clear where the world needs to focus its attention – China and India. When you view the emissions bubble per person across the countries of the world USA, UK and Japan are relatively high but this is a numbers game and put simply China and India have vast numbers. These countries CO2 emissions since the 1960’s have been building and since the 1bn population has been exceeded in each country both India and China’s emissions have sky rocketed beyond USA and Europe, and they will not stop. In many ways we are all responsible for India and China because we have all been happy for them to be our global workshop but the time is coming when we will have to be far more pointed in driving emissions reductions, and that will not be an easy pill for either to swallow.

We are already seeing the de-carbonisation of generation with wind, biomass and CCGT technology and this will continue gathering pace in the decades ahead as we de-centralise our outdated generation sites for smaller, regionally specific plant. The use of gas in European generation is not predicted to drop drastically over the next 25 years, but the ways we use it will become ever more efficient. Whilst coal is on decline it is predicted that some coal will still be used by 2050, whilst nuclear will remain pretty much the same, click on the link below for the stats;

De-carbonisation of generation in europe 2010 to 2050

To put this in context in 2010 more than 50% of generation investments were for renewable projects. By 2050 renewable will dominate with over 50% take up.

The continuing volatility in the markets is forcing the need for significant flexibility, for example the increase in wind generation will lead to a substantial increase in negative or extremely low or extremely high prices for conventional power plants, thermal plant will have to effectively rely on a few hours per year with high prices to generate profits for the utility companies, hence the need for flexibility to enable quick take up and response to price spikes in the markets.

The three core gas markets remain north America, Europe and Russia with supply pipeline and shipped LNG providing supply via traditional routes, but the gas supply and pricing markets are changing, growth in further LNG linking Europe, America and Asian gas markets will continue to develop. Liquidity in the European gas supply market continues to gather steam leading to increased volatility of gas prices which offer both opportunity and risk to European energy companies. The shift has started and we are already seeing large service led organisations shift from key success factors like “volume creates value” to “flexibility creates value” and i see the energy companies struggling with the same issues. Whether you can be a generator and a supplier in the markets of the future is an interesting question that will cause providers to polarise on the customer journey.

Goldman Sachs use quantum computing to analyse certain high value markets, one consideration is what’s called price to earnings ratio which basically measures a company value based on the difference between its market value per share and earnings per share. Generally, a high P/E ratio means that investors anticipate high growth in the future (either that or it’s over valued). The current average market P/E ratio is approximately 20-25 times earnings. When you look at the P/E ratio of most of the European energy company’s core generation businesses (gas and electricity) it ranges from 8 to 13, interestingly when you look at the P/E ratings of renewable divisions of these companies then they are considerably higher at 19 to 31. Now this can mean investors are expecting solid growth in this area or that they are over-valued at the moment, the Tesla or Netflix effect, either way this is where a large amount of the industry investment is going.

One thing is for sure – the party is well and truly over. Most of the large scale utilities have credibly managed to keep on course (except perhaps RWE’s npower) throughout the last ten years, that will not be the case in the next 10 years. Liberalisation and cost pressures, commodity run-up and extraordinary market environments, including the financial market and ongoing economic crisis will pile pressure on what are already financially stretched organisations, consider the future infrastructure investment needed and a perfect storm exists that will see the market consolidate massively over the next 10 years, watch out for mergers and acquisitions coming thick and fast. Those that have invested in infrastructure have increased net debt considerably whilst cash flow from operating activities is suffering due to increased competition. At a time when energy companies need to enhance flexibility this indebtedness takes that away at a crucial time, add commodity price impact, project delays (they happen) stricter rating standards and more regional pressures like taxes in Germany on nuclear fuel elements (post fukushima) just adds to eat away at the operating results, cuts are going to be inevitable. GDF Suez and EDF maintain dominance on the European markets with E.on, Enel, Iberdrola and RWE bringing up the rear, but when you look at the market capitalization of these big 6 there is a 50% difference between the top and bottom, a huge amount. If you look back over the last 10 years all the top players have made at least one big move;

• EDF – British Energy
• GDF Suez – International Power
• on/ Enel – Endesa
• Iberdrola – Scottish Power
• RWE – Essent

But the European competitor universe has shrunk due to the acquisition activity that help to level the markets. Of all the top players only Iberdrola have bucked the trend when you look at capex programs, EDF’s almost stable capex program is starting to weaken, whilst GDF Suez and E.on have posted the largest capex reductions so far!

So, the market is gurding itself for new challenges in the decade ahead, focusing on perhaps 3 key areas;

• More sustainable – There must be a strong expansion of renewable energies by all utilities (solar and wind still top the tech list). Opportunity exists for all solar and wind operators to align themselves with large energy companies adding value along the supply.
• More International – The European market has shrunk and continues to be competitive, negative competitor activity like 0 profit contracts and out dated government procurement practises have affected supply chains and taken away flexibility and innovation. Energy companies will be forced to look beyond Europe to strengthen already known business as well as secure new territory.
• More robust – Strengthening business along the entire value chain, reducing risk from different markets and regulators by geographic diversification. Reduce selective commodity positions (CO2). Create stable, low volatile and regulated businesses.

As a result of these initiatives energy companies effectively help to de-risk their business, add value for future investment and ensure the continued success of what are some pretty large employers of people across the globe.

When the European energy companies start looking outwardly to global markets then trends that will assist in changing the outlook for their specific business segments are;

• Upstream (exploration and production) – Gas & Oil production will find continuing importance of global and primary fuel value chains. Power Generation conventional power will focus on the trends of de-carbonisation of power generation and flexibility demand. Renewable Energy will align to global CO2 policy and changing incentive schemes.
• Midstream (transportation, pipeline and wholesale markets) – Energy trading/ gas midstream activity will focus on converging global markets, increasing liquidity & volatility.
• Downstream (Refining to the consumer) – Electricity & Gas grids will have continuing high regulatory influence & pressures as well as adoption of new technologies. Electricity & Gas supply will come under pressure from continued competitor activity and transparency in the markets as well as much needed re-regulation.

When utilities look to adapt their portfolio strategy to meet these trends then the words “need to do more” springs to mind. Now will not be a time to sit on their laurels, continued management of de-carbonisation strategy and capex allocation and adoption of new technologies, aligning increased flexibility to tackle the highly volatile nature of markets will be crucial. Tackling new social contracts and the real issues of market design failure as well as the globalisation of converging gas markets will sure up future performance in core markets whilst significant investment is given to the growth engines that will drive our future (excuse the pun) like smart grid, smart meter and emobility.

What next for the consumer?

Energy consumption as the starting point…

When utilities look to adapt their portfolio strategy to meet these trends then the words “need to do more” springs to mind. Now is not a time to be complacent, continued management of de-carbonisation strategy and capex allocation and adoption of new technologies, aligning increased flexibility to tackle the highly volatile nature of markets will be crucial. Tackling new social contracts and the real issues of market design failure as well as the globalisation of converging gas markets will sure up future performance in core markets whilst significant investment is given to the growth engines that will drive our future (excuse the pun) like smart grid, smart meter and emobility.

In my tenure at npower i was introduced to a piece of data capture software that was neither used often or valued very highly. I insisted it played a considerable role in the energy services business model for one very important reason – it got us close to the client and talking about how npower could help energy reduction straight away. I know it sounds strange an energy company talking about energy reduction but it is the fundamental question the industry has had to reconcile, this software was so under-valued it was given away with any new commercial customer order for gas or electricity. Because it was so under-valued the clients were not shown how it worked, didn’t value it and therefore ultimately discarded it. As proof of its future value i introduced it to a previous key client of mine and exposed them to its value at c-suite level, the take up was almost immediate, within weeks we had orders for sub meter installations and i insisted the software was installed and a training programme arranged with all the clients key facilities staff on all UK sites, this was also used to harvest much needed organisational data for future account management planning. They were blown away at the level of usage analysis that this software could now show them in terms of asset consumption by building, by floor, even by client. Soon we were talking national gas and electric business, we were talking planned maintenance and condition surveying of equipment that was now clearly and visibly creating spikes in energy usage. On one of the floors of an office block in Leeds they found a spike in energy due to a manual override of the A/C system that effectively had the entire floor on full at 2am – when it was empty, and yes the BEMS system could have been interrogated but this software showed how much it was costing them, it also easily produced presentation analysis as board material. Tools like this that enable organisations to establish customer propositions that add real value are worth their weight in gold, the value and credibility that an organisation can gain from widening the conversation and really listening to the customer is, in my humble opinion, how it should always be done. Before you start looking for the money, start looking for the opportunity to make a difference, you usually find the other will follow in time. Let’s also not forget how saleable these items are in their own right, capable of enriching your supply chain, adding revenue streams and aligning it to your long term benefit.

Watch out for further blogs on this subject and how to engage with those high value, asset rich organisations that will need your expertise.

Watch out for my next blog – Where does all the time go…