Investing in the future of energy

Over the Christmas weekend German energy consumers got an unexpected gift — negative prices. In other words, utilities paid to draw power from the grid. This is not the first time this happened either — Germany has had negative prices over 100 times this year on the EPEX Spot exchange, through October 2017. This problem — if it can be called that — has its roots in regulation that encouraged the impressive growth of renewable solar and wind power. Such power can often flood in, stretching the capabilities of an inflexible grid designed for more traditional baseload power generation.

Half a world away, another significant development occurred. Tesla’s new Hornsdale battery system — the largest battery in the world — successfully responded to and helped avoid energy outages in Australia, as it stepped in to quickly compensate for transitory drops in power generation from traditional power plants. Ironically, Hornsdale is charged by wind energy.

These two developments illustrate two complementary sides of a massive disruption taking place across the energy landscape. Utilities were once considered “defensive stocks” — representing a staid sector of the economy where investors always found regular yields. Today, nothing could be further from the truth and the pace of change in the industry continues to accelerate.

Change is, to a large extent, being forced upon the industry. According to PwC’s Global Power and Utilities Survey, 97 percent of utilities executives surveyed in 2015 expected a medium or high amount of market disruption by 2020.

LCOE and installed capacity wind/solar (source: Lazard)

This disruption, initiated by regulation, has accelerated with technological progress. Falling prices for new renewable wind or solar energy projects increasingly makes such sources competitive, disrupting the economies of scale achieved by traditional baseload power sources and requiring a higher degree of flexibility. A similar fall in prices of energy storage and localized generation from off-grid solar or small-scale wind means demand for energy is also less certain. Customers are increasingly both consumers and producers of energy, which makes the dominant business model of utilities — of centralized generation and monopolistic distribution of power — rapidly redundant.

A transforming value chain

This new reality is affecting the entire value chain within which utilities operate (for a great summary, see this infographic from Accenture) and will completely transform the power and utilities landscape across the supply, network, and retail ends. The latest data from Bloomberg’s new energy outlook confirm this:
• New power generation capacity will increasingly be renewable: 72% of the $10.2 billion spent on new power generation capacity will be spent on renewables.
• Distributed energy resources (DER) and demand energy storage systems (DESS) will proliferate: Rooftop solar PV, for instance, will account for as much as 15% of energy generation capacity in Germany. Similarly, EVs will account for 13% of electricity demand in Europe.
• Smart meters will grow to be a $19.98bn market by 2020. 
• Finally, availability of data and connectivity will enable efficiencies across the value chain — from predictive maintenance for lower O&M costs, to optimization of power generation, to the ability to better forecast and trade on energy generation, even at the local level.

As noted in a prior article, such transformation results in a change in business models. Thus, the business model of the utility will change from that of a product provider (the product being power), to being a digital utility that delivers energy services — with opportunities in managing demand response, dynamic pricing, and arbitrage.

Utilities have already started to position for this new world, where they must be a digital utility to survive. E.ON, for instance, launched an energy services business in 2015 to provide O&M services. In doing so, it competes with both the wind turbine OEMs and other O&M providers that have traditionally been suppliers to E.ON. Enel, another utility, recently acquired the UK-based operator of the Tynemouth standalone battery energy storage system. And Engie recently bought Fenix international, an African startup that was one of the pioneers of distributed, off-grid solar home energy systems. We looked at FENIX in its early days and invested in a similar company in India. For a European utility to buy an African upstart illustrates how existential crises can make for strange bedfellows.

The most recent M&A statistics confirm this. Power and utilities (P&U) deals in Q2 2017 outnumbered those of Q1, with a particular focus on renewables and new technology. Small value deals in renewables accounted for 48% of total deal volume globally, and 55% in Europe. Investments in transmission and distribution (T&D) increased substantially, from US$76m in Q1 to US$4.3b in Q2, totaling 40% of deal value. And a number of transactions, as noted above, involved battery storage and new technology. And TenneT, a German utility, and Vandebron, a renewable energy marketplace operator, are testing blockchain technology for electric vehicles in the Netherlands.
These M&A trends — smaller deal value and a focus on new technology — confirm what we have known for some time: that utilities are looking to position themselves as service providers covering the integrated value chain in the new energy landscape. As EY noted:

Traditional utilities continue to diversify geographically and with an increased focus on renewable energy and disruptive technologies, including smart grids, blockchain and battery storage. This strategic shift in focus is starting to pay off with several major European utilities, including Iberdrola and Enel, indicating improved operating results.

Investing in the new energy landscape

Given this likely evolution of the energy industry, where should one invest one’s time and money?

To answer that, one needs to look at the intersection of two criteria: what parts of the energy value chain offer the largest spend on disruption with the highest profitability; and where do utilities lack capabilities?

Innovation is already directed towards segments of the industry that represent large use cases — IIoT smart grid investments, for instance, represent an estimated $57.8bn opportunity. Similarly, 55% of deal volume in Q2 2017 was directed towards renewables, where utilities continue to evolve their capabilities away from coal, nuclear, oil & gas.

Data team and analytics capability within utilities (Source: PwC)

Capability gaps exist across the value chain, but the most obvious ones are in energy storage and generation and in data analytics. For instance, PwC noted (see graphic) last year that the majority of utilities have less than 20 people dedicated to data analytics, with a quarter having no capabilities at all! And even where capabilities exist, they are focused more on operational efficiency and less on monetization and new business models.

At this intersection are startups that target a) large markets with, b) near term spending traction, and c) a clear buyer willing to pay increasing valuation premiums. Analysis has led me to focus, amongst others, on the following:
1. Energy storage and EV technology and services: mobile or distributed charging infrastructure, and DESS (storage services e.g. Sonnen).
2. DERM centric technology and business models: small-scale or high-altitude wind/solar and business models such as VPPs (e.g. LimeJump) and “wind as a service” (e.g. UnitedWind).
3. Smart metering: Consumer or industrial smart metering and associated analytics (e.g. Verv or Enit Systems).
4. Data analytics across the value chain: Platforms and Predictive Maintenance solutions (e.g. Smartive), optimization (Spark Cognition), and demand-response solutions
5. Energy trading services: peer-to-peer or backend trading solutions (e.g. Grid+, Conjoule, Electron, Hive Power, or Power Ledger).

Despite their reputation for being slow moving, utilities have been investing into and supporting innovation across these and other segments. One must be careful, however, not to read too much into that support — as utilities’ own business model evolves, so will their shopping list, and companies that today have contracts or have conducted pilots may find themselves replaced by others elsewhere in the value chain. One solution to this is to seek and invest into adjacencies, ensuring synergies across the portfolio while diversifying risk.

This is a brave new world in which anyone — including upstarts like Tesla — can become a utility, just as a utility can become an O&M provider. And therein lies the opportunity. It is not a greenfield one and so speed is one’s friend, but as utilities turn into digital energy service providers, the opportunities for innovation are enormous.