Six trends that will remake the Global Energy Industry
Introduction
Energy runs the modern global economy, and the need to decarbonise, along with rapid development of new technologies, is remaking the global energy industry in a way which will have profound consequences for energy companies and consumers.
These six trends are decarbonisation, decentralisation, electrification, digitisation, optimisation and financialisation.
In a relatively short period of time, the bulk of our electricity generation is moving from large, expensive, constant and carbon intensive central power plants; to distributed, cheap, intermittent wind and solar electricity.
The megatrend of decarbonisation, driven by an emerging global consensus on net-zero, is the overarching theme of energy industry in the first half of the 21st Century. Decarbonisation, decentralisation, and electrification are the physical forcing functions which will remake the fabric of our physical energy system.
Meanwhile, digitisation, optimisation and financialisation are the non-physical enablers that facilitate the continued expansion of renewable energy, electrification of energy use, and decentralisation of energy generation.
Decarbonisation
The World must decarbonise its energy system within 10–30 years in order to avoid the worst consequences of climate change. This is being driven by politics — through international consensus, which will punish non-complying countries; and business — which will pivot to renewable energy to meet the desires of their shareholders and customers, and to prepare themselves for the new global energy economy with all the opportunities it presents.
While there are many forms of renewable electricity, those that will provide the preponderance of new renewable electricity supply are wind and solar, because these modular technologies are already well progressed along a learning curve.
This means that costs fall in relationship to expanding manufacturing capacity. As more solar panels are made, the unit cost (per Watt) to make them falls. As the cost falls, they become more competitive as a substitute for other forms of energy, so demand rises, and manufacturing capacity expands — further driving down costs in a virtuous cycle. From 1976 to 2019, the price of solar modules has fallen by around 99.6% in real terms.
Solar PV, in particular, is becoming so cheap that it makes economic sense to substantially overbuild capacity relative to demand. In October 2020, the South Australian electricity grid was the first large grid in the world to meet 100% of native demand from solar PV. Yet the SA grid only averages slightly over 60% wind and solar over a year.
To meet the Government’s goal of 100% renewable electricity, SA will substantially ‘overbuild’ its solar capacity. Instead of just meeting 100% of demand at mid-day on an October weekend, solar will be built to meet 100% of demand on a scorching January afternoon, and a cold-mid winter day too.
This means that much of the year around 10am-3pm, output of solar PV will be surplus to demand. It’s a concept explored in Ross Garnaut’s Superpower, which isn’t just used in its geopolitical sense, but also in its more literal sense, to mean power which is super, or excess, to needs.
Since renewable generators a have a zero marginal cost to generate, they will only switch off when the price is below zero. Therefore, it seems likely that this future state of the grid will mean much of the year, the wholesale cost of energy around the middle of the day will be zero, likewise when it is very windy. Particularly challenging for the grid is rooftop PV, which unlike large-scale generation is typically not sensitive to the spot market, and will not turn off — even when the energy price is deeply negative.
Decentralisation
This brings is to the second trend — decentralisation, which is currently synonymous with rooftop solar photovoltaic (PV) panels; but increasingly will include battery storage, backup generators and vehicle-to-grid (V2G) electric vehicles (EVs).
We can also expand this more broadly to include dispatchable demand response (to the grid, a negawatt is just as good as a megawatt), heat pumps (a distributed technology which allows heat energy to be extracted from the air) and less commonly: small hydro, biomass, geothermal and micro wind-turbines.
This does not mean the end of the electricity grid. While some ‘enthusiasts’ and remote properties will be off-grid, the typical owner of distributed energy resources (DER) will gain far more benefit being on-grid — particularly in the ability to sell surplus power at a profit. It will mean, however, that electricity networks will have to change their cost and operating models to make their pricing structures more reflective of their costs.
This will be an expensive lesson for many unprepared electricity consumers. While in the 2010s, it made complete sense for homeowners to just install the biggest solar array they could fit on their roof and pump electricity to the grid at a great windfall, the 2020s and beyond will be a vastly different equation.
Look at the recent moves by SA Power Networks, the operator of the South Australian distribution grid. Back in 2008, SAPN was required by the government to offer those who installed solar panels a 20-year guaranteed 44c/kWh feed-in rate (to incentivise early uptake of solar). Now, with one of the highest penetrations of residential solar in the world, SAPN reports that the need to support excess rooftop PV exports will be the number one consideration in upgrading the network.
Whilst peak demand is still a consideration in building [the] network to respond to customer needs, it is no longer a key driver for how we manage our network and the associated costs we incur… The primary consideration in network response over the 2020–25 [Regulatory Control Period], particularly for residential networks, is the need to manage the uptake of solar generation.
Consequently, SAPN is offering an 85% discount for electricity used from the grid from 10am-3pm, while also moving a rule change through the Australian Energy Markets Commission, which will allow networks to charge customers for exporting solar during congested times — and reward them for exporting during periods of high demand.
Electrification
Simultaneously with decentralisation, energy consumption for most consumers will move from three fuels (electricity, fossil (‘natural’) gas and petroleum) to all-electric. This means a massive expansion of electricity consumption at the expense of the oil and gas production and distribution industries.
The world’s leading advocate for this process of electrification is Australian-American entrepreneur Saul Griffith. He is the founder of Rewiring America and author of Electrify. The approach can be summed up with the Twitter hashtag worthy phrase: #ElectrifyEverthing. This means the conversion from fossil fuel powered, to electricity powered, of one hundred million small machines in Australia over the next 20 years. Think: replacing gas heaters, gas hot water and petrol cars; with reverse cycle air conditioners, electric hot water and EVs.
The gas industry is trying to sell the illusion of a 100% H2 gas grid. But the iron laws of economics mean that a rapid death-spiral of the gas-grid is inevitable. Simply put, electricity is a cleaner, cheaper and more efficient source of energy.
The 35,000 (and rapidly growing) members of the ‘My Efficient Electric Home’ Facebook group are an early warning sign for the gas industry. Members share tips, and post proud photos of their disconnection from the gas grid (which largely means switching gas heating, gas hot water and gas stoves; to reverse cycle air conditioners, heat pump hot water systems and induction cooktops).
While gas has been a relatively cheap source of energy (on a joule for joule basis), it is very inefficient compared to its electrical counterparts. Switching from gas to electric heat pumps means efficiency improvements of around 5 to 10-fold, overwhelming any cost benefits of gas — which in any case may be short lived.
Further, the daily grid connection cost for gas is significant. On a household level, it makes little sense to be paying two lots of fixed grid connection charges. Replacing any gas appliance for electric, means the move to all electric is increasingly inevitable, as the fixed grid charge becomes more significant.
On macro level, as more households and business disconnect from the gas grid, the networks must increase charges on the remaining connection points to recover the fixed capital costs, further driving the economics in favour of electricity, and pushing the gas grid into a death spiral. It also pushes the economics in favour of bottled gas, so that even those that might be clinging to a gas cooktop will likely abandon the reticulated gas grid in favour of bottled LPG deliveries.
The reverse is true for electricity. The electrification of energy will significantly push up electricity consumption but push up peak demand by a relatively smaller amount (at least in summer-peaking grids), increasing the utilisation of the electricity grid and driving down overall costs.
In warm climates the electricity grid is built to meet demand on hot summer evenings, whereas new demand for heating, hot water and car charging will mostly occur in the middle of the day, overnight and in the winter. This means electricity consumption will grow faster than costs, and regulated networks tariffs will fall as a result.
In winter-peaking grids, there is a risk that electrification will push up peak demand. Efficient heat pumps, cost-reflective tariffs, building-efficiency standards and smart control will be essential to ensure that electrification does not drive-up grid costs.
The switch from oil derived fuels to EVs for personal transport will also be a significant driver of decarbonisation and electrification. While still significantly more expensive than their petrol counterparts, EVs have much lower running costs and lower carbon and toxic gas emissions.
Financialisation
Complementing the physical forcing functions are the financial and digital enablers, being digitisation, optimisation and financialisation.
Saul Griffiths predicts that the necessary reconfiguration of the average household will cost around $100,000. This consists of 1.8 EVs, reverse cycle air conditioners, heat pump hot water, a solar-battery system and an electric cooktop.
Australia has around 10,000,000 households, which gives a cost of around $1 trillion to electrify Australian households. While that sounds like a big number, it’s worth remembering that the appliances being replaced already have a limited lifetime; and also that it’s an investment that will pay dividends to households in the form of reduced ongoing expenses as well as improved energy security.
Nevertheless, it’s unlikely that such an expense can be worn on the balance sheets of stretched Australian households. With consumption moving from products towards everything-as-a-service it’s not hard to imagine how most of this investment will occur off the balance sheet of households, and instead by managed by household asset managers, and financed by an avalanche of cash from superannuation funds looking for secure long-term asset backed returns in a low interest rate environment.
For example, instead of spending $15,000 on a rooftop solar + battery system, the system will be procured, installed, financed, maintained, and managed by a specialist small renewable asset manager — and your electricity retailer will sell you the electricity at a reduced rate to what would be paid from the grid.
Similarly, instead of paying $1,500 for a gas hot water system, along with an ongoing gas bill, households will pay a bundled charge for the hot water delivered to them from a high efficiency heat pump hot water system. The hot water retailer recovers the asset costs and input costs through selling hot water to the customer. The household will pay less for the (heat pump powered) hot water than they would have paid for their previous gas fuel to make their own hot water. No upfront costs, no expensive gas bill, no ongoing maintenance liability and much lower CO2 emissions.
Financialisation is such a powerful enabling force because it provides the monetary firepower for a raft of innovators and disruptors to upend the existing energy industry cartel. Despite 20 years of privatisation and deregulation of the energy system, the industry remains dominated by a cosy oligopoly that use the advantage of scale and vertical integration to maintain their dominant positions.
This lack of competition means that the retail energy industry is a technological backwater, burdened with archaic systems, high costs, unprepared workforces, and a lack of innovation. A wave of disruptive startups, backed by deep-pocketed venture capital will rock the incumbent players and likely send most of them the way of Kodak and Blockbuster. Origin, for example, has already given up on building its own technology platform and has instead locked up exclusive access to the UK’s leading energy disrupter, Octopus Energy.
While plenty of potential disruptors (think: Telcos and supermarkets) have looked at leveraging their customer base for a lateral expansion into energy, they have ultimately baulked at the need to build large energy generation businesses(probably involving a mix of renewables and gas) in order to provide long term insurance against energy price shocks.
To understand what happens when businesses enter electricity retailing without the backing of a generation business — or otherwise through hedging arrangements — just look to the recent Texas and UK energy crises which has seen large numbers of retail businesses blown-up by supply (in the case of the UK) or supply and demand (in the case of Texas) driven price shocks.
Financialisation — combined with decentralisation — means a very significant change in the risk equation for energy purchasing. It means energy retailers will no longer be so reliant on the support of generators to de-risk themselves from energy prices going up. Instead they will work with emerging distributed energy asset managers to generate and supply energy from a consumer’s roof, their shed, their car and even the air surrounding their home; rather than a far flung coal power station.
Existing energy companies will be poorly equipped to participate in this revolution, because their previous experience building, operating and financing large, centralised power stations is irrelevant in building a network of small and distributed systems.
Digitalisation
In this new energy system, data is king. It’s a cliché that data is the new oil, but it could be true that data is the new coal and gas too. Incumbent energy businesses need to be good at making investment decisions on large new energy projects: like new gas power stations or new hydroelectric schemes, as well as large wind and solar farms. A successful decision is one where the costs to generate the electricity are less than price at which it can be sold.
The same basic equation applies to a distributed energy asset constructed on customer’s roof. Installing the wrong assets, in the wrong place at the wrong time means that the capital cost of the asset will be more than what the energy output can be sold for. The difference is that instead of one big decision to build a 1,000 MW power station, the energy company must make 100,000 small decisions on installing behind-the-meter systems.
Rather than a team of experienced engineers and accountants manually crunching the numbers — as would be the case for a large power station — this data-driven decision will leverage enormous data sets and artificial intelligence. We can see that as the electricity grid is digitalised, the successful neo-energy companies will be first and foremost, technology companies.
DER investment decisions come down to understanding the unique demand patterns of the consumer of the energy. Except for Victoria, most electricity connections in Australia are metered through an analogue meter. These analogue meters are read manually every three months and tell the retailer how much to charge the consumer for their electricity. But they tell the retailer nothing about how that electricity was consumed over the quarter (like when the energy was used, or in what appliances).
The company that can use big data and AI to better understand the drivers of energy consumption — location, household composition/business type, types of appliances, building fabric and a host of other factors — will be best placed to offer DER to that consumer at the lowest cost and lowest risk.
As electricity meters and appliances move from analogue to digital, there will be increasing opportunities to control DER production, electricity storage, and vary consumption.
Optimisation
The final force remaking the energy industry is optimisation. The grid of the past was comparatively simple: large coal power stations ran flat out all the time, while gas and hydroelectricity ramped up and down to match the peaks and troughs of demand over the day. A few hours per year, diesel ‘peakers’ would be fired up to meet ultra-high demand peaks driven by extreme summer heat, or less commonly extreme cold snaps.
Contrast this to today where wind and solar can go from supplying 100% of electricity demand at one point, and close to zero percent a few hours later. There’s little room for lumbering coal power plans which struggle to flex up and down — not to mention the higher cost, carbon emissions and toxic gas and particulate emissions.
In the new grid, gas becomes the ‘god of the gaps’ stepping in to meet demand when the sun and wind go missing in action. Because of the variable nature of wind and solar, the need for ‘firm’ supply is about 100% of demand, yet the utilisation becomes extremely low. The need to recover capital costs means that prices will need to rise to astronomically high levels (around $60,000/MWh — or around 1000x typical prices according to the Energy Security Board) in order to keep the grid running.
Meanwhile, an increasing oversupply of electricity during the daytime, and during windy periods means that electricity buyers can expect to pay next to nothing during the day time for electricity, and even be paid to use it. Generators on the other hand, will have to pay to put more electricity into the grid.
The most exposed will be unsophisticated ‘prosumers’ who have no ability to manage their DER exports to the grid. Consequently, this increasing complexity will supercharge the financialisation trend. Yes, consumers have willingly adopted and paid for rooftop solar, due to generous subsidies and high feed-in tariffs. But tell them they might have to pay to export, or otherwise keep a constant watch on their generation and consumption, and you will get a very quick ‘no thanks — you can pay for and manage this thing, I just want cheap, clean and reliable energy’.
While there’s a notable cohort of energy geeks and tech-heads willing to do their own optimisation of their energy consumption and production, often subjecting themselves to the wholesale spot market — most consumers have no interest in such things. Therefore, optimisation becomes the remit of a new type of energy company — the energy optimisation provider. It’s not clear yet what this industry is going to look like, but it is set to be one of the biggest economic opportunities of the 21st Century.
Because of the increasing complexity of the energy grid, and volatility of prices, optimising energy demand and optimising production from DER becomes very important. An EV charged for 1 hour at the wrong time may cost significantly more than the entire rest of the year of charging that vehicle. Likewise, solar systems that export during common negative spot-market prices will be a liability rather than an asset.
Hot water systems and pool pumps which optimise their operations down to the 5-minute energy settlement periods could be close to free to run over the year and could even be paid to provide stabilising ‘frequency control ancillary services’ (FCAS) to the grid.
Conclusion
There are six trends that will turn the energy industry on its head. Unlike the internet, which has fundamentally changed the way people interact, communicate, shop and be entertained; the energy transition will have far less impact on people’s lives, which is what will make the transition so swift and easy.
Do people really care that your hot water is delivered by a gas system or an efficient electric heat pump? No. Because the reality is no one consumes energy. They consume hot water, cold and hot air, light, heat for cooking, and transport. They consume the outcome which is enabled by energy, and care little about how the sausage gets made — they just want it to be cheap, and increasingly, want it to be clean.
Consumers have no allegiance to incumbent energy companies; in fact, they will switch in an instant if they can see a cheaper and better way to be supplied energy. Moving the cost and management of appliances off the household balance sheet will be readily embraced by households who will see managed assets as just one less thing in their life they need to be concerned about — while also being financially and emotionally rewarded by moving to cheaper and cleaner sources of energy supply.
