The days of the monolithic, vertically integrated utility company are numbered. With new market entrants, new technologies and new pro-market regulation on the rise, new utility business models are a requirement, not a nice to have.
In recent years we have seen this imperative become more apparent. In the energy sector, the growth of new entrants, though halting at first, has swelled to see them capture close to 20 per cent market share.
These alternative utilities do not just offer customers a more intimate version of the same service they got from their old incumbent. Municipal energy companies, community energy companies, green energy companies, techy energy companies – there is now a multitude of flavours on offer, including not-for-profit, so long the sole domain of Welsh Water in the utility world.
Furthermore, while vertically integrated giants with decades-worth of cumbersome legacy IT systems struggle to adjust their economics for a world in which carbon-rich balance sheets are no longer the asset they once were, their unencumbered rivals are exploiting the agility of cloud computing and scalable enterprise.
The big beasts are responding. Eon, RWE and Centrica have all unveiled plans to overhaul and recalibrate their business models for an era of clean, mass-customised, technology-enabled energy services. Many, though, are still struggling to find a way forward that does not leave them with stranded assets – not least energy networks, whose ability to balance a decentralising, decarbonising energy system is being tested.
In the water sector, meanwhile, the change to business architectures locked in at privatisation has been more sudden and definitive. The imminent opening of the non-domestic market to competition has prompted a flurry of joint ventures, market exits and customer book sales. As Ofwat’s plans to deregulate markets like sludge and water resources take hold, it is likely we will see business models shift further, with more room for third parties in the value chain.
The role of utility regulators in facilitating business model change is key, and in recent years both Ofwat and Ofgem have made it clear they do not wish to stand in the way. With principles and outcomes-based regulatory approaches, and the introduction of measures to promote innovation, they have set the scene for a new era of business model change in UK utilities.
PROFILE:
Welsh Water adopts not-for-profit model
This year marks 15 years since Welsh Water became the UK’s first, and still only, not-for-profit water company.
It is owned by Glas Cymru, a single purpose company with no shareholders, and is run solely for the benefit of customers. It also aims to reduce Welsh Water’s asset financing cost, the water industry’s single biggest cost.
Financing efficiency savings to date have largely been used to build up reserves to insulate Welsh Water and its customers from any unexpected costs and also to improve credit quality so that Welsh Water’s cost of finance can be kept as low as possible.
The move came after the company’s previous owner, Hyder, found itself under immense financial strain and was forced in effect to put itself up for sale.
This compromised the long-term outlook until Jones and fellow Welsh Water director Nigel Annett decided to go back to the drawing board and radically reinvent the company as a not-for-profit enterprise, with no shareholders and an intrinsically customer-first ethos.
Regulatory viewpoint
Ofwat and Ofgem have taken similar stances when it comes to non-traditional business models (NTBMs). They want to see them flourish and are seeking to remove any barriers which may hamper their development.
In both instances, the main way in which the regulators hope to make way for more NTBMs is by adopting principles-based regulation – an approach that moves away from prescriptive, tick-box compliance with a complex set of rules, and towards a more flexible regime in which interpretation of the “spirit” of regulation is allowed.
Such an approach does pose challenges for regulators charged with protecting consumer interests, and early last year Ofgem put out a consultation to explore the transformative potential of NTBMs, as well as the potential challenges and risks they might pose. There is no solid outcome from this consultation yet, but broadly speaking there seems to be a view that the benefits of accommodating NTBMs outweigh the potential risks.
Speaking at Utility Week Live, Ofgem chief executive Dermot Nolan said he expects the “energy landscape to be transformed” in the next decade – and he was not just referring to the supply market.
The world of transmission and distribution is also changing fast and Ofgem is closely involved in work to identify regulation and market structures that are holding back new technologies and modes of system operation – like energy storage. A list of barriers to energy storage which Ofgem and government will reform is expected by the end of the year.
Ofwat’s plans to open up the water sector to more competition, as set out in its pro-market Water 2020 document, could also lead to NTBMs taking hold. Ofwat chief executive Cathryn Ross says that opening up markets such as sludge will give companies more choice about how they define their core competencies and should also lead to a bigger role for third parties in delivering customer value.
Meanwhile, the opening of the non-domestic water market is having a very direct impact on water company business models. Companies have been required to restructure or entirely split off their new retail businesses – or to exit the market as Southern Water, Portsmouth Water, and most recently Thames Water, have done in order to concentrate on other market segments.
Utilities are changing, and the regulators are changing too. Their focus is now on creating freedom to innovate while keeping a beady eye on customer interests.
PROFILE:
Ebico, the social enterprise
Ebico follows a similar model to Welsh Water insofar as it is a not-for-profit company.
The energy supplier, based in Coomb near Oxford, offers just one tariff for gas and one for electricity to all its customers regardless of their payment method.
It is also a registered social enterprise and is therefore free to pursue its social and environmental goals without having to generate a return for investors. Revenue just has to cover costs. Ebico also offers plans tailored to meet the needs of financially vulnerable customers on prepayment meters.
It holds over 30 contracts with housing associations and the company’s main focus is reducing fuel poverty. To that end, all surplus profits go to the Ebico Trust for Sustainable Development to improve energy efficiency in poor households.
Ebico has been in business for more than 15 years and currently provides energy to more than 60,000 UK households. The energy retailer has a white label agreement with SSE, which provides both its energy and the account management services.
The winds of change in Germany
With its Energiewende programme, Germany is committed to transforming its energy system. Mathew Beech looks at how the industry is organising itslef to cope with the challenge.
Germany’s energy transition – or Energiewende – is seen by many as the prime example of how non-traditional business models can develop and flourish.
It has its origins in the 1970s but came to the fore after the Fukushima nuclear accident in Japan in 2011 when chancellor Angela Merkel decided that all German nuclear power plants should close by 2022.
At that point, nuclear power was providing more than 20 per cent of the nation’s electricity capacity, but this has now been whittled down to around 16 per cent, with more closures planned. To make up the gap, Germany has commissioned and built new coal plants, but the share of the energy mix for renewables has grown by seven percentage points since 2011.
This dramatic political change has been the main driver behind the major structural changes at Eon and RWE (see p15) and has benefited other non-traditional business models that are commonplace in Germany, such as local grid ownership and community energy.
In the state of Saxony Anhalt, for example, there are 23,000 photovoltaic (PV) systems and around 2,700 wind turbines installed at 97 sites.
They have benefited from a long-standing feed-in tariff regime, which offers guaranteed returns for communities investing in them.
Last year, 48 per cent of Saxony Anhalt’s energy was generated from wind, solar or biomass plants.
Central to the Energiewende’s principles is the delivery of various long-term targets, with renewables due to account for 60 per cent of final energy consumption – and 80 per cent of electricity consumption – by 2050.
Germany’s distribution system is the “most complex in Europe”, according to think-tank Agora Energiewende. It comprises around 900 distribution system operators (DSOs), including the four large companies – Eon, RWE, EnBW and Vattenfall – as well as 700 municipality-owned utilities.
The big DSOs operate a large proportion of the municipality-owned networks as part of 20-year franchise deals.
The community ownership model for energy generation is one that is gaining traction in the UK, and further non-traditional business models for our European neighbours could begin to take hold here in the future.
PROFILE:
Tailor-made by Albion Water
Albion Water was the first new entrant to compete against the incumbent water suppliers in England when it received its licence from Ofwat in 1999.
Its business proposition is to create tailored solutions for hard-to-serve customers and new housing developments, serving a niche by providing services such as drainage solutions to sites that fall below the bigger players’ thresholds for bespoke services.
It has so far gained its 2,000 customers via inset appointments, which Ofwat grants to allow one water company to replace another as the supplier of water or sewerage services within a specified geographical area.
Wessex Water took a 51 per cent stake in Albion in March this year. Albion chairman Jerry Bryan said the deal would give his company the “financial and technical strength” to meet a growing demand for sustainable and resilient solutions for new housing.
PROFILE:
A bundled play from Utility Warehouse
Utility Warehouse is unlike the other domestic retail suppliers because it offers its customer bundled packages including energy, home phone, broadband, and mobile services.
It states that by combining its services, it is able to offer customers a discount because this helps it to keep its own costs down.
Utility Warehouse owner Telecom Plus agreed a £218 million deal with Npower to buy 770,000 customer accounts in November 2013.
Telecom Plus paid an initial £196.5 million, with an additional £21.5 million due to be paid after three years. It also agreed a new wholesale supply deal which will see Npower continue to supply electricity, gas and other services to Utility Warehouse for the next 20 years.
Npower had previous been the owner of the Electricity Plus and Gas Plus arms, both of which are now part of Utility Warehouse following the deal, but these had been managed by Telecom Plus since March 2006 following a management services agreement between the two companies.
PROFILE:
Bristol Energy pursues a local solution
Bristol Energy is municipality-owned energy retailer, wholly owned by Bristol City Council, and offers electricity and gas tariffs for domestic and business customers across Bristol, the South West and Britain.
The company, which only began trading in September 2015, provides an innovative way to support Bristol City Council in its economic, social and environmental goals, with any dividends from its operations returned to its parent organisation for investment in the city.
At the end of June, Bristol Energy was supplying electricity and gas to just under 10,000 customers. Currently around 15 per cent of its customers are from Bristol and the surrounding area, while 42 per cent are from four of its closest DNO regions, including Bristol. And 58 per cent from the rest of the UK.
Comment: North Star Solar and the battery revolution
The dream of affordable energy storage was always viewed as the Holy Grail for customers, businesses and networks alike – it was deemed possible but never proven. That has changed in the past few years as solar and battery combinations are now becoming affordable in a number of markets around the world. Australia is perhaps leading the world deployment with forecasts for three million batteries to be installed by 2025. In Germany. some 25,000 batteries have been installed, and here in the UK North Star Solar has announced a deal to market its unique Home Energy Management System to 22,000 homes in Stanley Council.
North Star Solar has evolved its original PV-only model into the current Home Energy Management System (Hems), which combines PV, battery storage and LED lighting, together with free or low-cost broadband access. This new model has been conceived from the outset so that over time it could be entirely viable without any form of government subsidy, while requiring no financial outlay by end-users. Customers save on average 20 per cent on their electricity bills and those in fuel poverty using prepayment meters will see greater savings.
North Star operates a radically different model from others in this sector, based on partnerships, co-operation and profit sharing. North Star offers its partners a profit share in order to create social capital to benefit local communities and support business activities. We have announced one deal and have two more council deals likely to be announced shortly plus we are in active discussions with five others. In addition, we are talking to a number of energy suppliers about marketing Hems to their customers.
Batteries along with solar are going to disrupt the market significantly and will be embraced by the government as it seeks low carbon, affordable, and secure sources of energy. It is moving away from the world of large generation plants with subsidies to embedded local generation without subsidies. This will create huge challenges for DNOs and National Grid, not least of which will be how they continue to recover earnings as less energy moves over the transmission lines. As indicated by the National Infrastructure Commission, moving to a smart grid with storage is likely to save the UK significant amounts of money and carbon. Post Brexit, we need to make sure we are leading the way in this new world, innovating in ideas and embracing these changes.
The Holy Grail may just be closer than you think.
North Star Solar chief executive Paul Massara.
He is also the former Npower chief executive, an executive member of Centrica, and he advises the government on fuel poverty.
The end of traditional structures?
Monolithic vertical integration has served utilities well, from their public service inception through three decades of privatisation, but changing political and commercial considerations are forcing a fundamental rethink, says Mathew Beech.
The behemoths of the energy and water sectors developed as we know them in the post-privatisation world. But many have a history dating back more than a century. Their structures derive from the linking up of the wholesale and retail elements of their businesses and this has long been deemed a common sense approach. But now this is being questioned. Global decarbonisation and suspicion from both customers and politicians that vertical integration allows profiteering have caused the model to fall out of fashion.
That last charge was rejected by the Competition and Markets Authority (CMA) in its probe into the energy market. Back in early 2015, the CMA said it did not find any disadvantages to the energy market from big, vertically integrated companies.
This opinion was reaffirmed by the CMA and the industry at an Energy and Climate Change committee meeting this month.
The chair of the CMA energy market investigation panel, Roger Witcomb, told MPs that vertical integration is “not a problem” and that “there are possibly some internal advantages to companies to be vertically integrated, but that does not translate into damage to consumers”.
Energy UK director of energy supply Audrey Gallagher added that “there is only a modest benefit to vertical integration”. Which? head of campaigns Pete Moorey echoed this, saying: “I do not see it as a particular tension.”
However, while the vertical integration of energy companies has not been condemned, RWE and Eon have moved away from this traditional structure anyway (see graphics, right). The move has been driven by the changing environment for traditional generation rather than by the retail market, and the desire to prevent stranded assets holding back the business as a whole.
The water sector is filled exclusively by traditionally structured and vertically integrated companies, bar Welsh Water (see profile, p10).
However, the Water Act and its provision for retail competition in the non-domestic market has led to some changes. So too could the regulator’s plan to introduce more upstream competition.
Ahead of market opening in April 2017, some water companies have adopted new business models. Prime among them is Water Plus, the joint venture between United Utilities and Severn Trent. This new company will take on the business customers of its parent companies and aims to be different from the “old” model.
Chief executive Sue Amies-King told Utility Week: “We’ll be set up separately with cloud-based systems, so we can make changes and deliver new offerings to customers much faster than the competition.”
Wessex Water has also pursued the joint venture model, taking a 51 per cent stake in independent water company Albion Water.
The way Ofwat views the upstream market is also changing. At the end of May, the regulator published its Water 2020 document, setting out its decisions on the design of its regulatory framework. This includes steps to inform, enable and encourage the development of two new markets: sludge; and water resources.
To adapt to these changes, water companies may further fragment and evolve, potentially with spin-off businesses, and new entrants may enter the sector.
This all chimes with what Ofwat chairman Jonson Cox said early last year. He set out a vision of vertical disaggregation, non-traditional consolidation and “de-consolidation” and looked forward to a more fragmented, diverse and differentiated water sector.
In reference to the upcoming opening of the water market to competition for non-household customers in April 2017, Cox said: “The logic of vertical integration no longer works.” And he emphasised the importance of service delivery in a fragmented structure.
It appears the days are numbered for traditional structures, with the model evolving to feature a more fragmented industry. This is unlikely to mean the end for the utility giants, but their 2.0 iterations are likely to look decidedly different to what we’ve become accustomed to.
Comment: Eon and RWE hope that radical restructuring will mark new beginnings after some lean years.
The massive earthquake that hit eastern Japan in 2011 and crippled the Fukushima nuclear reactor has had many consequences well beyond the Far East.
In Germany, it was the prime factor for the government’s U-turn whereby all nuclear plants would be closed by 2022, and their effective replacement by the controversial Energiewende policy.
When combined with the panoply of climate change initiatives, which have ousted coal-fired output from its long-established baseload status, the impact on Germany’s two energy leviathans, Eon and RWE, has been profound.
From their peaks in late 2007, shares in both companies have plunged by over 80 per cent. Hence, radical action has been required. Both companies have announced far-reaching changes in the structure of their business operations. The details vary but business separation is the common mantra.
In Eon’s case, it has transferred its supply operations, its conventional generation – approximately 40GW of dispatchable hydro, natural gas and coal capacity – and its energy trading into a new business, Uniper. Uniper is due to be partly spun off later this year.
New Eon is now focusing on renewables, energy networks and customer solutions.
In RWE’s case – and unlike the Eon model – the original RWE retains the core generation portfolio, namely the nuclear, gas-fired and coal-fired plants.
The new business, Innogy – described by chief executive Peter Terium as “colourful, flexible, full of energy and creative ideas” – includes renewables along with grids and sales.
While the restructured models may be welcomed by the participating management consultants and lawyers, there is less evidence that shareholder value will be enhanced.
On the generation front, the key factor will be selling prices. In recent years, German wholesale electricity prices have been depressed, thereby sharply cutting underlying profits.
Furthermore, output levels have been constrained by the priority given, under the feed-in-tariff mechanism, to renewables output. And, as 2022 nears, nuclear returns will also be cut. Furthermore, at the insistence of the government, both companies will be carrying heavy – and long-contested – provisions to finance nuclear plant decommissioning.
Eon and RWE will expect that, by ring-fencing their renewables generation within their new business, a higher stock market rating will be achieved, If subsidies are changed, this is far from guaranteed.
For investors, the solid grid returns will be key. However, the adoption of Energiewende means that heavy capital expenditure will be required in the next few years to enable power to be “wheeled” into central and southern Germany where several shortly-to-be-decommissioned nuclear plants are located.
Although RWE’s share price has rallied in recent weeks, the market remains to be convinced that these two new business models will create enduring shareholder value. Interestingly, the privatised British Gas adopted a similar strategy in the late 1990s when BG and Centrica were separated. Until oil and gas prices plunged in 2014, this strategy delivered.
Both Eon and RWE will hope that British Gas’s pre-2014 scenario can be suitably replicated.
Nigel Hawkins, director, Nigel Hawkins Associates
PROFILE:
Nissan goes to grid with EVs
Japanese motoring giant Nissan is seeking to disrupt the electricity distribution model with the use of its energy storage devices, as well as its electric vehicles (EVs) and vehicle-to-grid (V2G) trials. This would shake up the traditional way electricity distribution network operators (DNOs) run their systems, especially if, as has been seen, EV ownership develops in clusters.
Nissan plans to connect 100 vehicle-to-grid (V2G) units across the UK in the first ever trial of using electric vehicles as mobile energy storage devices. To do this itt has teamed up with power management company Eaton to develop the xStorage battery storage unit, which forms a central part of its V2G solution. The 4.2kWh unit will retail at £3,200 and it is being touted as the most affordable domestic energy storage solution on the market. Nissan and Eaton expect to sell 100,000 xStorage units in the next five years.
Nissan will locate V2G units at places across the country agreed to by consumers and fleet owners of the Nissan Leaf and e-NV200 electric van, giving them the opportunity to plug in their vehicles and sell energy stored in their vehicle battery back to the system.