Electricity is a vital societal resource; ensuring the secure, affordable supply of electricity is a fundamental task of governments. During the past decade, the power sector has undergone a profound disruptive shock. This ‘first phase’ of transformations has been driven by three major factors: unprecedented deployment rates of renewable energy; slower than expected or stagnating demand growth, due to tougher energy efficiency standards; and, in many jurisdictions, market reform. This has led to solar PV and wind power becoming the largest sources of new capacity.
As this trend continues, solar PV and onshore wind power will become the lowest-cost generators globally, driving increased deployment of those technologies. Continued and accelerating deployment of renewables is likely to further depress utilization rates for conventional power stations, impairing the economic performance of coal, gas and nuclear generators. For example, the contribution of solar PV and wind power to electricity generation in the EU increased from 2.5 per cent to 13.0 per cent between the end of 2006 and the end of 2016. In the same period, the average share price of the major power utilities in Europe halved.
A second phase of transformations is emerging, driven by and intimately linked to the first. Renewable deployment will continue, joined by the electrification of transport and heating. Electrification is paramount to achieving climate and air quality targets. As the electricity sector increasingly dominates the wider energy system, flexibility will likely define this second phase of transformations, and will be the key enabler for ensuring affordable electricity.
Governments seeking to encourage entrants to the market for the provision of electricity system flexibility will need to develop new market and regulatory mechanisms that balance two imperatives: appropriately valuing the evolving suite of ancillary flexibility services; and ensuring that core principles of energy security, affordability and environmental protection are upheld.
The business models of power utilities have historically been based on predictable and steadily growing demand, supplied from large coal-fired, nuclear or gas-fired power stations that economically are designed to run at predictable levels of output. A number of new technologies are crucial to enhancing system flexibility: smart EV charging, battery storage, digitalization with intelligent control, and demand-side management. These will complement or replace the existing flexibility mechanisms, currently provided by power plants’ operational regimes and the use of interconnectors.
This second phase of flexibility transformations is likely to turn out to be more wide-reaching than the changes to date. Many traditional utilities have recognized this, but they are often either unaware of, or unable to adapt to, the pace of change. Shareholders and asset managers will need to recognize the risks of traditional utilities failing to keep pace with sector transformations.
Maintaining reliable and affordable electricity systems that integrate greater penetrations of renewables will be a priority for policymakers, regulators and the wider market. As penetration levels of renewables reach around 30 per cent, countries could experience increased integration costs. Therefore, country-specific policies need to be developed to ensure that whole-system costs remain affordable. The integration challenge is attracting some of the world’s most economically powerful companies, many with roots in the transport or digital sectors. These companies, if they successfully meet consumers’ needs, may well dominate the power sector in the coming decades.
If EV charging is controlled by smart technology, then national demand profiles could flatten as electricity demand becomes more even throughout the day, increasing the efficiency of the system. However, smart EV charging could go further, enhancing system flexibility and allowing greater integration of renewables at lower cost, especially if combined with vehicle-to-grid technology. However, these benefits will not occur unless manufacturers, regulators and policymakers soon recognize the system benefits of smart electrification.
A virtuous circle is developing, in which the EV battery sector is enabling increasingly affordable battery storage, in turn supporting greater integration of renewables. Batteries already offer economic solutions for a range of short-term functions, including frequency response, distribution network reinforcement and integration of renewables. The modular nature of batteries enables their cost and size to be optimized for their function; this, combined with their speed of deployment, will likely increase competition with traditional market-balancing mechanisms. Traditional utilities are well placed to invest in larger, capital-intensive, grid-scale battery storage facilities, as well as in the integration of batteries into conventional power stations.
Technological innovation is signalling the extent to which the power sector could change, but unless new regulatory structures and incentives are put in place so that new market actors can operate profitably, then the necessary rapid structural reforms are unlikely to be achieved.
Digitalization will enable traditional utilities to become more operationally efficient by enhancing control of infrastructure via remote sensors, improving management of supply chains, and optimizing internal accounting and customer billing. Digitalization also raises the prospect of flexible-demand services expanding, including into the household market. Flexible demand presents both an opportunity and a threat for traditional utilities – utilization rates of generators may increase, and grid reinforcement may be avoided, but will these benefits be offset by lower barriers to the integration of renewable energy? To counter competition from new market entrants, traditional utilities could offer more comprehensive service-based packages to existing household consumers, creating new value as their traditional business model disappears.
The ownership of, and capacity to analyse, data from the Internet of Things will dictate which market players can offer new services to consumers. Internet giants such as Google are already entering the market with skills beyond those of the traditional utilities. Working with new, nimble market players to provide flexible demand could allow traditional utilities to secure additional revenue streams.
New payment and transaction methods are emerging. Peer-to-peer transactions facilitated by blockchain could partially replace the need for electricity suppliers to play the role of broker between producer and consumer. If changes to regulations enable such payment methods to become the norm, electricity suppliers could use their established retail tariff relationships to offer similar services, such as selling low-cost power from newly built solar PV and wind farms, or selling energy stored in utility-owned grid-connected battery storage facilities.
Pilot schemes in New York show how regulators are encouraging traditional utilities to develop energy service platform business models. Regulators, governments and utilities will need to work together to design the rules and protocols for such platforms, which will enable the connection of distributed energy resources (DERs) and the emergence of associated new services. Traditional utilities, particularly network operators, could develop energy service platforms by working with regulators on distribution system operator rules and protocols. These energy service platforms could enable utilities and new actors to build digital infrastructure-oriented business models to provide new services to customers and enable the connection of the growing numbers of DERs.
Grid cybersecurity is a growing concern, demanding that traditional utilities integrate advanced digital security technologies. Technology specialists, such as Cisco, will play an increasingly fundamental role in ensuring security of supply and guarding against reputational damage from avoidable cyberattacks.
The likely extent and potential pace of the second phase of electricity sector transformations raise fundamental questions for generators, grid operators, regulators and governments. Technological innovation is signalling the extent to which the power sector could change, but unless new regulatory structures and incentives are put in place so that new market actors can operate profitably, then the necessary rapid structural reforms are unlikely to be achieved. The extent to which the power market is segmented by separate incentive schemes also raises questions about the role of the state in potentially owning and running the sector.