Power station

If you are feeling short on ideas in a business facing low growth, competitive pressures, social change, and disruptive technology – you may gain some inspiration by casting your eyes to the energy sector – particularly those fighting it out within energy utilities. Traditional energy utilities are fighting for survival in an environment undergoing tectonic change.

Energy utilities are being engulfed by change in all arena affecting competitive advantage including:

– Underlying demand growth is low to declining (at least in the western world) due to slower overall economic growth, improvements in energy efficiency, and reductions in the energy intensity of growth;
– Technology is transitioning from analogue, centralized and standardized to digital, distributed and personalized leaving utilities holding high fixed cost and less efficient generation assets at a time when lower cost distributed energy generation is opening the door to new competitors;
– Customer expectations are being transformed by digitization and climate change with retail customers not frightened to search and execute alternative energy solutions and industrial customers setting ambitious goals to reduce demand, increase efficiency and diversify energy sources (often including offgrid solutions);
– Competitors are using technology and customer trends to open new doors in new markets and in particular the battle for aggregation of connected services in the home and office is playing out between utilities, telecommunications, entertainment and retail platforms; and
– regulator and policy makers are juggling the energy trilemma of decarbonizing the energy sector at an affordable cost and in a way that ensures energy security – often in the public arena and amongst a noisy, diverse and mostly self-interested (and rarely aligned) set of stakeholders.

In response to these challenges, there is much discussion amongst industry participants of innovating new energy products and services, of establishing transactive platforms that facilitate two way communications with producers and consumers, of adjusting business models in response to changing customer needs, and of evolving new technologies in a range of areas including electric vehicles, small mobile reactors, fuel cells, or perovskite (flexible) solar cells.

But noticeably absent from this debate is a discussion on a foundational economic principle – the power of more efficient pricing to drive an efficient operating and investment environment for all market participant.

In 2016, MIT in the USA published a paper on the Utility of the Future which addressed the crucial role of accurate pricing signals and incentives to support the transition of energy systems. Aligned with first principle economics, they argue that granular pricing is the most efficient mechanism to put all energy resources (suppliers and consumers) on a level competitive playing field and in facilitating decision making that internalises tradeoffs between competing technologies, in competing locations, of competing scales, and at competing times.

Their recommendation in relation to pricing included;
– improving the temporal, locational and service type granularity of energy pricing to better reflect the true cost and value of the service provided at a particular location at a particular time and for a given service type,
– being technology agnostic and base pricing only on the cost and value of injection and withdrawals of energy at a given time, place and service type (reliable, quality, predictability),
– being symmetrical with injection of power at a given time and place compensated at the same rate that is charged to withdrawal at the same time and place,
– separating any charges that are not affected by particular consumption or injection behaviors (such as residual network charges, taxes, policy charges) from the volumetric ($/kwh) component of the tariff,
– applying peak coincidence charges with a locational differential as networks do not get congested uniformly, and
– exploring methods to address distributional concerns associate with more granular cost and value reflective prices and charges.

The foundation of their recommendations is that in a network, the cost and value of energy can vary markedly at different locations, at different times and for different applications. Average pricing, technology based tariffs, and decoupling cost and value of price signals (all characteristic of the Australian NEM) is unlikely to deliver the most efficient or effective network outcome.

Understanding these insights provides important signposts for where utilities can drive their agenda to both leverage their scale and influence and rediscover their competitive advantage.

Firstly, the foundation for more granular pricing is materially enhanced network metering and utilities should be the primary agents in leading this transition of the network; either through direct investment or through strategic partnerships. Secondly, utilities should be leaders in driving more granular pricing models for products and services that helps stimulate consumers and producers to make the right decisions at the right place and at the right time. Thirdly, utilities should be the primary stakeholder lobbying policy makers and regulators to refine the granularity of pricing signals in areas that extend outside their area of control – particularly in relation to distribution networks.

For utilities, the prize for leverage economics 101 with improve pricing is efficient signals driving efficient investment and operating decisions, ensuring more efficient resources displace more costlier resources, ensure efficient business models crowd out inefficient ones, delivering less expensive services, enhancing societal welfare, and embedding a more sustainable competitive advantage.