On the last day of this year’s 37th IAEE International Conference in New York a distinguished panel of experts, among them Ralph Izzo (Chairman and CEO of Public Service Enterprise Group Incorporated (PSEG)), Jigar Shah (Founder of SunEdison) and David Newbery (Director of Energy Policy Research Group (EPRG), University of Cambridge) discussed the profound challenges the traditional utility business model is facing from different vantage points with their own distinct points of departure. This session again encapsulated in miniature what made the entire IAEE conference on “Energy & The Economy” so invaluable; namely, it provided fertile grounds for the exchange of ideas between practitioners across the entire energy spectrum and academia in order to drive necessary future energy discussions further into the 21st century.
Mr. Izzo of PSEG set the stage by identifying the three transformative forces to have a substantial impact on the traditional utility business model: changes in individual behavior, environmental protection, and technology. Obviously, all those perceived factors imply major investment needs without necessarily leading to increases in sales of electricity. The latter is a major headache for the industry given that utilities are traditionally paid on a kWh basis. In this context, Mr. Izzo pointed to the relative underinvestment in energy efficiency innovations/improvements, for example, in buildings compared to investments in solar in the last couple of years. “Germany has the lowest electricity bills because of energy efficiency improvements,” he added.
Picking up on utilities’ profitability concerns due to changing revenue streams Mr. Shah of SunEdison, a solar power and renewable energy solutions company, tried to draw a parallel to the cell phone evolution. Over time and due to technology advances as well as the right marketing strategy, customers started to get the perception that they receive embedded in their cell phones more value for their money. Consequently, they are now willing to pay much higher prices for their cell phone service than in the past if for nothing else than just the perception of some ‘value-added’. According to Mr. Shah, it is crucial for utilities to understand that power customers “value what comes from electricity, not electricity itself.” This is not different from what Mr. Izzo referred to as electricity having just an “implicit value/price” in the eyes of the public.
So, how do utilities secure enough revenue streams to attract low cost capital in order to make necessary infrastructure investments? Mr. Shah advocates for allowing as much innovation as possible on the customer side. He also inserted another interesting thought into the discussion; namely, that in the future the “vast majority of revenue [for utilities] will come from the unregulated area” comparing it to Verizon’s revenue composition. While in 1996 about 90 per cent of Verizon’s revenues, according to Mr. Shah, originated in the regulated area, its revenues now come predominantly from the unregulated area.
Meanwhile, Professor David Newbery of the University of Cambridge stressed from an energy security perspective the benefits as well as the need of energy market coupling in order to spur investment into the energy sector following the straightforward logic that de-risking will lower the cost of capital. “Interconnections in capacity markets increase the security of supply, provided they are free to respond to scarcity. If this is so, this should displace domestic reserve capacity,” he noted.
In sum, one thing is clear whether customers pay in the future performance-based rates – i.e. utilities satisfying certain reliability metrics and thus de-linking it from investment – or for some kind of ‘value-added’ in utilities, they will have to pay more for electricity due to externalities in energy markets. At this point, Mr. Izzo’s previous comment on energy efficiency becomes even more important. Most customers of utilities would love to not think about their utility bills and would generally agree with Mr. Izzo’s view that “utilities are most valuable when they stay invisible.” Note, however, that Mr. Izzo’s point of departure here is the constant attempt by utilities to strike a balance between the optimization for their customers and their shareholders. As he acknowledged himself, today a shift in the direction of the latter is visible.