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Changing utility business models and electricity investment in Europe

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Authors: Michael Waldron and Yoko Nobuoka

The traditional utility business model of selling electricity from large-scale thermal power plants and expanding grids to meet rising demand historically has supported strong balance sheets.

With this financial strength, utility retained earnings served as the primary financing source for the electricity sector. In many markets, utilities serve as reliable purchasers of power, facilitating investments by independent power producers.

But as the role of electricity in the world economy expands, technology innovation creates new opportunities and governments simultaneously prioritise electricity security and a transition toward more sustainable energy use, investment decisions are becoming more complex. The economic performance of utilities will have crucial impacts on financing for investments needed in the transition. How their business models interact with policies and market design will have strong implications for meeting energy goals.

In Europe, these changes started decades ago with the unbundling of vertically integrated companies and the establishment of wholesale markets and retail competition. In recent years, more challenging economic conditions have emerged. At the same time, policies supporting renewables prompted competition from independent power companies, communities and corporations investing in low marginal cost solar photovoltaics and wind, and the success of energy efficiency contributed to weaker electricity demand growth.

Taken together, these forces have weakened price signals for investment from energy-only markets and sapped the profitability of existing generation assets dependent on wholesale market revenues. Now, digital technologies are facilitating new business models, such as virtual power plants (VPPs), based on bilateral power exchange and increased roles for consumers and third parties to provide energy, capacity and flexibility services that were once the exclusive domain of utilities.

Recent financial performance of European utilities reflects these trends. In 2017, the aggregate earnings of the top twenty utilities likely continued to decline, to around 35% lower than in 2012. This reduction over time stemmed mostly from reduced profitability for merchant generators (largely thermal plants) fully exposed to weak wholesale market pricing, as well as lower revenues from the retirements of these plants. In the past five years, retirements of thermal capacity in Europe have outpaced investment decisions for new thermal plants by more than two-to-one.

Around three-quarters of utility earnings now stem from segments that offer more stable and predictable cash flows, such as networks and generation (e.g. renewables, co-generation and some thermal power plants) that benefit from contracted or regulated pricing, and to a lesser extent retail supply and decentralized services, such as energy management and digital solutions. Five years ago, these areas collectively accounted for less than 60% of earnings.

These indicators are consistent with trends observed globally, where electricity sector investments have a strong relationship with government policies. In 2016, nearly 95% of power generation investments were made by companies operating under fully regulated revenues or mechanisms to manage the revenue risk associated with variable wholesale market pricing.

European utilities are adapting to this situation by strategically re-orienting their businesses. Utility plans now consistently emphasize themes around business model transformation, enhanced operational efficiency and improved financial management. The European electricity industry association has called for a new strategic vision for the sector.

However, this ongoing shift has not yet resulted in an earnings boost. One reason is that business models for grids and renewables are capital intensive, requiring continuous investment over time to expand revenues. These investments also remain largely linked to policy incentives and can face risks related to resource availability, integration and demand, while governments are focused on the affordability of power prices for consumers. While recent policy changes, such as increasing competition for new renewable contracts through auctions and adjusting regulated returns and frameworks for networks can stimulate more cost-effective development, they can also put pressure on profit margins.

Utility transitions are also proceeding at different speeds. The share of regulated, contracted and retail business models in earnings ranges from upwards of 85% for top performers, to only around half in some utilities. Moreover, the earnings picture is impacted by activities abroad, with European utilities having different degrees of exposure to overseas investments.

Nevertheless, European utilities are generally increasing their investment capabilities. Despite a challenging economic environment, capital expenditures as a share of earnings have strengthened in recent years. In November, six utilities collectively called on the European Union to support a strengthened renewable energy target of 35% by 2030, compared with an originally proposed one of 27%. This higher target is also supported by the European renewables industry associations. So far in 2017, utilities have been involved as investors in 90% of the 2.4 GW of offshore wind — among the most capital intensive of power projects  reaching final investment decision in Europe.

At the same time, the electricity sector has also witnessed rapid growth in new, less capital-intensive business models that leverage digital technologies to provide system and consumer services. One such approach, the VPP model aggregates and trades small-scale energy resources on wholesale markets, creating revenue streams for owners of distributed generation, battery storage and demand response, by providing coordinated balancing and ancillary services to grid operators. In 2017, VPPs managed over 10 GW of assets, a more than fivefold increase from 2014, though these equalled only around 1% of total generation capacity in Europe.  

To date, most VPPs, which rely on regulatory frameworks for market participation and a market design that remunerates distributed resources, have been led by independent developers with expertise in software development. Utilities have recently increased their role, in part through acquisitions. Such asset-light business models have the potential to avoid or defer expensive future capital upgrades, for example by limiting the network size to meet peak demand. The potential value proposition for utilities, developers and system operators remains an area for further analysis.     

Ultimately, future investment in the electricity sector will have an even stronger interaction with policies for energy security and the clean energy transition. In Europe, with anticipated thermal power retirements of over 20 GW in the next two years, questions persist over whether current market designs can deliver sufficient investment to ensure adequacy. Investment will depend on clear policy and market signals for renewables, grid modernization and other forms of flexibility, but also on the capabilities of governments to adapt regulations to changing technologies and business opportunities.

Regulatory frameworks for networks are evolving to facilitate more complex business models and gradually shifting to incentives based on cost efficiency, reliability and performance, rather than capital spending. Meanwhile, the economics of thermal generation will be determined by the interplay of capacity mechanisms, pricing carbon emissions and the evolution of power market fundamentals.

Finally, the evolving business cases for fast-growing new technologies, such as battery storage, electric vehicles and other electrification trends have the potential to change investment needs and approaches for the system as a whole. All of these factors can raise uncertainties over investment decisions, but can also create further strategic opportunities.

Electricity sector business models are analysed in a number of IEA work areas, including World Energy Investment, Digitalization & Energy, analysis on electricity security and electricity market design, the World Energy Outlook, Energy Technology Perspectives and the Market Report Series. Source

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Australia’s commitment to affordable, secure and clean energy

MD Staff

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Australia should rely on long-term policy and energy market responses to strengthen energy security, foster competition, and make the power sector more resilient, according to the International Energy Agency’s latest review of the country’s energy policies.

In line with global trends, Australia’s energy system is undergoing a profound transformation, putting its energy markets under pressure. Concerns about affordable and secure energy supplies have grown in recent years, following several power outages, a tightening gas market in the east coast and rising energy prices.

Besides assessing progress since the IEA review of 2012, the Australian government requested the IEA to focus on how Australia can use global best practices in transitioning to a lower-carbon energy system. This question points to safeguarding electricity supply when ageing coal capacity retires, increased variable renewable energy comes on line and natural gas markets are tight. In this context, the IEA also contributed to the Independent Review into the Future Security of the National Electricity Market (NEM) by Chief Scientist Dr Alan Finkel.

“The government’s efforts to ensure energy security and move ahead with market reforms have been impressive. Australia can develop its vast renewable resources and remain a cornerstone of global energy markets as a leading supplier of coal, uranium and liquefied natural gas (LNG), securing the energy for growing Asian markets.” said Dr Fatih Birol, the IEA’s Executive Director, who presented the report’s findings in Canberra. “A comprehensive national energy and climate strategy is needed for Australia to have a cleaner and more secure energy future. The National Energy Guarantee is a promising opportunity for Australia to integrate climate and energy policy.”

Along with the United States, Australia is leading the next wave of growth in liquefied natural gas (LNG). As a major exporter of coal, Australia is also a strong supporter of carbon capture, utilization and storage technologies. The report commends Australia’s efforts which can be critical globally to meeting long-term climate goals.

The IEA’s review points out that the sustainable development of new gas resources is critical for natural gas to play a growing role in the energy transition, satisfying a growing domestic gas demand in power generation and industry and to honor export contracts at the same time. The report calls on Australia to continue efforts to improve transparency of gas pricing, boost market integration and facilitate access to transportation capacity.

Welcoming the government’s energy security focus, including the creation of the Energy Security Board, the Energy Security Office, and Australia’s plan to return to compliance with the IEA’s emergency stock holding obligations, the IEA recommends regular and comprehensive energy security assessments to identify risks early on, and foster the resilience of the energy sector.

In terms of power system security, the report offers a series of recommendations on how to improve the market design of the National Energy Market (NEM), one of the most liberalised and flexible power markets in the world. To accommodate higher shares of variable renewables, the IEA recommends that the NEM prioritises measures to safeguard system stability, enhance grid infrastructure, including interconnections, and regularly upgrade technical standards. As consumer choice and prices in retail markets are liberalised across Australia, the government needs to focus on wholesale competition and demand-side flexibility, in recognition of the changing ways energy is produced and consumed, thus contributing to reducing peak demand.

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5 myths about solar panels, debunked

MD Staff

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Home solar panels can drastically cut or even eliminate electricity bills, reduce a home’s carbon footprint, increase resale value, and may even help a home sell faster.

The cost of rooftop solar systems has fallen dramatically in recent years, and most homeowners have the option of buying the system, leasing it on reasonable payment terms, or having a third-party pay for and install the system at no up-front cost at all for the homeowner. Plus, home solar systems are eligible for federal tax credits.

All of this explains why the number of homeowners installing solar has sky-rocketed across America. Nevertheless, many homeowners remain skeptical about taking control of their energy use and installing solar. Why? The various myths that still persist around solar power could be the reason.

“Solar technology has been around for a long time, but even though it’s entered the mainstream, many homeowners are still skeptical,” says renewable energy expert Roger Ballentine, president of Green Strategies, a leading Washington-based consulting firm. “That’s because a number of myths persist, pointing to the need for better consumer education about the benefits of home solar installations.”

Ballentine points to private and government studies providing real information that debunks the myths surrounding solar power. For example, research by the U.S. Department of Energy’s National Renewable Energy Laboratory (NREL) and the Lawrence Berkeley National Laboratory found solar panels help homes sell faster and for more money than those without solar.

If you’re considering installing a solar panel system on your home, here are five common myths — and why you shouldn’t believe them:

Myth 1: Solar panels only work if you live in a warm, sunny climate

While solar panels work best when they get a lot of sun, a lack of bright sun doesn’t mean they’re not working. Panels can still absorb ambient sunlight, even on cloudy days or in regions that get less bright sun. What’s more, today’s solar panels are more energy efficient than ever. Newer systems like the “LG NeOn R” maximize sunlight absorption and generate the maximum possible output — as much as 26 percent more than other comparably sized solar panels. This higher efficiency means that solar panels can work in virtually any climate and every season.

Myth 2: You need a lot of roof space for solar panels

Just like other amazing technologies (think microchips), solar panels are getting smaller, more powerful and more efficient. High-efficiency panels take up less space because fewer panels are required to produce the electricity needed to power your home. So even a smaller home could have enough roof space to fit the number of panels needed to generate the necessary power and save you money.

Myth 3: Installation is a long, drawn-out hassle

While adding solar panels to your home isn’t a DIY project, installation usually takes only a day or two. New models streamline the process further, eliminating the need to install a separate inverter. Most solar panels require a separate inverter to bring electricity into your house, but new panels from LG, for instance, incorporate the inverter, simplifying and accelerating the installation process.

Myth 4: If something goes wrong, you’re on your own

As with any major investment in your home, you should make sure you understand the manufacturer and installer warranties for your solar panels, including how long the coverage lasts and what types of problems are covered. One leading solar player, LG, even offers an industry-leading, 25-year product and power warranty. And unlike a furnace or an air conditioning system, a solar installation has no moving parts to wear out and typically requires little maintenance and repair.

Myth 5: Solar panels will look big, bulky and ugly on your roof

Solar panels are becoming smaller, sleeker and more aesthetically pleasing. Higher-efficiency models are also offering increased flexibility of configuration. Instead of having to cover an entire roof with panels in a specific arrangement in order to generate power, modern options allow you to arrange panels to meet your sense of aesthetics.

Adding solar power to a home offers homeowners many benefits, from reducing energy costs, to increasing the value of your home and helping the environment, Ballentine says. “Overall, it’s a decision most homeowners feel positively about once they’ve made it.” The NREL notes in its study: “Buyers of homes with (solar panel) systems are more satisfied than are comparison buyers. A significantly higher percentage … indicate they would buy the same houses again.”

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ADB-Supported Kyrgyz Republic’s Largest Hydropower Plant Achieves Key Milestone

MD Staff

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photo: ADB

JSC Electric Power Plants (EPP), the major state-owned power generation company in the Kyrgyz Republic, today announced the award of a turn-key contract for the Asian Development Bank-supported (ADB) modernization of the Toktogul hydropower plant (HPP) to a joint venture of GE Hydro (France) and GE Renewables (Switzerland) for $104 million.

The modernization project includes new state-of-the-art units which will improve safety, efficiency, reliability, and availability of the Toktogul HPP, located on the Naryn River in the Jalal-Abad Province and considered the country’s largest and most important hydropower plant, increasing its overall capacity to 1,440 megawatts. The additional capacity will be sufficient to supply about 200,000 households for an entire year.

ADB and the Eurasian Development Bank (EDB) financed the replacement of four units of the Toktogul HPP, which has been generating about 6,000 gigawatt hours per year for 43 years. Because of aging equipment, however, the plant has experienced increasing number of failures in recent years.

“ADB has been supporting the energy sector in the Kyrgyz Republic since 1996 as the rehabilitation, replacement, and augmentation of power sector assets are critical for energy security in the country”, said Candice McDeigan, ADB’s Country Director for the Kyrgyz Republic.

“The phased rehabilitation of the Toktogul plant has been the key priority for ADB’s energy sector support in the Kyrgyz Republic and its timely rehabilitation is key to the country’s plan to export summer surplus to Afghanistan and Pakistan through the CASA-1000 power transmission line”, said Ashok Bhargava, Director for the Energy Division at ADB’s Central and West Asia Department.

EPP commenced phased rehabilitation of the Toktogul HPP project in 2012, starting with the refurbishment of the secondary electrical and mechanical equipment, the rehabilitation of two Toktogul units, and later completed by the remaining two Toktogul units, with an overall target completion by 2024-2026. The latest milestone was a result of the extensive competition among all major players and EPP’s innovative approach to procurement and design, which brought in competitive pricing and accelerated completion of the project by 3 years.

“In 2016, EPP decided to fast track the procurement of the four turbines and generators of the Toktogul HPP through single procurement for economies of scale, resulting to completion three years early. With ADB support, the EPP conducted multiple roadshows to improve the

procurement design based on industry feedback and international best practice to increase completion for the project,” said EPP General Director Uzak Kydyrbaev.

GE Capital, the ultimate parent of the GE consortium, has provided a guarantee to support its operation in the Kyrgyz Republic. GE has committed to commission the first unit by November 2020, and one additional unit each year by November 2023

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