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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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Energy

Indonesian Coal Roadmap: Optimizing Utilization amid Global Tendency to Phasing Out

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Authors: Razin Abdullah and Luky Yusgiantoro*

Indonesia is potentially losing state revenue of around USD 1.64-2.5 billion per year from the coal tax and non-tax revenues. Although currently Indonesia has abundant coal resources, especially thermal coal, the coal market is gradually shrinking. This shrinking market will negatively impact Indonesia’s economy. The revenue can be used for developing the country, such as for the provision of public infrastructures, improving public education and health services and many more.

One of the main causes of the shrinking coal market is the global tendency to shift to renewable energy (RE). Therefore, a roadmap is urgently needed by Indonesia as a guideline for optimizing the coal management so that it can be continuously utilized and not become neglected natural resources. The Indonesian Coal Roadmap should also offer detailed guidance on utilizing coal for the short-term, medium-term and long-term.

Why is the roadmap needed?

Indonesia’s total coal reserves is around 37.6 billion tons. If there are no additional reserves and the assumed production rate is 600 million tons/year, then coal production can continue for another 62 years. Even though Indonesia’s coal production was enormous, most of it was for export. In 2019, the export reached 454.5 million tons or almost 74% of the total production. Therefore, it shows a strong dependency of the Indonesian coal market on exports, with China and India as the main destinations. The strong dependency and the global trend towards clean energy made the threat of Indonesian coal abandonment increasingly real.

China, one of Indonesia’s main coal export destinations, has massive coal reserves and was the world’s largest coal producer. In addition, China also has the ambition to become a carbon-free country by 2060, following the European Union countries, which are targeting to achieve it in 2050. It means China and European Union countries would not produce more carbon dioxide than they captured by 2060 and 2050, respectively. Furthermore, India and China have the biggest and second-biggest solar park in the world. India leads with the 2.245GW Bhadla solar park, while China’s Qinghai solar park has a capacity of 2.2GW. Those two solar parks are almost four times larger than the U.S.’ biggest solar farm with a capacity of 579 MW. The above factors raise concerns that China and India, as the main export destinations for Indonesian coal, will reduce their coal imports in the next few years.

The indications of a global trend towards RE can be seen from the energy consumption trend in the U.S. In 2019, U.S. RE consumption exceeded coal for the first time in over 130 years. During 2008-2019, there has been a significant decrease in U.S coal consumption, down by around 49%. Therefore, without proper coal management planning and demand from abroad continues to decline, Indonesia will lose a large amount of state revenue. The value of the remaining coal resources will also drop drastically.

Besides the global market, the domestic use of coal is mostly intended for electricity generation. With the aggressive development of RE power plant technology, the generation prices are getting cheaper.  Sooner or later, the RE power plant will replace the conventional coal power plant. Therefore, it is necessary to emphasize efforts to diversify coal products by promoting the downstream coal industries in the future Indonesian Coal Roadmap.

What should be included: the short-term plan

In designing the Indonesian Coal Roadmap, a special attention should be paid to planning the diversification of export destinations and the diversification of coal derivative products. In the short term, it is necessary to study the potential of other countries for the Indonesian coal market so that Indonesia is not only dependent on China and India. As for the medium and long term, it is necessary to plan the downstream coal industry development and map the future market potential.

For the short-term plan, the Asian market is still attractive for Indonesian coal. China and India are expected to continue to use a massive amount of coal. Vietnam is also another promising prospective destination. Vietnam is projected to increase its use of coal amidst the growing industrial sector. In this plan, the Indonesian government plays an essential role in building political relations with these countries so that Indonesian coal can be prioritized.

What should be included: the medium and long-term plans

For the medium and long-term plans, it is necessary to integrate the coal supply chain, the mining site and potential demand location for coal. Therefore, the coal logistics chain becomes more optimal and efficient, according to the mining site location, type of coal, and transportation mode to the end-user. Mapping is needed both for conventional coal utilization and downstream activities.

Particularly for the downstream activities, the roadmap needs to include a map of the low-rank coal (LRC) potentials in Indonesia, which can be used for coal gasification and liquefaction. Coal gasification can produce methanol, dimethyl ether (a substitute for LPG) and, indirectly, produce synthetic oil. Meanwhile, the main product of coal liquefaction is synthetic oil, which can substitute conventional oil fuels. By promoting the downstream coal activities, the government can increase coal’s added value, get a multiplier effect, and reduce petroleum products imports.

The Indonesian Coal Roadmap also needs to consider related existing and planned regulations so that it does not cause conflicts in the future. In designing the roadmap, the government needs to involve relevant stakeholders, such as business entities, local governments and related associations.

The roadmap is expected not only to regulate coal business aspects but also to consider environmental aspects. The abandoned mine lands can be used for installing a solar farm, providing clean energy for the country. Meanwhile, the coal power plant is encouraged to use clean coal technology (CCT). CCT includes carbon capture storage (CCS), ultra-supercritical, and advanced ultra-supercritical technologies, reducing emissions from the coal power plant.

*Luky Yusgiantoro, Ph.D. A governing board member of The Purnomo Yusgiantoro Center (PYC).

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Engaging the ‘Climate’ Generation in Global Energy Transition

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photo: IRENA

Renewable energy is at the heart of global efforts to secure a sustainable future. Partnering with young people to amplify calls for the global energy transition is an essential part of this endeavour, as they represent a major driver of development, social change, economic growth, innovation and environmental protection. In recent years, young people have become increasingly involved in shaping the sustainable development discourse, and have a key role to play in propelling climate change mitigation efforts within their respective communities.

Therefore, how might we best engage this new generation of climate champions to accentuate their role in the ongoing energy transition? In short, engagement begins with information and awareness. Young people must be exposed to the growing body of knowledge and perspectives on renewable energy technologies and be encouraged to engage in peer-to-peer exchanges on the subject via new platforms.

To this end, IRENA convened the first IRENA Youth Forum in Abu Dhabi in January 2020, bringing together young people from more than 35 countries to discuss their role in accelerating the global energy transformation. The Forum allowed participants to take part in a truly global conversation, exchanging views with each other as well as with renewable energy experts and representatives from governments around the world, the private sector and the international community.

Similarly, the IRENA Youth Talk webinar, organised in collaboration with the SDG 7 Youth Constituency of the UN Major Group for Children and Youth, presented the views of youth leaders, to identify how young people can further the promotion of renewables through entrepreneurship that accelerates the energy transition.

For example, Joachim Tamaro’s experience in Kenya was shared in the Youth Talk, illustrating how effective young entrepreneurs can be as agents of change in their communities. He is currently working on the East Africa Geo-Aquacultural Development Project – a venture that envisages the use of solar energy to power refrigeration in rural areas that rely on fishing for their livelihoods. The project will also use geothermal-based steam for hatchery, production, processing, storage, preparation and cooking processes.

It is time for governments, international organisations and other relevant stakeholders to engage with young people like Joachim and integrate their contributions into the broader plan to accelerate the energy transition, address climate change and achieve the UN Sustainable Development Agenda.

Business incubators, entrepreneurship accelerators and innovation programmes can empower young people to take their initiatives further. They can give young innovators and entrepreneurs opportunities to showcase and implement their ideas and contribute to their communities’ economic and sustainable development. At the same time, they also allow them to benefit from technical training, mentorship and financing opportunities.

Governments must also engage young people by reflecting their views and perspectives when developing policies that aim to secure a sustainable energy future, not least because it is the youth of today who will be the leaders of tomorrow.

IRENA

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The Urgency of Strategic Petroleum Reserve (SPR) for Indonesia’s Energy Security

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Authors:Akhmad Hanan and Dr. Luky Yusgiantoro*

Indonesia is located in the Pacific Ring of Fire, which has great potential for natural disasters. These disasters have caused damage to energy infrastructure and casualties. Natural disasters usually cut the energy supply chain in an area, causing a shortage of fuel supply and power outages.

Besides natural disasters, energy crisis events occur mainly due to the disruption of energy supplies. This is because of the disconnection of energy facilities and infrastructure by natural disasters, criminal and terrorist acts, escalation in regional politics, rising oil prices, and others. With strategic national energy reserves, particularly strategic petroleum reserves (SPR), Indonesia can survive the energy crisis if it has.

Until now, Indonesia does not have an SPR. Meanwhile, fuel stocks owned by business entities such as PT Pertamina (Persero) are only categorized as operational reserves. The existing fuel stock can only guarantee 20 days of continuity. Whereas in theory, a country has secured energy security if it has a guaranteed energy supply with affordable energy prices, easy access for the people, and environmentally friendly. With current conditions, Indonesia still does not have guaranteed energy security.

Indonesian Law mandates that to ensure national energy security, the government is obliged to provide national energy reserves. This reserve can be used at any time for conditions of crisis and national energy emergencies. It has been 13 years since the energy law was issued, Indonesia does not yet have an SPR.

Lessons from other countries

Many countries in the world have SPR, and its function is to store crude oil and or fuel oil. SPR is built by many developed countries, especially countries that are members of the International Energy Agency (IEA). The IEA was formed due to the disruption of oil supply in the 1970s. To avoid the same thing happening again, the IEA has made a strategic decision by obliging member countries to keep in the SPR for 90 days.

As one of the member countries, the US has the largest SPR in the world. Its storage capacity reaches a maximum of 714 million barrels (estimated to equal 115 days of imports) to mitigate the impact of disruption in the supply of petroleum products and implement US obligations under the international energy program. The US’ SPR is under the control of the US Department of Energy and is stored in large underground salt caves at four locations along the Gulf of Mexico coastline.

Besides the US, Japan also has the SPR. Japan’s SPR capacity is 527 million barrels (estimated to equal 141 days of imports). SPR Japan priority is used for disaster conditions. For example, in 2011, when the nuclear reactor leak occurred at the Fukushima nuclear power plant due to the Tsunami, Japan must find an energy alternative. Consequently, Japan must replace them with fossil fuel power plants, mainly gas and oil stored in SPR.

China, Thailand, and India also have their own SPR. China has an SPR capacity of 400-900 million barrels, Thailand 27.6 million barrels, and India 37.4 million barrels. Singapore does not have an SPR. However, Singapore has operational reserve in the form of fuel stock for up to 90 days which is longer than Indonesia.

Indonesia really needs SPR

The biggest obstacles of developing SPR in Indonesia are budget availability, location selection, and the absence of any derivative regulations from the law. Under the law, no agency has been appointed and responsible for building and managing SPR. Also, government technical regulations regarding the existence and management of SPR in Indonesia is important.

The required SPR capacity in Indonesia can be estimated by calculating the daily consumption from the previous year. For 2019, the national average daily consumption of fuel is 2.6 million kiloliters per day. With the estimation of 90 days of imports, Indonesia’s SPR capacity must at least be more than 100 million barrels to be used in emergencies situations.

For selecting SPR locations, priority can be given to areas that have safe geological structures. East Kalimantan is suitable to be studied as an SPR placement area. It is also geologically safe from disasters and is also located in the middle of Indonesia. East Kalimantan has the Balikpapan oil refinery with the capacity of 260,000 BPD for SPR stock. For SPR funding solution, can use the state budget with a long-term program and designation as a national strategic project.

Another short-term solution for SPR is to use or lease existing oil tankers around the world that are not being used. Should the development of SPR be approved by the government, then the international shipping companies may be able to contribute to its development.

China currently dominates oil tanker shipping in the world, Indonesia can work with China to lease and become Indonesia’s SPR. Actually, this is a good opportunity at the time of the COVID-19 pandemic because oil prices are falling. It would be great if Indonesia could charter some oil tankers and buy fuel to use as SPR. This solution was very interesting while the government prepared long-term planning for the SPR facility. In this way, Indonesia’s energy security will be more secure.

*Dr. Luky Yusgiantoro, governing board member of The Purnomo Yusgiantoro Center (PYC).

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