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Sep 10, 2014

Consumers at the Gate

Has energy reached “peak centralization”?


Throughout history, societies have relied on a mix of distributed and centralized organizations. And technology in its modern form has often favored the centralizing tendencies in any society. For example, with transport, many people rely on centralized forms such as trains, trams, buses, and airplanes that adhere to rigid schedules. And even cars rely on central infrastructure such as oil refineries and distribution systems, highways, and bridges. The same could be said of snail mail and land-line telephones: they are services used by individuals, but that depend on centralized networks.

Centralization has also taken place in manufacturing, education, health care, and in government itself. And, of course, energy has become highly centralized, in the way electricity, natural gas, and oil are produced and distributed.

Yet there are signs that suggest that this tide of centralization may be turning, that we may have reached ‘peak centralization’.

Struggling centralized systems

Incumbent energy producers are already under pressure. Large central utilities, once the safe haven of dependable returns stemming from a stable, well-protected, capital-intensive business model, are losing public and regulatory support, money, and talent.

The cause is a change in the economics of the conventional energy business. Demand has actually fallen in many parts of the U.S. and EU, due in part to the recent recession and increasingly efficient energy use. Coupled with strong investment in distributed renewables in many markets, the centralized energy business has become more marginal. Incumbents are losing customers to attackers with lower costs and more appealing propositions or brands. The retail margins on the remaining customers have eroded and sometimes disappeared. Finally, forced decommissioning of older thermal generation is threatening to take away the remaining profit cushion.

Rattling at the gate

But whatever happens, all this may pale before the general trend towards decentralization, if it comes to pass. In that case, consumers will shift away from central production and large organizations. To understand how that transition will occur, it’s important to keep in mind that consumers don’t really consume electricity, gas, or oil. They consume hot water, warm and cool air, illumination, entertainment, information, transportation, chilled or frozen food, heat for cooking. They consume energy services, and what they know is when, where, and how they want those services.

And what is now changing perhaps more rapidly than anyone could have imagined even a few years ago is the nature of the relationship between these energy services and the primary energy upon which they rely.

The reason for this change is that the conveniences made possible in the past 200 years by the extraction, processing, and storage of fossil fuels come at an environmental price greater than anyone realized. Concern about climate change has led to the development of alternative sources of energy. The nature of these alternative sources is forcing a change in the nature of the complete energy system. For although there is enough—or more than enough—generation capacity, the variability of some of the key sources of renewable generation compared to traditional sources will drive a need for new system architectures to ensure security of supply at a reasonable cost.

One solution is to move to a more flexible mix of generating resources. Regulators are considering incentive schemes (such as capacity markets) and strategic generating reserves. But as ‘smart appliances’ are rolled out and new and unconventional players get in the game, consumers themselves may become key players in allowing demand to track varying supply based on the rapidly evolving ‘internet of things.’ It may turn out that the old paradigm of a centralized power grid slavishly following demand for energy services will no longer be much of a barrier.

Who will fund the necessary investments in these innovative grids and appliances, in transforming the generation mix and in renewables? Many of the traditional utilities have retreated from investments in conventional power generation, while they are also seen to be cutting back investments in renewable generation. Traditional retail suppliers have demonstrated limited capacity to revolutionize their relationship with their customers. Will new players step in? What will be their business models?

In many countries, energy costs are increasing. There are many reasons for this, including the cost of replacing aging infrastructure (in developed markets) or building new infrastructure (in developing markets), rising fuel costs, taxes, subsidies, and environmental regulation. The end result is that the shrinking cost of self-supply options such as photovoltaics is on a collision course with the rising cost of continued reliance on centralized power networks.

At the same time, consumers are already investing for a range of different reasons. About 20 percent of the large power users in Germany have made investments in photovoltaics, combined heat and power, or energy storage to meet their energy needs. Use of the centralized network is slowly eroding and some customers have even moved to ‘cut the cord’ altogether by adding local storage systems to their own renewable energy sources.

When customers decide to go completely off-grid, a fascinating effect takes place: for the remaining customers, costs to use the central system increase, triggering even more customers to go off-grid. So the adoption of self-supply, for instance from photovoltaic systems, sets in motion a virtuous circle in which the presumption of ‘round-the-clock, unfettered access to centralized production and delivery systems will become ever more costly—or less true.

But a complete ‘death spiral’ leading to the abandonment of all central power generation seems unlikely for the foreseeable future, as there will remain a large core of customers for whom going off the grid is not very easy: city dwellers. As a result, changes in consumer preferences and differences in consumer circumstances will be met by be a steady stream of new entrants offering innovative services—often with business models very different from those of the incumbents. In energy, these services range from lowest-cost offerings to premium green products. But new entrants are also emerging in the area of power equipment. Photovoltaics manufacturers and installers, financing companies, energy installation companies—each of them is trying to get close to the consumer.

This trend is getting help from regulators interested in giving consumers options for controlling their costs and sources of energy. For instance, a new law in California has created ‘community choice aggregation’ (CCA). This means that counties can wrest control of power procurement from their monopoly utility. Marin County (population: 265,000) created Marin Clean Energy, and Sonoma County (population:
491,000) created Sonoma Clean Power. The city of Boulder, Colorado, has recently voted to secede from the local monopoly provider in order to control its own energy choices, with the approval of state regulators. These are local power agencies that seek to procure cheaper and cleaner power than they were getting through their old utility.

Gates wide open

What would a completely decentralized energy sector look like? What lies beyond the obvious trends of more efficiency and more renewables?

In, say, 2025 you might hand-pick your energy source in your neighborhood. Already, for instance, a Dutch company called ‘Van de bron’ (‘From the source’) allows Dutch consumers to see which solar, wind, combined heat and power, or other energy source exists in their vicinity and buy their energy from there. Balancing services are provided by the network operator. No traditional retailer sits between the consumer and the producer. Energy generation becomes as sharable as lodging through AirBnB or cars through Lyft. And like these peer-to-peer platforms, it seems almost inevitable that some new entrant will seek to offer a ‘concierge’ service at a price that will make this sort of option attractive to a large and expanding consumer segment.

Helping this along will be an increasing value in the participation of demand to balance energy consumption with variable renewable supply. This will be made possible by a steady decoupling of the use of energy services from energy delivery. For some applications, such as refrigeration and water heating, this is already the case: they involve thermal storage, so their energy demand isn’t very time sensitive, and it is surprisingly easy and cheap to expand that functionality. There is vast potential to extend that to other energy services that traditionally required immediate energy delivery.

So let them in?

As a result of these developments, consumers won’t need to worry about how much energy they use, when they use it, and what the cost per kilowatt-hour is. Rather, they will concentrate on the services they get, and what these will cost per month or per year. Thanks to the ‘internet of things,’ consumers can share with an ‘energy services provider’ what equipment and devices they use and receive targeted proposals for the delivery of their services.

Amid all those changes, the concept of a utility will become lost. To stay in the race, companies need to invent, develop, and market exciting, decentralized energy products. As these are usually not the core skills of current energy companies, and as their privileged regulated access to customers disappears, new companies will take over—companies with more positive and exciting brand identification for consumers than the utilities they have been forced to rely upon for so many years.

But won’t the big centralized energy companies simply be supplanted by big centralized information companies? Possibly, but the battle over control of information has raged for some time and will be decided on a broader stage. What is new for the energy industry is that, for the first time in many decades, consumers may have a prominent voice in deciding who wins.

And what remains for the incumbents? In the spirit of decentralization, they may break down the functional silos and cut off parts of the company that can survive on their own in the global network. Complexity, cost, and lack of ownership will outweigh the synergies upon which they used to rely. The winners will be those players, whether new entrants or hived-off components of incumbents, that can empower customers to decouple their enjoyment of energy services from a sustainable but increasingly unresponsive portfolio of primary energy sources.

Jurriaan Ruys is CEO of the Land Life Company, active in sustainable agriculture and nature restoration. He experience also includes past roles as partner at McKinsey & Company, COO of Dutch utility Eneco, and chemical engineer at Shell. Michael Hogan works on electricity decarbonization policy with the Regulatory Assistance Project. He previously led the European Climate Foundation’s Power Programme and holds master’s degrees from both Harvard and MIT.

A version of this article originally appeared in The Colours of Energy: Essays on the Future of Our Energy System. Adapted with permission.

Image courtesy of Shutterstock.


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