The energy world is changing fast. Investments into renewable energy are outpacing investments into conventional energy. The incumbents, unused to this pace of change and tied down by large asset bases and long-term investment strategies, are struggling.
The first to be hit were the utilities in developed countries with a high share of renewables in the electricity mix. But other industries relying on conventional energy sources are now feeling the heat, too: Large electrical component manufacturers like GE, Siemens, and ABB are scrambling to maintain their central positions in the electricity industry. Oil companies, for decades the unassailable behemoths of the global economy, have been underperforming for investors over the past few years as the risks, costs, and complexities of their business has risen sharply. They struggle to replace oil resources at competitive rates. (Here is an excellent analysis by BCG on this: “Big Oil’s Road to Reinvention.”) In addition, as the recent Exxon case shows, they see climate change as an existential threat — to their business, rather than to mankind.
And now, even car companies are in trouble. Not only because of the vast diesel scam that engulfs many more manufacturers aside from VW — the result of relentless pressure from environmental standards. They also, finally, seem to be concerned about disruptive innovation from electric mobility, like Tesla or the Google car (see this excellent recent article).
The overall business environment is clearly shifting towards a clean energy future. Just a couple of days ago, the ambitious Paris Climate Agreement was signed by 177 countries. Ever more investors are making sustainability a part of their strategy, channelling trillions of dollars in greener directions. The UN-backed Principles of Responsible Investing initiative, for instance, which provides a minimum code of conduct, has signatories managing $59 trillion — or half of global asset wealth (see article).
While some investors do this for environmental concerns, most do it out of sound business risk assessment: old energy has a big “licence to operate” problem. In response, companies are beginning to improve their sustainability footprint and their way of doing business. Some adjust their product portfolios and corporate strategies.
In addition, political regulations are more favourable to resource efficiency and renewables in more countries than ever before. As new energy technologies are becoming ever more competitive, and politicians, consumers, and businesses see this as a great opportunity rather than as a threat, regulatory support will likely grow. This trend has not been dampened even by the sudden and huge fall in oil prices.
Yet, it seems really difficult to earn money with this monumental, global energy transition. Why is this the case?
The trouble is, the global energy transition is threatening conventional energy markets without yet having created functioning new markets. Both the risk-taking, disrupting pioneers as well as the asset-heavy, path-dependent incumbents are often at a loss. “We haven’t totally figured out exactly what the business models are going to look like — who wins, who loses,” says Jason Bordoff, director of the Center on Global Energy Policy a Columbia University. So where is the market stuck?
- Cost: Renewables and energy efficiency might just not be cheap enough yet to radically disrupt the way people use and buy energy. Storage at a fourth of today’s cost would be a game changer. Solar, while competitive with grid power in many countries, still needs to be much cheaper to really become an unbeatable option (see, e.g., the “value of solar” argument put forward by Shayle Kann and Varun Sivaram). The same is true for energy efficiency solutions. The new energy world will have different structures from the current one (more distributed, smarter, more versatile, etc). There is a “hassle factor” as societies, economies, and consumers need to change their way of operating. They will only do that and overcome their inertia if the new option is much more attractive than the old. How much is “much more?” That is anyone’s guess. Maxine Ghavi of ABB once suggested that new options need to be at least 30% cheaper at the same or better functionality.
- Size: New energy is still small in size compared to old energy. An oil company can spend tens of billions of dollars on developing a new oilfield. A utility can spend billions on a new large coal, gas, hydro, or nuclear power station. Renewables investments are still counted in millions. Tesla sells tens of thousands of cars. GM, VW, or Toyota alone sell millions. Why does that matter? Because it makes it almost impossible for the old energy players to change toward new energy. They are simply too large. They employ hundreds of thousands of people and have management structures and corporate cultures designed for large, long-term investments. They would need to become much smaller to fit through the narrow doors leading to future growth. And who wants to become smaller?
- Differentiation and technology: Renewables and power grids are surprisingly conservative industries. New technologies are difficult to finance. Solar is the best example: PV technology, which dominates the market, has become a commodity. Successfully developing solar projects is now a financing game. Along the entire value chain, there are few unique selling propositions that could protect margins. As a result, very few people actually make money.
I think it takes great strategic courage — and at scale — to be a winner of the global energy transition. Existing, large energy companies will find it difficult to succeed. They must risk a lot (yet, what is their alternative?) and their shareholders are typically not venture capitalists but seek stable, regular returns.
There are investors ready to bet on change-makers: new technology, new platforms and infrastructure, and customer access. In a fast-changing world, who knows the many ways in which this can eventually be capitalised? This approach can work, as it seems in the case of Tesla (or earlier in other technology companies like Google, Facebook, etc.), and pay off enormously. But it might also not pay off, as in the case of SunEdison or Abengoa or Q-Cells.
The challenge for the new disruptors is that: Firstly, it might take too long for markets to change and investments to generate a return. Companies and their investors might run out of cash and patience. Secondly, the early movers might not be the winners. While their spending on educating customers, fighting regulations, or building new organisations is essential for the overall market development, it might not pay back for them. Many of the companies that will really benefit from the revolution in the way we generate and use energy are probably not around yet.
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