Tulsa, Oklahoma, USA — The share of renewable energy in overall electricity generation increased from 13 to 16.6 percent between 2001 and 2008 in EU and from 7.7 to 9.1 percent between 2001 and 2008 in the U.S. When looking only at “new” renewables, excluding hydro, they thus constitute the most dynamically growing segment in the overall mix. Figure 1 displays the growth path by renewable energy source in the U.S. and the E.U.
Wind is the main driver of the increasing renewable share in both geographies. In the EU, biomass CHP drives growth and solar photovoltaics begins to show increasing penetration. In the U.S., neither biomass nor solar PV shows a significant upward trend in power generation through 2008.
The key assumptions underlying the discussion in this article are:
- The growth trend for power generation from renewable energy sources will continue and
- The relative share of distributed technologies such as PV and biomass CHP will increase.
The degree to which both assumptions will hold true is greatly dependent on policy making.1
In the U.S., 29 states have mandated renewable portfolio standards addressing electricity sales. These range mostly between 20 to 25 percent of 2020/2025 electricity sales, thus indicating a significant increase compared to the national average of 9.1 percent share in generation. Federal support such as the production tax credit (PTC) as well as Department of Energy funding support the implementation of these state-level goals.2
Different than in the U.S., all 27 EU member states adopted binding renewable energy targets comprising power, heat and transport. While varying between members, they show high levels of ambition stipulating two, four or even six fold increases within 15 years. The overall target is a 20 percent share in energy consumption by 2020. The EU Commission expects that at least 35 percent of EU power generation will then come from renewable energy.
Given these clearly defined political targets and ongoing implementation efforts, we feel that Assumption 1 is a safe bet for the coming 10 to 15 years. With regard to Assumption 2, the precise way the political support systems are designed to foster distributed sources is crucial.
In Europe, wherever policies are favoring a least-cost approach, neither PV nor most biomass applications can compete against on-shore wind.3 Many countries such as Germany, Spain and France decided to provide technology-specific feed-in tariffs (FiTs) or have supplemented renewable quota obligations to ensure sufficient returns for investment in distributed technologies (for example, the UK and Italy).
In the U.S., the prevalent renewable portfolio standards (RPS) at the state level are designed to follow a least-cost approach. Players will choose the most economic way to fulfill their obligation: wind parks, in most cases. In many states, however the RPS is modified by “set aside” quotas or credit “multipliers” for specific technologies. Solar, in particular, but also other distributed generation technologies, are required by, for example, a 4 percent “solar quota” in New Mexico, a 4.5 percent “customer sited” generation share in Arizona or a 2x multiplier for all non-wind technologies in Texas.4 An emerging policy trend in the U.S. is the implementation of FiTs; for example, the introduction of a cost-based FiT for solar applications in Gainsville, Fla. and the considerable interest in the example of Ontario in Canada.5
Taking into account these policy trends and the increasing difficulties with integrating large amounts of wind power in the grids, we think Assumption 2 regarding the increasing role of distributed biomass and PV describes a likely scenario.
We thus view it as very likely that the renewables share will grow significantly and it is likely that a more broad-based technology portfolio will be incentivized or mandated by policymakers. It follows that utility companies need to have answers to two strategic questions: (1) Should a utility add distributed renewable energy technologies to its generation portfolio? And, if so, (2) which business models would be suitable to do so?
Should a utility add distributed renewable energy technologies to their generation portfolio? Short answer: Yes, in most cases.
Distributed renewable energies pose challenges to utilities and provide opportunities. Figure 2 sums these up.
Among the key challenges is the simple question if a utility can afford to lose generation market share. If other players are taking advantage of the support policymakers are willing to provide for distributed renewables and build up customer base as well as know-how. Also, homeowners and commercial clients increasingly like the idea of being independent from energy price developments, for example, by installing solar roof-top or biomass cellar systems. This ultimately endangers not only the sales volume but the entire client relationship. Hence, any utility should develop a strategic understanding if it can afford not to offer products and services in the growing renewable energy segment of their home market. If overall electricity consumption in a specific market grows less dynamic than the renewable share, the utility will need to answer the difficult question of whether it might be better to displace its own conventional capacity rather than having this capacity displaced by someone else.
At the same time, strategic opportunities exist for those ready to capitalize on them. Diversifying risks early by supplementing a portfolio with distributed renewable energies might bring multiple benefits ranging from positive analyst ratings and end-consumer image to political goodwill. While “green energy” might be a niche segment now, it can become a sizable segment. Also, distributed power generation can become a stepping stone to a smart home/smart grid future that might fundamentally change market dynamics for utilities in the future. Hence, developing a diversified renewable energy portfolio can be more than a reaction to a perceived threat, but a proactive way to capture business opportunities.
Which business models would be suitable for utilities to enter distributed renewables? Short answer: there is no silver bullet.
There is no limit to the level of detail which describes a business model, particularly in a dynamic and heterogeneous environment like renewable energy. In the following, a rough characterization of renewable energy business models for utilities is offered along selected dimensions:
- Technology and typical project size
- Main value proposition
- Value chain configuration
Project size is a key driver. It impacts the availability of project locations, the eligibility for support and feasibility of grid connection and thus the overall financial viability of a project. Figure 3 displays typical project size by technology as observed today for new capacity installations. Obviously, market dynamics and business models are vastly different in a market where project numbers can be in the thousands compared to one where a few dozen projects make up the same installed capacity.
In the following, primary utility business models are discussed along the selected dimensions.
Wind power has evolved to be a mid- to large-scale business, with project sizes for wind parks from a minimum of around 10 MW to an observed maximum of around 1 GW. This was driven by significant technological progress in turbine size, but also is due to the economies of scale in project siting and development. At the same time, it diluted the “distributed” nature of wind significantly. Large parks are often located at significant distances from consumption centers thus impacting grid utilization patterns.
The main value proposition of an investment in wind capacity from a utility point of view is that it provides a comparatively low levelized cost of electricity over system lifetime. Also, it is suitable to significantly increase installed renewable energy nameplate capacity at a relatively low investment cost. This is relevant as corporations tend to set targets in simple terms. While still undergoing dynamic technological development, it is proven and a broad supplier base is available. Hence, wind allows utilities to deploy significant capacities comparatively quickly by focusing on obtaining permits and financing for large-scale projects, as well as selecting and managing experienced technology and service suppliers.
While utilities are experienced in this, it is not a particularly differentiating skill that would underline a utilities’ specific value proposition. More relevant is the ability to find finance at attractive rates. Here, cash-flow-rich utilities are usually better off than smaller wind power project developers.
Regarding the supply chain, a strategic view on project development and turbine procurement is key, as good sites and low initial capital expenditure are the most important drivers of financial viability. The supply bottlenecks for key components during 2006 to 2008 underlined this. Some utilities entered strategic partnerships or large volume contracts to ensure supply at competitive cost. Others boosted their know-how base by acquisition of wind project developers or the targeted hiring of wind specialists, while staying clear of further vertical integration. With the financial crisis, some bottlenecks were relieved, but given the ongoing dynamism, ensuring supply of technology and qualified human resources remains a key success factor.
The main market for biomass projects, as depicted in Figure 3, is in a much narrower, mid-scale size ranging from 0.5 to 10 MWe. This refers to CHP generation, for example from woodchips or biomass-derived methane. Larger projects are usually of singular nature as the availability of biomass and the demand for base load heat tend to be locally limited. Biomass CHP plants are thus usually closer to demand and more distributed than large wind parks.
The main value proposition of utilities engaging in biomass CHP is the combination of electricity generation with heat sales for example to district heating networks or to municipal or industrial consumers. Biomass is an option to “green” for example an existing contracting offering, that is combining optimization of consumption with a modernization and/ or fuel switch. Utilities thus can help their clients to become more sustainable while bolstering long-term client relationships.
The value chain of biomass fuel supply is challenging as forestry or agricultural markets tend to be structured locally/regionally, posing risks to the long-term viability of projects. For this reason, the first wave of biomass development mostly addressed biomass substrates from waste, as these are available more reliably and at low cost. While most utilities active in biomass have relied on contractual frameworks with foresters, farmers or waste sector players, some players are integrating the fuel supply by buying or leasing land to supply for example short rotation biomass.
Photovoltaic offers the broadest range of application sizes due to its modular character. Typical roof-mounted household systems range between 3 to 6 kWp, while commercial rooftops reach up to several hundred kilowatts-power. Industrial applications can be in the megawatt class, partly still on rooftops, but with size above 2 to 3 MWe mostly as ground-based systems. The largest ground-based PV power plants reach 50 to 80 MWe, with announcements for systems reaching over 200 MWe.
The main value proposition of a utility in the PV business is less obvious than in wind or biomass. Project development skills needed are not similar to conventional power installations and constitute a relatively low value added compared to the high investment cost. Nevertheless, in countries with significant PV support schemes, utilities decide to participate in low risk, regulated schemes, for example under FiTs. End customer access of utilities, however, could be leveraged in two mayor ways: either to support customers in the planning, purchase and installation of their PV system or to offer leases and standardized products to maintain ownership of roof-mounted systems while sharing profits with the final customer. Also, PV can serve as a distributed source of peak load capacity. This can be leveraged by utilities which are integrating PV into “smart” grid management approaches.
Regarding value chain positioning, some utility players have formed strategic alliances with PV producers to enable producer’s investment in production capacities. Examples are SCE and EdF with First Solar and Enel of Italy with Sharp. Others, such as E.On in Germany hold stakes in PV technology producers and have installed plants with “in house” produced modules. At the same time, PV producers/ installers become utilities. Several players moved “downstream” and sometimes include maintaining minority ownership stakes in plants as this builds trust with investors and helps to develop new markets for their core product.
Checklist for Portfolio Strategy
As each technology choice brings with it its particular set of options regarding business models, utilities need to do more than to “pick” a technology and start to develop projects. Instead, they need to embed such a choice within a systematic renewable energy strategy. A set of key strategic choices to be made is included in Figure 4.
We highlight three questions that we see our utility clients frequently working on:
1. Do we have/can we build the required competencies?
Even large utilities do not usually have all it takes to successfully engage in renewable energy project development. While certain project management skills are similar, renewable energy technologies provide specific technological challenges as well as regarding support systems, regulatory demands and supply chain bottlenecks. Many players went through significant learning curves. Hence, utilities entering late often buy such competencies, sometimes together with a pipeline of projects to ensure a sizable and speedy impact on their portfolio.
2. What is the impact on risk position and profitability?
While utilities also enter renewables to reduce overall risk exposure, for example of a heavily coal-dominated generation portfolio, managing risks at the project level is often a significant challenge for new players. This includes technology risks, as all renewable technologies are still developing dynamically and lack a long track record. Furthermore, supply chain risks, for example, regarding biomass supply or when dealing with bottlenecked technology markets in wind and PV, need to be managed.
Profitability often strongly depends on the incentive system in place. While this reduces the financial risk, policy makers usually set support levels in ways to allow only for modest returns. Realizing attractive returns is nevertheless possible by combining prime project conditions with efficient project development and optimal usage of available support. For late entrants, such a combination is more difficult to find than for experienced players. This can lead to somewhat unattractive returns in initial projects, which might put the overall strategic move to enter renewable energy in jeopardy. Hence utilities need to build competencies quickly while at the same time managing shareholder expectations. For this they need a clear view regarding the evolution of portfolio profitability, taking into account learning curve effects and the development of policy and technologies.
3. What is the right business model to sustain growth?
Utilities are large corporations with significant overhead cost that are rolled over to be borne by projects. When competing for mid-scale projects (for example in biomass or PV) a full allocation of these overhead cost to a project business case often prices a utility out of the market. Adopting a lean approach while identifying projects where the specific utility value proposition offers additional benefits is thus key. Hence, a holistic business model, where organizational and partnership structures are adjusted to the focus project size and client segment is crucial. Utilizing synergies with existing offerings in contracting, heat supply and grid management are examples where utilities differ from renewable specialists or independent power producers and could generate an edge to develop projects successfully.
- For an exhaustive discussion of all significant drivers of renewable energy growth please see for example the discussion paper “Renewable energy markets – will the boom go bust?” by Jochen Hauff and Orlando Wagner, www.atkearney.com. Also published in the proceedings of PennWell’s Renewable Energy World Europe Conference, Milan 2008.
- Wiser and Barbose, LBNL 2009.
- Compare for example: International Energy Agency (IEA): Deploying Renewables – Principles for effective policies. Paris 2008.
- See Wiser and Barbose, LBNL 2009
- See, for example, Paul Gipe’s account of FiTs at www.wind-works.org
Jochen Hauff is Global Sustainability program manager with A.T. Kearney based in Berlin, Germany. Patrick Haischer is a principal with A.T. Kearney and is based in New York City. Kish Khemani is a partner with A.T. Kearney and is based in Chicago.