Readiness tips for energy disruption

The energy sector faces huge disruption over the next few years, and some companies are better prepared than others.

The cost of solar energy, which has fallen by 70% since 2010, is expected to fall by a further 50% by 2020, Adnan Amin, head of the International Renewable Energy Agency (IRENA), said at the recent Abu Dhabi Sustainability Week — the existence of such an event since 2008 is itself another indicator of how much things are changing.

Meanwhile, costs for wind power and battery energy storage continue to decline, further adding to the pressure on conventional energy producers.

“There is now an understanding that there is an energy transformation underway — and the scale and pace of transformation is accelerating, which is leading to very significant structural changes to energy systems around the world,” Amin told reporters. “In power generation, we have passed the tipping point for renewable energy.”

This is leading to some astonishing developments — for example, Saudi Arabia, the world's largest oil producer, announced at the conference that it is planning to generate 10% of its electricity from renewable resources by 2023, up from virtually nothing last year. A year ago, in the words of Michael Liebreich, founder of research group Bloomberg New Energy Finance (BNEF), the country’s largest renewable energy project was the solar canopy on the car park at national oil company Saudi Aramco. Saudi Arabia says it wants to create a domestic clean energy supply chain capable of exporting to the rest of the world within five years.

The US is far from immune to these trends. By the early 2020s it will be cheaper to build new renewables than to continue running existing coal and nuclear plants, according to Jim Robo, CEO of NextEra Energy, which counts among its assets Florida Power & Light, America’s third-largest electric utility. Robo made those remarks to investors in January, according to a transcript of the company’s fourth-quarter 2017 earnings call. It won’t just be cheaper to build new renewables than to build new coal and nuclear power plants, but it will be cheaper to knock down existing plants and replace them with wind and solar.

The upheaval is driven not just by the cost reductions of the technology but also by an increased focus on air pollution concerns and demand for 100% renewable electricity from companies that signed contracts procuring 5.4 gigawatts (GW) of clean energy in 2017, according to BNEF.

In the World Economic Forum’s 2018 global risk report, four of the five risks that it says will have the biggest impact in the next five years are environment-related (extreme weather events; natural disasters; failure of climate change mitigation and adaptation; and water crises).

The shift to renewables will be exacerbated by the rapid advance of e-mobility. Tony Seba, an author and Silicon Valley entrepreneur who lectures at Stanford University, predicts that within a decade of autonomous vehicles being approved for operation, “all transport will be electric, autonomous, and on-demand”. This, he says, will massively cut the price of mobility and the number of cars on the road. Even without the push from autonomous, electric vehicle sales are set to rise by 40% this year, BNEF says. These cars represent a huge chunk of energy storage capacity that could easily be integrated into grids around the world.

All of this points to upheaval for the global energy sector, leading IRENA to set up a Global Commission on the Geopolitics of Energy Transformation, with the support of the governments of Germany, Norway, and the United Arab Emirates to “examine the immediate and longer-term geopolitical implications of global energy transformation driven by large scale-up of renewable energy in the context of global efforts to tackle climate change and advance sustainable development.”

It will also have an immense disruptive effect on the automotive sector, Seba pointed out. “It will disrupt the model of individual ownership and of gasoline-fuelled cars,” he said. “Transport-as-a-service fleets will own cars. They will be electric because electric vehicles [EVs], which have only 20 moving parts, can last for 500,000 miles. An internal combustion engine [ICE] car has 200,000 parts and will run for about 140,000 miles. That means that over a five-year time frame, for every EV travelling 100,000 kilometres, you will need 2.5 ICE cars.”

EVs are 80% cheaper per mile to run and 90% cheaper to maintain, Seba adds. “By 2021, a potential new buyer will have to face this choice — do I want to spend $50,000 to buy a new car or $1,000 a year on transport-as-a-service,” Seba said. “A large family will save $6,000 a year by not owning a car.”

Seba’s predictions are challenging, to say the least, but as he said, “Everyone loved horses, but 13 years after the introduction of the car, they were gone. Ten years ago, no one had a smartphone. Now, we all do.”

But despite this confluence of trends, there is complacency in the energy sector, Amin said, with OPEC leaders believing they have “another 30 years”. He and other observers believe this is overly optimistic. “Mobility technology is moving so fast that companies are having to change far faster than they planned,” Amin said. “We’re going to reach the point where real demand for oil will be impacted quite soon. It’s not going to be 30 years, for sure. We’re going to see indications of peaks in the next five to six years.”

Andrew Logan, director of oil and gas at sustainable investor network Ceres, said, “It was one of the stories of last year that change has happened much more quickly than a lot of incumbents had anticipated. Oil companies in particular were focused on the policy side and saw that moving quite slowly. They didn’t anticipate the technological changes and how quickly we are getting to convergence.”

There are real costs to this failure. New policies and taxes spurred by the Paris Agreement on climate change put significant amounts of profits at risk across a range of economic sectors, according to Trucost. The research group analysed almost 100 companies across 16 countries spanning electric utilities, chemicals, and automobile manufacturing sectors and found that the average profit at risk for the electric utilities sector could reach 90% by 2030 and exceed 150% by 2050. For the chemicals sector it could reach 30% by 2030 and 60% by 2050, and in automotive manufacturing the figure was 15% by 2030 and 30% by 2050.

The research showed that the pain is not spread equally. “The variation in risk exposure within sectors is significant and grows over time,” Trucost’s report said. By 2050, Trucost estimates that the profit at risk ranges from negligible to 600% for electric utilities and to 300% in the chemicals sector, and from 7% to 82% in automobile manufacturing.

One reason incumbent companies are being disrupted is that they are facing competitive threats from unexpected places — automotive manufacturers are having to deal with traditional competitors as well as companies such as Google and Apple. Those new players may not have experience in making cars, but they rival the carmakers in size and ambition. Traditional electricity generators face not only a host of new renewable energy technologies such as wind and solar but also carmakers from Tesla to Nissan offering energy storage products to homeowners and businesses.

Companies are reacting in different ways. “We’re starting to see a split in the oil industry,” Logan said. “Companies such as Shell, Total, and Statoil have taken significant steps to realign their strategies in line with the Paris Agreement by making significant acquisitions in clean energy. ConocoPhillips has been very thoughtful in this area. It was very early to do a low-carbon analysis, and it sold a lot of assets, including offshore and heavily polluting oil sands projects. Others seem to be taking a business-as-usual approach, particularly by investing in long-term oil and gas projects that may struggle in a low-carbon world.”

BP PLC’s annual energy outlook offers forward-looking scenarios that explore the implications of different judgements and assumptions. The company stresses that the scenarios are not predictions. In the 2018 outlook, it says that demand for oil grows for much of the period between now and 2040, hitting a plateau in later years. The transport sector, the BP outlook says, “continues to be dominated by oil (around 85% in 2040).” However, the outlook expects more passenger distance to be covered by EVs — 30% by 2040.

It is not just within sectors that there are different approaches — the oil industry and carmakers have differing views of how many electric vehicles there will be on the road. “Someone is wrong,” Logan said. “The carmakers are preparing for a future of much greater electric vehicle penetration than the oil companies are. There is no great historical track record of companies in any sector managing a transition of this scale and pace well.”

How companies can prepare for the energy transition

• Know your carbon risks. If you don’t already know it, find out your carbon footprint and which parts of the business are most carbon-intensive. You should also carry out a legal and regulatory audit to measure exposure to current and potential future rule changes.
• Incorporate renewable generating capacity into your energy mix. More customers, corporate and individual, want to buy clean energy. If they cannot buy it from you, they will buy it from someone else.
• Embrace change and look for new opportunities. The decarbonisation of the economy cannot be avoided and it will cause upheavals, but there will be winners as well as losers. Is your business strategy sustainable in the long term? Oil and utility companies are buying into areas ranging from solar and wind projects to energy storage and electric vehicle charging points. Auto companies are facing challenges from software groups to ride-hailing firms as the very nature of what constitutes a car comes under challenge.
• Future-proof your operations. Take advantage of resources from organisations such as the CDP (formerly known as the Carbon Disclosure Project) and RE100, which provide guidelines to help companies become more sustainable.
• Adopt an internal carbon price. This will help limit investments that could become stranded assets in future years, and prepare you for a carbon-constrained world.

— Mike Scott is a UK-based freelance writer. To comment on this article or to suggest an idea for another article, contact Neil Amato, an FM magazine senior editor, at Neil.Amato@aicpa-cima.com.