Navigant Research Blog

The Future of Energy: Open or Closed?

— January 20, 2015

Among technology giants, two predominant business models dictate the way in which consumers connect (and interact) with the broader Internet and the way in which innovation unfolds: open and closed.  This tug-of-war between open versus closed has been going on ever since the Internet first started to hit the mainstream.  As described by GigaOM, “It’s a battle that has been at the heart of the technology industry for most of its modern history.”

Open models seek to facilitate universal access and maximize creativity, but potentially breed chaos, error, and design catered to the lowest common denominator.  Closed systems limit the number of participants and exert more control over the flow of information, but can make it easier to roll out dynamic products while minimizing the potential for error.  In more specific terms, it’s a battle between the Google, Android, and Adobe business models and those of Facebook, Apple, and Microsoft.  Each carries with it specific advantages and disadvantages.

Advent of the Cloud

Although still in its infancy, in the emerging Energy Cloud, the battleground is divided similarly, with advocates of open and closed models both beginning to stake claims.

The Energy Cloud – the end result of an evolutionary shift away from a financial and engineering model that relies on large centralized power plants owned by utilities to one that is more diverse, in terms of sources of generation and ownership of assets, and enables the integration of new, distributed energy resources in addition to traditional generation – provides a rich ecosystem for breeding innovation as energy becomes increasingly democratized.  As depicted in the graphic below, the hallmark of the Energy Cloud is a shift away from one-way power flows to bidirectional flows in which consumers become both consumers and producers of power:

The Energy Cloud

(Source: Navigant Research)

Lessons from the Revolution

There are many lessons from the Internet revolution that can be applied to the Energy Cloud.  Open and closed Energy Cloud models alike must balance the need for access, reliability, safety, and ultimately, innovation.

The question comes down to this: will the Energy Cloud take the form of a walled garden, as CompuServe and America Online attempted in the early days of the Internet and Facebook is doing today, or will it remain an open landscape?  Or, perhaps of more relevance to stakeholders, which model best serves the goal of fostering a thriving, ubiquitous Energy Cloud?

Likely, both open and closed models will play key roles, as the Energy Cloud will serve multiple objectives simultaneously.  According to an essay on the topic from PricewaterhouseCoopers, innovation is almost never an either/or choice.  As most companies have discovered, their innovation goals involve a complex mix of closed and open models that is uniquely tailored to their specific innovation objectives.

Customers and Providers

For the incumbent utility, for example, objectives remain focused on preserving market share and maintaining safety and reliability while also growing profitability.  For the consumer, access to inexpensive and reliable power around the clock and choice in how and by whom their energy is produced remain key objectives.  Some stakeholders will seek to maximize either one of these positions, while others will seek to bridge the two.

In either case, the emergence of the Energy Cloud will require a rethinking of standards, protocols, and relationships among stakeholders.  With a slew of innovative technologies gaining market share – solar PV, distributed storage, home energy management systems – the integration of these assets into an efficient and resilient system remains among the greatest challenges ahead for all Energy Cloud stakeholders, and will likely be where the greatest emphasis on innovation will occur.

 

How Oversupply Could Benefit the World Oil Market

— January 19, 2015

For economists, it has been fascinating to watch what’s been happening in the oil & gas market since OPEC’s meeting in November, when it decided (driven by Saudia Arabia) to maintain production of 30 million barrels of oil per day.  This decision, combined with the sharp rise in U.S. production and a decrease in demand driven from China’s slowing economy, has sent oil prices to their lowest levels since May 2009.  Saudi Oil Minister Ali al-Naimi has explained that OPEC’s reason for maintaining the production level is to recoup market share lost to what he considers high-cost or inefficient non-OPEC oil producers, such as Russia, Brazil, and Canadian tar sands producers.  Of course, there’s also a geopolitical side to the story, but let’s take a deeper look at the situation in economic terms.

The demand for oil is fairly inelastic to price; that is, as the price changes, demand stays relatively consistent, especially in developed countries.  As such, OPEC has been able to essentially set the price of oil by choosing how much to produce.  Over the past 5 years, however, non-OPEC oil production has exploded, especially in the United States.  The country, which was OPEC’s biggest customer only 10 years ago, is now the world’s largest producer of total oil (crude and natural gas liquids) and moving toward self-sufficiency.

Consumers’ Delight

OPEC has typically responded to increases in non-OPEC oil supply by cutting its own production in order to keep the price of oil above $80 per barrel.  Now it appears the oil market and OPEC have reached a turning point as the huge influx of supply and a slowing of demand growth from China and Europe (among other reasons) have sent the price of oil on a steady decline since June.

At the meeting in November, OPEC ministers faced unenviable choices.  They could cut production in order to raise the price of oil and increase their margins in the short term, but this would not have served them in the long run.  If only OPEC cuts production, not only do their competitors share the benefit of higher margins, but also OPEC concedes more market share.  Instead, OPEC decided to forego profits in order to thin out the herd.  By declining to cut production, the Saudis hopes to drive higher cost producers out of business while giving oil-consuming economies a shot in the arm.

Thinning the Herd

As my colleague Richard Martin has pointed out, the stronger members of OPEC (i.e., Saudi Arabia and Kuwait) can likely withstand drastic price declines, while the weaker members (Venezuela, Iran, Nigeria, and Algeria) could face economic disaster.

The current market trajectory will end up benefiting those countries that have a comparative advantage in oil production, as it should, and it’s likely that the market will be left more efficient and better off in 2 to 5 years as a result.  According to some, the U.S. might actually be better positioned for a price war than Saudi Arabia, which as a society has grown accustomed to the benefits of $100/barrel oil.  According to Naimi, we may never see $100/barrel oil again.  As far as he’s concerned, Saudi Arabia and OPEC will see this price war through, regardless of how low it goes: “Whether it goes down to $20, $40, $50, $60, it is irrelevant.”

As for the effects of all this on the natural gas market and renewables, that’s for another blog.  The December issue of Navigant’s NG Market Notes includes a great infographic about the breakeven prices of oil for producers around the world.

 

The Energy Efficiency Way to Emissions Reductions

— January 15, 2015

The Obama administration has few levers to pull to shift the United States’ position on climate change, besides enforcing the Clean Air Act of 1970.  That legislation authorizes the U.S. Environmental Protection Agency (EPA) to enforce regulations on power plants and associated pollutants.  The Clean Air Act put the onus on individual states to design programs to follow the EPA’s federal guidelines.  Last June, the EPA released its Clean Power Plan (CPP), with a new ambitious target: carbon emission reductions totaling 30% relative to 2005 emissions by 2030.  The proposed rule includes the following primary components:

  • Four building blocks that define the EPA’s Best Strategy for Emissions Reductions
  • State-by-state 2030 carbon emissions reduction targets and interim targets based on a 2012 base year
  • Numerous alternative emissions reduction strategies, including renewables, under-construction nuclear generation, and energy efficiency

Cost-Effective Efficiency

Not surprisingly, some legislators are arguing that the CPP is unconstitutional, functioning as a federalization of states’ activities via the EPA.  Some utilities are also not happy with the CPP, as they are going to have to be held to real climate goals.  Utilities that burn coal or other fossil fuels inefficiently will have to pay to upgrade their facilities or face stiff penalties.

In a recent white paper, Navigant reported that energy efficiency is a cost-effective way for states, utilities, and businesses to achieve the CPP targets, with considerably less investment than upgrading or building new power plants.  Of all the building blocks, energy efficiency is the only one that is not a form of generation.  From a cost perspective, energy efficiency is a highly competitive approach to offsetting supply requirements and reducing carbon emissions.   This approach can be used for both overall total load reductions, but also for peak shaving (i.e., reducing the carbon intensity of electricity demand at the times when the grid is dirtiest – usually in the afternoons).

The Challenges

The major challenge for using energy efficiency as a way to achieve policy goals lies in how and where it is implemented.  Utility energy efficiency programs are one approach, and are forecast to grow, according to the Lawrence Berkeley National Laboratory (LBNL).

Energy Efficiency Spending by Utilities

(Source: Lawrence Berkeley National Laboratory)

Many utility programs require 5 or 6 years to mature and develop savings streams that persist.   Developing efficiency programs today will allow the savings potential to grow prior to the start of the CPP requirements.

It’s not just up to the utilities.   By focusing on the bottom line – the financial savings – the business community can help states achieve their CPP goals, whether they realize it or not.  Navigant Research’s report, Energy Efficient Buildings: Global Outlook, found that the current energy efficient building market is generating over $300 billion annually and is expected to grow, in major part, because the software and hardware works, and saves end-users money.  If the EPA uses the green of a dollar to promote the CPP, it could help states reach its targets.

 

The Geopolitics of Energy Efficiency

— January 15, 2015

The crisis in Ukraine has put the country’s energy security at risk.  Among other threats to the country’s economic stability, natural gas supply is a lingering concern.  In December, Naftogaz, Ukraine’s state-owned gas company, managed to settle the $3.1 billion debt it owed to Russia’s Gazprom, averting the risk of gas supply being shut down.  Longer term, there’s a little-noticed solution: Investing in energy efficiency could help Ukraine avoid importing any gas from Russia.

According to the International Energy Agency, Ukraine’s energy intensity is nearly 3 times greater than the average for Organisation for Economic Co-operation and Development (OECD) countries and 25% greater than the average for non-OECD European and Eurasian countries.  Energy efficiency has not been a priority in the former Soviet republics.  Subsidies provided by the gas monopoly that were designed to keep the populace complacent also created a disincentive to upgrade Soviet-era equipment and controls.

After the Fall

After the fall of the Berlin Wall, many of the same problems plaguing Ukraine were faced by East Germans.  But, since reunification, hundreds of buildings with poor thermal characteristics in East Germany have been demolished and replaced with more efficient ones.  Additionally, in the buildings that remain, major upgrades were made to the thermal envelope and heating systems were replaced.  As a result, total energy use in Germany fell between 1996 and 2008.

To be sure, some modernization projects are happening in Ukraine.  In Odessa, upgrades to a district heating network provided total energy savings of 50%.  But antiquated heating systems in Ukraine suffer from years of neglected maintenance.  In addition to the equipment, heating controls are an issue.  Many systems only have basic on-off control, they are either heating at full blast or are off – a terribly wasteful limitation.    Easy efficiency investment opportunities with short paybacks are abundant in Ukraine.  But, as with many energy efficiency investments, financing is the hurdle.  The problem is especially acute in Ukraine, as loans from the International Monetary Fund are keeping the country afloat.

Future of Financing

Worldwide, major changes in financing options seem to be in store for 2015, aimed at lowering the cash needed for energy efficient investments.  By converting upfront capital investments into operating savings through innovative finance, more projects will get the green light.  To date, energy service companies (ESCOs) have served as the primary means of outside funding for energy efficiency improvement projects.  But new approaches, such as independent energy savings insurance products, are beginning to emerge.  Currently, private real estate fund managers have $110 billion of equity available for investment, an all-time high.  As the situation in Ukraine demonstrated, there are abundant opportunities for investment being overlooked.  The changing world of energy efficiency financing appears to be the clearest way to bridge that gap.

 

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