Earlier this week I attended, and was @TheCrowd tweeter, at XEnergy, a half-day conference on the energy revolution organised by The Crowd. I was moderating the roundtable on the Energy Revolution. So, I had a ringside view of what is going on, and how big companies are responding. I can see what’s going on in five categories (see diagram) and how big companies are responding in one word: sluggishly, because they only think in terms of a financial case for marginal efforts. They risk missing out, and we risk more delay in getting to a low carbon world.
What’s going on in the energy revolution?
The first category of activity in the energy revolution is technologies for energy production and use. At the conference people were getting excited about storage (“less than five years away”). As Michael Liebreich makes clear in this brilliant 2016 Bloomberg New Energy Finance keynote, we have already seen a miracle in renewable energy. Wind costs have fallen 50% since 2009. Solar PV costs have fallen 80% since 2008. This is having consequences. US independent oil and gas producer solvency ratios have deteriorated, with 69 companies under credit ratings review. Coal is in distress. The last 3 years have seen GDP growth with carbon emissions growth.
But more important are digital technologies, that control and match the production and use of energy. By far the most astonishing presentation of the day was from Mustafa Suleyman of Deep Mind, the Ai research company recently bought by Google. Their mantra is “solve intelligence; use it to make the world a better place”. Deep Mind is famous for being the first computer to beat a person at Go, the fiendishly difficult board game. They did this by throwing lots of data at an AI, and then letting that AI learn for itself, not from pre-determined rules about the game ‘Go’.
Now here’s the thing about ‘solving intelligence”. If you do that with Go, then you can do that with lots and lots of situations where there is more data than a human mind can cope with. One situation like that is energy management in data centres. These clusters of servers – on which your email, this blog, any internet really – sit consumer around 3% of the world’s energy. Google engineers had been pretty savvy on energy use in Google’s own sever farms. Deep Mind learnt from the data and had novel ideas that added up to an extra 40% of savings.
Let that sink in. The best specialist engineers in the world were out by 40%.
What a boon to the world to roll out that problem-solving capability across many, many domains! But. Do you feel safe in your job? If you do, then you either spend all your time doing non-routine things, or your function doesn’t depend on using data – or you’re not paying attention.
As well as control, the other critical thing digital technologies can do is match generation and use, on much quicker cycle times and with much greater accuracy. The possibility is of only producing what is needed at the moment it is needed. Which reduces the requirement for spare capacity or base-loads. The vital element here is the interfacing between all the various digital control systems and data. The other thing, of course, is avoiding the rebound effect, where the efficiency gains are wiped out by using the newly-released resources in other impactful ways.
No one technology makes up the energy revolution. Instead the potential comes from being able to the combine many, especially the ability to make many interrelated decisions quickly.
A third category are social technologies that underpin the relationships between system actors. We’re very used to generators generating, users using and contracts between the two making sure each party knows what they’re getting. But what if someone has a solar panel on their roof? Sometimes they are a producer, sometimes a consumers. What are the right contractual relations for such a ‘prosumer’?
This is what people mean when they say ‘business models are challenged’. The existing relationships no longer fit with what the technologies can do. and the social technologies like contracts that govern those relationships are obsolete. As the value starts to go to those who can match better, then expect to see the rise of more platform business models, that create value by facilitating exchanges between two or more interdependent groups. Will the trade din ata about energy production and use be more valuable than the energy itself?
The two remaining categories are physical infrastructure and enabling context. We risk locking ourselves into a grid which is well-suited for the past – a small number of large producers – rather than the future – a large number of small producers. Whatever else one thinks of nuclear and Hinkley C, it risks crowding out the investment needed for a diffuse, dynamic grid. The roundtable participants were full of tales of their staff resisting adopting new technologies, and so the company missing out.
The sluggish response from big companies
When people talked of their experience in big companies we, inevitably, talked about the business case. People had been successful in getting capex, but often the teeth of opposition. There is lots of baggage that ‘sustainable’ must mean costly. Energy itself is rarely considered a strategic priority: either the cost to the business is too small, or it is assumed to be a given. There’s nothing we can do about it, so let’s comply, be efficient and put our scarce capital behind other ways our company can win.
All this reminded me of Clay Christensen’s classic HBR piece: “Innovation Killers: How Financial Tools Destroy Your Capacity to do New Things”. He wasn’t writing about sustainability, but just the lessons of how normal financial decision-making lets companies down. (If you are interested in the business case for sustainability then you must read the full article.) The key insight for energy and big business is this:
“The way that fixed and sunk costs are considered when evaluating future investments confers an… advantage on challengers and shackles incumbent firms.”
In any NPV calculation you look at the marginal cost and benefit – the extra cash invested to make something new happen and the extra cash back in over time. Everything else is assumed to continue on as before, with fixed costs and the same returns over time. The decision on the investment is treated as only about the new cashflows. It’s not worth including the existing cashflows in the analysis because of an unconscious assumption they will not change.
That’s fine “as long as the capabilities required for yesterday’s success are adequate for tomorrow’s as well”. So, it’s not fine in a period of revolution. If new capabilities are required for future success, then the existing ones are going to become obsolete. The cash spent on maintaining those current capabilities is a waste but, because of the unconscious assumption that things will not change, it does not get included in the marginal investment analysis.
On the other hand, challengers are looking at the total cashflows in and out. In a period of change, they had the advantage because they are considering how best to use all their resources, not just the marginal part (because most of the budget is already spent in people’s heads on the usual stuff, even before the year begins).
In the HBR article Christensen gives an example of steel mills:
“Nucor, the attacker, had no fixed or sunk cost investments on which to do a marginal cost calculation. To Nucor, the full cost was the marginal cost. [A new mill] was the only choice on its menu—and because the IRR was attractive, the decision was simple. USX, [the incumbent] in contrast, had two choices on its menu: It could build a greenfield plant like Nucor’s with a lower average cost per ton or it could utilize more fully its existing facility.“So what happened? Nucor has continued to improve its process, move upmarket, and gain market share with more efficient continuous strip production capabilities, while USX has relied on the capabilities that had been built to succeed in the past. USX’s strategy to maximize marginal profit, in other words, caused the company not to minimize long-term average costs. As a result, the company is locked into an escalating cycle of commitment to a failing strategy.”
Any of that sound familiar? Is your company maximising marginal profit today and so ‘locked into an escalating cycle of commitment to a failing strategy’? Are you sure? Because that’s what I heard behind the stories from people on the roundtables again and again.
Energy: vital but invisible and interchangeable
Where I have more sympathy with incumbents is on the nature of energy. For the vast, vast majority of customers – whether business or consumers – do not buy something because of the type of energy used to make it. They care about price, quality, convenience and so on. Our modern world is built on the viability of cheap energy, starting with steam for the industrial revolution. But the quality of this blog does not depend on whether the electricity powering my computer is renewable or not (full disclosure: yes, it is renewable, through Good Energy). Energy is vital but invisible and the different sources are – from the end-user’s function point of view – interchangeable.
One roundtable member argued that the business case will only come when there is revenue growth, which means making the customer care about the carbon impact of the product they are buying. I cannot say I agree. We’ve had 20 plus years of trying to convince mainstream consumers and businesses that they should care about ‘green’. Quite apart from any ethical concerns on social engineering, it simply hasn’t worked.
In general things get to scale when they are good-enough for the end-user and they are cheap. So, surely the way to drive the energy revolution is to about giving your end-product or service a cost advantage. The operating costs of renewables are part of taking us to a zero marginal cost society. Taking part in the energy revolution means you have cost advantage over your competitors. Use that to reduce the price point and sell more, or make more profit per unit – but use it to win.
At the end of Energy, John Elkington gave a typically rousing talk on the need for exponential, following on from the excellent Breakthrough Business Models (full disclosure: I inputted at points and commented on a draft of this report). He had four Ds for everyone’s new year’s resolutions: disrupt; decentralise; democratise; decarbonise. I agree with all four.
What struck me was also that, for companies who use energy but are not in the energy sector, focussing on the energy revolution keeps this all off to one side. To make it strategically relevant, perhaps we need to talking about the wider digital revolution, of which massive changes in the economics of energy is one part.
Otherwise, I fear incumbents will miss out, and our progress to a low carbon world will be delayed.