The recent development of new technology which can collect information from cheap sensors, transmit the data across the world, then store and process it in novel ways, enables the potential for new ways of working in all industries. The energy industry is no different. This article looks at what incumbent utilities are doing to develop new technologies. The reading time is 5 minutes, 13 seconds.
1. Energy innovation is recovering in the UK following a long slump after privatisation
Figure 1 illustrates the changes in R&D spending on energy in the UK. The UK experienced a 90% decline in R&D spending between an annual rate of £800 million (2015 prices) before 1985, to less than £100 million per year from 1995 to 2005. Experts attribute this decline “to the run down of nuclear technology and the loss of R&D function after the privatisation of the energy utilities”.[1]
Figure 1: Total energy technology research development and demonstration expenditure 1974–2014 (in £ million, 2015 prices)
Source: International Energy Agency, ‘Data Services: RD&D statistics database’: http://www.iea.org/statistics/RDDonlinedataservice. Accessed December 2016.
The past five years have seen an increase in the UK’s energy spending on R&D to around £400 million. We are still, however, spending only half of the pre-privatisation rate. There are two main reasons for the pick up:
- decarbonisation of generation technologies – the development and improvement of low carbon generation technologies like nuclear, onshore/offshore wind, solar and carbon capture storage (CCS);
- digital technology – the growth of cheap sensors, which are wirelessly connected to a central cloud storage service and the potential to process and analyse the data using new techniques like neural networks
Both of these will remain important themes for the coming decades. Also, the current narrowing of the capacity margin in the UK may trigger further increases in R&D spending in the shorter run.
2. Most utilities innovate by mixing in-house development with VC funds
The incumbent utilities, like Centrica and SSE, need to adapt to remain competitive in future new energy environments. There are four main ways to innovate:
- In house development – internal teams working on specific projects;
- Partnerships – collaboration with other parties on specific projects;
- Venture Capital (internal fund) – equity investment directly into start-up businesses;
- Venture Capital (external fund) – investment into a Venture Capital fund which has multiple underlying equity investments in energy start-ups.
Each approach has different risk and return profiles, but it is extremely difficult to conclude that one is more successful than the another. VC funds typically aim for a 20% annual return but achieve it by making outstanding returns in only one or two investments out of a portfolio of ten (10x to 100x). [2] The remaining eight investments fail. In contrast, in-house innovation is likely to be more targeted and requires a less uncertain return structure.
We can, however, draw some comparisons from the strategic positioning of each of the four approaches (Figure 2). The main benefits of in-house and partnerships are the greater control over the project, the development of internal skills and also the greater potential to apply the technology to the utilities own generation or supply portfolio. In contrast, VC funds provide wider exposure to innovation across different technologies, countries and firms. It also provides a separate unit with a ‘start-up’ culture which is more tolerant to failures, but expects 10x to 100x returns on a small number of its investments.
Figure 2: Comparison of the four approaches that utilities are taking to innovation
Source: Company websites and accounts. Accessed March 2017.
When we look at how utilities are actually innovating (Figure 3), we see that all of the UK’s Big 6 firms (or their group companies) use some form of VC fund. Five of them have an in-house fund and only EDF rely on an external VC approach – utilities clearly value specialised units that think in a different way to the main business.
In addition to their VC units, most of the utilities surveyed also use in-house projects and partnerships. In-house projects tend to be favoured when the utility identifies a specific problem to be solved. For example, Centrica developed Io-Tahoe, a ‘data lake’ which combines multiple sources of customer data into a single source for analysis. The initial need was for British Gas, but the end product is one that can be applied in other businesses. Partnerships are often used when the identified problem requires specialist skills or assets which are not held within the company. For example, RWE has extensive partnerships with universities to develop specific products and processes.
Figure 3: Approaches taken by the Big 6 UK utilities and their group companies in relation to VC innovation
Source: Company websites and accounts. Accessed March 2017.
Last, we can drill down into the investment themes that each of the six utilities have focused on (Figure 4). RWE, EON and SSE are the most active companies with the most investments. The others like Centrica have only started their fund recently, or take a more hands off approach like EDF.
Low carbon generation, which includes storage, is the most active investment activity area for all utilities. There is then a thinner coverage across demand management, asset intelligence, data management and trading / portfolio management. The majority of customer focused solutions concentrate on technologies that enable demand awareness and response.
Figure 4: Thematic areas of VC investment by the Big 6 UK utilities and their group companies
Source: Company websites and accounts. Accessed March 2017.
3. But is the utility culture ready to maximise the benefits of innovation?
The traditional utility business model is still rooted in an asset backed culture, which is expected to generate consistent cash flows in proportion to the asset base size. Innovation does not follow this cash flow profile. The strategy to set up in-house VC is a sensible start in transitioning to a more flexible and service led business model.
When new technology and services become successful then the next challenge utilities must manage is to scale. Businesses capture the majority of a technology’s value when it diffuses amongst the masses and not in the innovation or early adoption stages (Figure 5). The first mover is often not the most successful firm, despite being the pioneer of the new offering. Utilities are on the right track to creating winners, but they also need to be ready to successfully scale when they find one.
Figure 5: The ‘Diffusion curve’ which charts the spread of a new technology amongst a population
[1] House of Lords. Select Committee on Economic Affairs. 2nd Report of Session 2016–17. Written evidence from Prof Richard Friend and Prof Richard Jones
[2] 10x corresponds to a return that is 10 times the initial investment. 100x corresponds to a return that is 100 times the initial investment.
Energy Envelope 