Five key priorities for utilities for 2016

The energy sector went through a turbulent and disruptive year in 2015 - and it arguably was the tipping point for more radical change.

Oil prices crashed to 2003 levels and the benchmark Brent oil price is now hovering around $30 a barrel, a staggering 80% reversal in just over a year. Gas prices globally reached historic lows, encouraging departures from coal-fired generation. For the first time in history, carbon emissions fell even as the world economy grew, likely due to falling or leveling-out of coal use in the US and China.

Stagnant electricity demand, oversupply, commodity price weakness and the continued deployment of renewables mean wholesale power prices have little prospect of recovering from their current weak levels, exposing those companies with a heavy presence in short-term hedged generation and without credible restructuring plans.

Potentially one of the most significant developments of the year was the coming together of over 150 country leaders in Paris and their agreement to curb greenhouse gas emissions and limit the rise of global temperatures. This will trigger additional demand for clean technologies and drive innovation along the value chain.

The utilities’ attitude was to meet the disruptive forces head on, and we saw big names transform portfolios and undertake cost-based refocusing. 2016 is shaping up for more of the same, most likely taken up a notch. Strategies laid down now will pave the way for survival—or failure.

Given these dynamics, what are the priorities for 2016?

Benoit LaclauGlobal Sector Leader, Power & Utilities

Utility business models are under threat like never before. The trends in the market point to a structural shift in the sector, and utilities will have to adapt to survive. The pace of disruption will continue, but those companies that can get ahead will have a real first-mover advantage.

Embracing change means being aware of new risks but also offers the opportunities of new science and technology. There is no right or wrong path to follow but those that innovate, expand their global reach and adapt existing operations will be the ones to succeed. While 2015 may have been the year of change, 2016 is the year of opportunity.

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Balancing capital investment and new growth markets

Alongside low commodity prices, technology innovation and the rise of the “prosumer” are changing how energy is produced, and utilities need to recognize that the shifts are structural and long term.

Last year was a record for renewables despite the oil price slump; $329b was invested adding 121GW of new capacity, according to Bloomberg New Energy Finance, and 2016 looks set to be another strong year. The world is now adding more power capacity from renewables every year than coal, natural gas and oil combined.

This disruption to the generation mix is fueling innovation right at the very edge of the grid. Commerciality for battery storage is getting closer, and costs are falling every year. Unless utilities adapt they could see traditional revenue streams shrinking as distributed generation, coupled with storage, becomes mainstream.

Utilities, however, are expected to spend trillions of dollars on energy infrastructure to meet future demand and replace retiring assets. This means risk management will be required across asset life cycle to avoid costly overruns and delays. Weak power prices and reduced budgets are already accelerating plant closures and investment decisions on planned projects are becoming harder to justify; and some are even delayed. We could even see some high-profile nuclear projects reversed — only time will tell.

Capturing opportunities in the new energy world means utilities will need to innovate — and that

includes determining the best pace for their own fuel mix transition. In this environment, capital

will need to work harder. Utilities will need to know what their priorities are and have a credible

growth strategy for survival. There is no blueprint. Navigating this transition will also require new

skills to meet the new emphases on IT, distributed resources, and customer interaction.

Interest rate movement — real or anticipated — will affect performance

Utilities are vulnerable to interest rate rises due to their high debt burden and the need to invest in capital projects. Given historically low rates, utilities have been able to finance operations domestically and overseas, at the same time paying out dividends to investors.

In the US, the Federal Reserve’s decision to hike interest rates in December ended the six-year waiting game. Delivered against a backdrop of a stronger US economy, it should be a positive signal

as recovery can mean increased energy consumption and higher profits for utilities’. The latest Fed minutes show it expects falling energy prices to keep inflation down for longer than previously anticipated, so it is likely that any further rate rise by the Fed will be slow and gradual.

In Europe, the timetable of a rate rise is less obvious. The subdued pace of overall recovery, particularly against external forces such as a slowdown in China, is unlikely to generate significant domestic inflationary pressures. A consumer-led recovery on cheap energy prices could challenge this notion and bring forward a rate rise, but the signs are not there yet. We anticipate low interest rates will prevail in 2016, and investors attracted by above-average valuations will continue to seek stable revenue returns, supporting regulated names and assets.

With the utility market gradually transforming into a buyer’s market, utilities that have been able to

diversify earnings, or that have low-cost production will benefit. Cost control and capital efficiency are key areas of focus for 2016. We expect regulated T&D valuations to remain high. But the increased

cost competitiveness of new technologies, such as integrated solar-plus battery systems, may affect

regulated capex and asset valuations in the future.

M&A activity will rise as utilities seek earnings stability

Low commodity prices and weak wholesale power prices meant that utilities underperformed against other equities in 2015. In Europe, this was the sixth year in seven. We see commodity-exposed companies adapting their business models to price volatility, but there is still more to do with efficiency and working capital. Those utilities with less commodity exposure or with diversified earnings, either regulated or from long-term contracts, fared better.

In 2015 market conditions underpinned company restructuring, those seeking earnings stability and asset disposals. Our power transactions and trends report shows utilities are acquiring regulated businesses and clean energy assets looking for earnings diversity as part of the broader restructuring we are seeing.

With disruptive forces gaining momentum, such as greater renewables deployment and innovations around battery technologies and the connected

home, utilities are re-evaluating corporate strategies. Low interest rates and monetary easing

may continue to support utility shares, helping to cut debt and boost the value of assets that they may sell. We expect more M&A activity through 2016, with a focus on network businesses and

renewable assets, and restructuring in response.

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Beyond-the-meter services to boom as smart technologies drive change

We expect to see significant development in smart technology over the year. There is huge potential to drive productivity enhancements as more utilities embrace the digital utility concept. The online delivery of information to the customer will be a major focus area and remove back-office costs. Utilities will have more chance to differentiate — for example around the connected home — win new business, lower costs and develop new products and services.

Smart grid technologies will also develop in parallel. The ability to track consumer usage and connect to smart meters provides an opportunity to improve energy efficiency by adjusting power distribution. Utilities’ capabilities to see in real time what is going on at the edges of the grid will result in more efficient ways to run electricity networks.

But significantly, the market is opening up to new entrants. Utilities will need to be agile if they are to survive. We’re seeing new offerings from the telco sector, such as a connected home service bringing together central heating, home security and energy management under a single internet-based platform — all controlled remotely and automatically.

Disruption is lengthening the value chain and leading utilities are increasingly exploring

opportunities ‘beyond-the-meter’. Major developments in smart technology over the year will

bring in a raft of new entrants, often from outside the sector. To respond, many companies will have to

undergo a shift in mindset and develop interactive relationships with their customers.

In emerging markets, oil- and gas-rich states are hurting economically and are looking to remove costly subsidies. With smart technologies giving

customers control of their energy for the first time, this is arguably a unique point where smart

usage and subsidy removal come together to save countries billions of dollars in asset investment and

develop a new age of energy-aware customers.

Customer engagement and insights firmly in the spotlight

As smart technologies develop so will people’s curiosity. Utilities must re-engage with their customers differently to ward off the threat of new entrants and realize new revenue streams.

Customers have access to more choice than ever before about how and when they use energy. They want a more personalized experience, made possible by a better understanding of data around energy usage. Building direct, personal relationships based on helping customers get better value from energy is proven to boost customer satisfaction and improve customer retention. So investment in big data analytics needs to be at the forefront of utilities’ decision-making. Our experience suggests many utilities are lagging on this front.

The customer analytics market is taking off. Developments in analytical capabilities around personalized data, gamification and new ways to interact with customers mean utilities can take advantage of the growing data and analytics opportunities.

Unlocking the value of customer data is a pressing need for energy retailers. Utilities currently lag behind other industries in the science of

understanding customers. If they don’t catch up, their markets are vulnerable to attack by others

who are more technologically adept.

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