New Power Technologies: Too Important and Interesting to Ignore

November 1999

© 1999, Elsevier Science Inc., 1040-6190/99/$–see front matter PII S1040-6190(99)00083-4

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Richard T. Stuebi

is founder andPresident of NextWave Energy,

Denver, CO, an advisory services firmserving entrepreneurs and inventors,

established energy companies, andinvestors involved in the electricitysector. He has 13 years’ experience

in executive and consulting rolesin the electricity industry at

consultants ICF Resources andMcKinsey & Co., and at commodity

trader Louis Dreyfus.

GUEST EDITORIAL

Richard T. Stuebi

New Power Technologies: Too Important and Interesting to Ignore

s any observer or participant in the industry well knows,

the electricity sector is changing rapidly and dramatically all around the world. Competitive forces are reshaping the economics of wholesale power generation markets, new rules and institu-tions are reconfiguring the day-to-day operations of the transmission grid, and regulators are eliminat-ing the barriers that currently in-hibit customers from selecting their supplier of electricity.

Reflecting these groundbreak-ing changes, the main participants in the power industry—electric utilities, vertically integrated companies encompassing power generation, transmission, and dis-tribution—are very busy trans-forming themselves.

Strategically, many utilities are choosing to focus on those por-tions of the value chain that are most appealing to them. Some are selling long-held assets to pare down to their core area of interest,

while others are buying assets to increase their presence in their pre-ferred segment. Consequently, a tremendous amount of merger and acquisition activity (involving both individual assets and entire com-panies) is underway, accounting for billions of dollars of trans-actions annually.

Operational and organizational initiatives also are being actively undertaken by most utilities. Cost reduction, already a priority for utility management teams in the

early 1990s, has become even more critical in order to attain or main-tain an advantage in the increas-ingly competitive marketplace. To compete in deregulating retail or wholesale markets, entirely new skill sets based on commercial savvy rather than engineering ex-cellence and regulatory manage-ment are being developed, often by trial and error. Most utilities have made major infusions of se-nior management talent experi-enced in other industries in an attempt to achieve a successful transition.

Given this turbulent context, and the wide variety of sizable and easily envisioned opportunities that inescapably emerge from fun-damental restructuring of such a massive industry, why should the management team of any estab-lished energy company care much about the more ambiguous poten-tial roles of new technologies in the power sector?

Why Care?

It is tempting for well-estab-lished players to assume a techno-logical state of the world similar to what exists today in developing and executing their strategies. Even holding this variable con-

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stant, the magnitude of the chal-lenge facing players in the electric-ity industry is huge.

The rules of the game are chang-ing on the fly, companies are enter-ing and exiting businesses and geographies almost daily, and new merchant plants and gas pipeline capacity additions are being an-nounced continuously—all of which are driving tremendous near-term volatility (and long-term uncertainty) about energy market prices. With assets worth hundreds of billions of dollars being implic-itly revalued on virtually a daily basis, it is no wonder that techno-logical change is assumed away by many players active in the market. The added complexity of consider-ing this extra dimension of uncer-tainty appears to make a daunting management problem virtually intractable.

owever, the company that underemphasizes the issue

of electricity technology trends does so at its significant peril. Not only must technology advance-ment be considered from a defen-sive perspective (i.e., as possible threats to a company’s current in-terests), but new energy technolo-gies potentially represent compel-ling growth opportunities that might otherwise be overlooked.

Protecting against Threats

As utilities, other players in the power sector, and new entrants undertake strategic shifts in the restructuring electricity sector, assumptions about technologies loom large in making or breaking a company’s strategy choice. For

instance, several companies seek-ing to become leading power gen-erators have bought massive powerplant portfolios from utili-ties divesting their generation assets, at transaction prices often well into the billions of dollars. Given illiquid long-term forward markets in power (with very large bid-ask spreads, reflecting the major uncertainties and risks to which counterparties are

exposed), the value actually de-rived from acquired plants will depend critically upon actual fu-ture movements in a region’s spot power market prices. And, impor-tantly, power prices in the future will be determined in large part by the productivity potential offered by then-current technolo-gies involved in fuel extraction/delivery, fuel conversion and emissions control (generation), and grid management (ancillary and transmission services).

Hypothetically, what would happen to wholesale market prices—and hence powerplant values—if

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Power generation technolo-gies could be deployed for base-load utilization at customer sites in sizes of 100 kW or less for (say) $50/MWh?

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Electricity storage technolo-gies could economically (and in sizable scale) obviate the need for generating capacity used only to supply energy on needle peaks?

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Pollution control technolo-gies could yield major emission reductions from fossil-fired powerplants at minimal incre-mental cost?

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Innovative fuel preparation or delivery technologies could ex-pand the geographic extent of eco-nomic penetration of lower cost or cleaner fuels?

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Advanced transmission-related technologies could cheaply de-bottleneck grid constraints that currently result in local “pockets” of higher power prices?

Not all of these possibilities are likely to happen, but based on ac-tivities underway in R&D firms large and small around the world, any one could quite plausibly hap-pen within the next decade or so. Any one of these possible develop-ments coming to fruition would significantly reduce wholesale power prices. Since asset-based strategies require a very long time horizon to play out (and pay out), the success of a corporate strategy based on large-scale generation ownership/operation is critically vulnerable to the risks of such technology advancements. Similar technology-based exposures could also surface in relation to a strat-egy oriented to energy distribution or energy marketing.

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The broad implication, therefore, is that the management team of any company involved in the power sector should be explicitly aware of trends in relevant tech-nologies—their current status, re-cent trends, and expected (and possible) projections—in setting strategy. Evaluating these trends may not change management’s final strategic choice, but making such choice absent a solid assess-ment is hazardous and unwise, es-pecially since the effort involved in a robust analysis need not be unduly expensive or time-con-suming.

or is technology evaluation only a

strategic

consider-ation: the continuous march of progress will also yield incre-mental improvements of direct ongoing relevance to the opera-tion of the existing asset base. Fuel additives, catalysts, combus-tion alterations, and other such enhancements may be easily adaptable to existing power-plants—and may substantially change the relative competitive-ness of various power stations within the context of a regional power supply mix. New software for managing customers’ energy consumption and trading bulk power will become essential for optimizing day-to-day opera-tions for generation operators, power traders, and retail marketers alike. Evolutionary develop-ments such as these must be fre-quently monitored to anticipate threats from improving competi-tors—as well as to maximize profits if these innovations can be exploited internally.

Capturing Growth Opportunities

Monitoring power technology

developments for defensive pur-

poses is probably less important

than the flip side: monitoring

them for the huge growth oppor-

tunities they are likely to repre-

sent. And one clear lesson from

the ongoing bull market in

equities is that investors love

(perhaps too much!) a good growth story.

New electricity-related technol-ogies already represent the main growth areas within an otherwise mature energy industry. Wind and solar photovoltaic (PV) tech-nologies—widely ignored in re-cent years by many major energy players because of excessive hype and bad experiences in the past decade—have improved dramatically in the last 15 years, now representing the fastest growing portions of the world energy sector during the 1990s. While these and other emerging energy technologies have yet to

reach sizable penetration rates and revenues on a par with lead-ing conventional energy compa-nies, their rapid growth rates in the gigantic energy industry—$500 billion per year in the United States, perhaps $3 trillion annually worldwide—implies very attractive prospects that should not be dismissed lightly.

ndustry leaders such as Shell, BP/Amoco, and Enron have

made significant investment com-mitments in the renewable-energy arena, based on well-publicized projections that renewables could very plausibly represent up to 50 percent of total world energy supply by the middle of the next century. If the world energy in-dustry grows indefinitely at an annual real rate of 3 percent, then by 2050 global annual revenues for all forms of energy would ex-ceed $10 trillion, indicating that a 50 percent market share achieved by renewables would imply more than $5 trillion in annual reve-nues. That would mean that re-newables would have grown by over 15 percent per year for 50 consecutive years from today’s levels. This kind of story would be as impressive as the explosion of the high-tech sector that has occurred in the past 20 years, with the concomitant creation of wealth captured by early movers such as Microsoft, Intel, Dell, Netscape, and AOL.

By virtue of their customer bases, established brands, and fa-miliarity with related technologies, today’s major energy companies are in an advantaged position to take on this role in the power sec-

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tor’s transformation. The question remains if their appetite is strong enough: which utilities in 10 to 20 years will be like IBM and survive (albeit perhaps in a different form) to remain major forces in the re-shaped industry, and which will be more like Control Data and be-come mainly a distant memory?

A huge wild card favoring new technology development and adoption in the power sector is posed by the possibility of changed environmental regula-tions. Given that environmental quality tends to be a bigger con-cern among people born in the past few decades, as younger generations assume greater posi-tions of power (and represent a larger proportion of the popula-tion), it is likely that environmen-tal restrictions will become tighter, to the benefit of improved technologies.

f all environmental issues, the one with the greatest

projected impacts on energy mar-kets, businesses, and technologies is clearly global climate change. Policies to significantly reduce CO

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emissions will very probably be implemented in the coming de-cade, as decision makers in gov-ernment and business find it in-creasingly difficult to dispute the hazard of impending global cli-mate change. Energy companies therefore should seriously investi-gate new energy technologies to prepare for this future. Commit-ments now to new technologies serve not only as a hedge against financial downturn from policy changes that adversely affect the interests of their core (conven-

tional) energy businesses, but also as advanced platforms to capital-ize on market opportunities that will emerge if energy market con-ditions are significantly altered.

What To Do?

For those who come to realize that the new energy technology arena is too important or interest-ing to ignore, it may appear impos-sibly difficult to initially penetrate this opportunity space:

•

Some of the most interesting innovative power technologies are being developed by startup com-panies that are well below the radar screen.

•

Some of these new technolo-gies are radical enough so that it may not be obvious whether the concept is absurd or amazing.

•

New energy ventures are often led by scientists or engineers, who tend to have difficulty in pre-senting their technologies to the public in a manner that is easy to understand.

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Many energy entrepreneurs have limited understanding of their innovation’s economic mar-ket potential, as they have not as-sessed customer segment needs, relevant alternatives, and compar-ative economics.

If it were truly easy for promis-ing innovations to be identified and robustly assessed, such oppor-tunities would probably already have been captured. Creating suc-cess with something new and totally different is never easy.

ccepting, then, that evaluating new power technologies

will be a messy and sometimes

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Some of these new technologies are radical enough so that it may not be obvious whether the concept is absurd or amazing.

frustrating exercise, what should a company interested in this arena do to capture the value that likely lies hidden in this arena?

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Limit the relevant technolo-gies to carefully consider

. Taking the company’s current strategy and capability base relative to the power sector as a given, it is im-portant to first define the bound-aries of technology relevance in order to set priorities (if not to weed out entire areas not worthy of investigation). For instance, a company focusing on local energy distribution probably need not spend much time evaluating ad-vancements in large-scale genera-tion, fuel conversion, or pollution control—but it should pay a lot of attention to distributed generation, metering, and energy management technologies. Also relevant will be the company’s risk tolerance and time horizon: impatient or cau-tious companies should not focus on cold fusion technologies.

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Identify potential winners based on expected performance and costs

. Once the appropriate technology space is defined, an ini-tial “outside-in” scan of the pri-mary developers working on these technologies will likely reveal which ventures have the best chances of surviving and thriving. While the relative economics of each approach is probably the most important consideration, the evaluation should also weigh such factors as management team qual-ity, financial backing, and strategic partners, under multiple scenarios tied to fuel prices, industry growth rates, regulatory developments, and so on.

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Determine how potential winners could create/capture value

. After identifying potential winners among the set of emerg-ing power technologies, it still re-mains to assess how such technol-ogies would actually succeed in the marketplace. The key issue is to ascertain whether a viable busi-ness model can be instituted to profitably produce and deploy these technologies. It is particu-

larly important to understand which customer or geographic seg-ments would be most economic for the technology to try to reach, and by implication what sales ap-proaches and distribution channels would be the most effective to em-ploy. Pricing then becomes a criti-cal consideration: The value could be captured from margins on the initial sale, from operating margins on ongoing service over the life of a contract, or from a stream of roy-alties for continuing use of the technology.

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Decide the best approach to participate in winning opportuni-ties

. After identifying potentially

winning technologies and proving that a plausible business model can be forged to exploit the technology, a decision must be made on how to try to capture value from the tech-nology. The three major options are (1) to become an investor in (or the outright acquirer of) an emerging venture, (2) to buy or license the ex-clusive rights from the inventor and then build a new company to commercialize the innovation, or (3) to form a partnership wherein the company could bring needed skills or relationships (plus cash?) to a technology company. Selecting among these options depends upon how much resource contribu-tion (human and financial capital) and managerial control (including integration with the core business) are needed to make participation in commercialization of the new energy technology successful.

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Gain participation in attrac-tive opportunities

. Ventures de-veloping possibly desirable tech-nologies can now be contacted. Due diligence must be performed on patent strength/duration, out-standing legal issues, management team reputation (e.g., through in-terviews with customers, suppliers, employees), and technology cost/performance claims. If this investigation yields satisfactory conclusions, negotiations must be undertaken to obtain preferred terms of participation. As always with negotiations, it is wise to list beforehand “deal-breakers,” “must-haves,” and a sequence of successive fallback positions in order to tactically proceed through the negotiations in the most prudent manner.

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New Power Technologies: Too Important and Interesting to Ignore