The changing face of energy networks

by David Leitch, Utilities Analyst, UBS

David Leitch spends his days analysing trends in utility markets and forecasting the impacts of new technologies on the sector. Here, he shares his thoughts on how the energy sector will respond to the challenges new technologies, such as solar and storage, present those who manage networks and distribution.

The history of the electricity industry has been well covered by others, but the point is that by around 2005, most of Australia had an interconnected grid with centralised generation dispatch, regulated monopoly distribution and transmission, and retailers competing for customer billing rights.

Coal-fired generation had shown that it could be produced using air rather than water cooling, but for all the talk about this being a critical development, little changed in the world of technology.

Then along came the Renewable Energy Target (RET), bringing with it centralised wind power. A new form of generation to be sure, but requiring no real change to the existing business model.

The real game changer was photovoltaic (PV) solar. PV solar’s essential difference is not that the fuel is ‘free’ or comes with greater environmental benefits. The thing that matters about solar is that it has very few diseconomies of scale. The unit cost of a cell used to power a torch is little different to the unit cost of a solar farm used to run a town. It might even be less. This meant in turn that solar could be used to arbitrage the existing system. Since 40-50 per cent of the delivered cost of thermal electricity is in wires and poles, if they could be eliminated via rooftop solar, then electricity could be consumed behind the meter in an economically effective fashion. Of course, it can’t all be consumed behind the meter, but we’ll get to that in a minute.

The next thing that separates solar from the conventional system is that the capital required is minute relative to the cost of centralised generation. This means it is perfectly practical and is in fact the ‘norm’ for the household to own the ‘means of production’, placing the consumer in control. If you like, the customer has become the competitor. This loss of control is a serious issue for existing industry players. The household doesn’t care what the AEMC or the AER or the ACCC say about what can and cannot be done. They don’t care about how much reserve capacity is needed or how it should be paid for. Many don’t even care how much solar is economically efficient. They simply make a consumer choice and get on with it. Regaining ‘control’ over the system is one of the challenges for the existing industry.

Of course, solar by itself cannot provide all of the power on demand that Australia needs. There is easily enough land to produce all of Australia’s electricity from solar, but we need a way to manage the on demand and after dark side of things. That’s where storage comes in. We don’t yet know where we will get to with storage, but lithium iron phosphate and chemical flow batteries (for utility scale) seem very promising. UBS anticipates a halving of lithium costs by 2020 and that won’t be the end of the matter. Lithium is very abundant and there seems to be no insurmountable barrier to producing a lot of storage.

In about five years’ time it is expected that solar and storage will be more or less competitive with grid-delivered electricity for a suburban house with the roof space to hold the panels. Much of the light industry in Australia (the big shed business) will find itself in the same position.

How will the utilities manage this situation? Will there be mass grid defection with ever higher charges for those that remain on the system? Will there be no need for thermal generation? Will it be the retailer or the network that owns the relationship with the customer?

It’s too early to answer these questions, but just as coming events cast their shadows before them, so too can we speculate. Our thoughts are as follows:

1. We don’t think there will be mass defections from the grid.
2. Networks will perhaps be in a more powerful position. They have the opportunity to effectively become micro-generators themselves, either by building small generation units or storage units where grid reinforcement is needed, or by owning the panels on household and business roofs. However, as this would be a commercial business and not a regulated monopoly, the challenge for the network will be to move fast enough.
3. Retailers will also continue to chase the relationship with the customer. Although the news headlines have focused on the ‘zero down’ options that the big retailers will offer (balance sheets are weaker than they used to be but still strong enough for this), in fact the immediate battle ground in states other than Victoria will be over the humble meter. Retailers claim to be able to put communicating meters in for $200-$250 each; about 15 per cent of one year’s bill.
4. Once all the households are connected it will then be up to the software jockeys to come up with innovative ways to minimise the cost of delivered electricity. For instance, it clearly uses fewer system resources to export solar power to the house next door than to one 100km away.

All power to the consumer

One thing seems clear: consumers have more power now than they used to. The economics have moved in their favour and with storage that will only increase. For everyone else, the challenge will lie in getting the consumer onto their team. The electricity industry has moved from being ignored to openly disliked as a result of higher costs. Not only that, but this author believes that coal fired electricity globally is the largest contributor to global warming and will have to be phased out, probably sooner rather than later. That’s controversial of course. But we think it likely that environmental costs will increase over time. As a result, all of the players in the industry need to adapt business models to maximise their position in the new order. This may mean making hard decisions and sooner than many may think. For instance, whether to bid for Queensland or remaining New South Wales generation assets; or whether to take some ‘early mover’ losses by setting up a leadership position in storage and associated ICT equipment.

Despite the world-leading position Australia has in rooftop solar, not only in its sun and space but also very much around the efficiency of installation, much more can be done. Storage in particular needs industry champions. Market forces dictate that if the need arises it will be filled. We wait to see who the players and the winners will be in this exciting market.