Most corporate energy management programmes operate on an investment criteria of two to three years.  Yet energy supply investments typically are made on much longer payback periods, typically seven to ten years.  This fundamental mis-match is one of the reasons we have over investment in energy supply and under-investment in energy demand reduction.  If we could move towards rebalancing this differential we would reap huge benefits in terms of energy cost savings, emissions reduction, improved energy security, economic development and job creation.  So how do we get to exploit “the power of seven”?

First of all we do need to include all the benefits of energy efficiency in our analysis.  All too often we just look at energy savings, even the famous Marginal Abatement Cost curve analysis just looks at energy saved or carbon abated – not at all the benefits.  By using this analysis tool we are doing down the benefits of energy efficiency.  As well as pure energy and hence cost savings, energy efficiency projects can bring many different types of benefits, all of which can have monetary value.  These include:

Reduced exposure to energy price volatility

By reducing energy spend through energy efficiency, organisations and individuals reduce their exposure to the effects of energy price volatility on profits or budgets.

Reduced emissions of carbon dioxide

Reducing energy use reduces carbon emissions. The value of this benefit depends on the local regulatory regime, for example the applicability of schemes such as the EU Emissions Trading Scheme, but even in jurisdictions where reducing carbon emissions carries no direct financial benefit some organizations will still value this benefit because of perceived reputational benefit.

Reduced need to invest in energy supply infrastructure e.g. electrical grid connections  

An example would be a situation where increasing production in a factory requires investing in a larger grid connection due to increased peak electricity demand.  Implementing energy efficiency measures can reduce, or even totally remove the need for this investment.

Improved quality of production

Improving energy efficiency can also bring with it improved quality control.  Examples include:

• better temperature control of furnaces and ovens

• better temperature controls in refrigeration in brewing and other processes

• better control of compressed air pressure leading to less down-time and the associated loss of quality due to plant stoppages as well as reduced equipment lifetime

• new welding techniques that reduce sputter and improve weld quality

• air drying of paper compared to infra-red drying.

Higher productivity, health and well-being of employees

Many studies have shown that lighting upgrades, which bring with them an improvement in energy efficiency, also result in higher employee productivity. Improved control of space temperatures have also been shown to bring higher productivity.  A number of studies have shown that energy efficient offices are more productive, perhaps by as much as 15 to 25 per cent, and that they can also improve worker morale, reduce sickness, reduce employee turn-over and ease recruitment.   Other studies have shown that green, energy efficient schools can reduce levels of asthma, colds, flu and absenteeism.

Improved comfort and associated health effects

Improving energy efficiency, notably through the application of additional insulation to buildings in cold climates, brings with it improved comfort for the occupants. Improved comfort conditions can bring with it improved health, particularly in the case of the very young and the elderly.

Increased property values  

There is evidence that in some markets at least, energy efficient offices and homes can command a higher value and sell faster than equivalent, less efficient properties, although this has not yet been widely accepted – particularly in the UK. Building occupiers assign value to many different characteristics of buildings including location, a sense of well-being, health, and employee productivity.  Energy is very low on the priority list when organizations are looking to move to a new building, and in many cases is not on the list at all but it should be.

Regulations around building energy performance can clearly drive value that needs to be accounted for in investment decisions.  In the UK, the Energy Act of 2011 prohibits selling or leasing a residential or commercial building with an energy rating of less than ‘F’ after 2018.  This kind of regulation will clearly affect property values directly if fully implemented and enforced.

Reduced local pollution

An improvement in energy efficiency can reduce local air pollution, both indoors and outdoors.   Although the value of this effect is hard to quantify there is a benefit which may come through improved local perceptions, improved health and well-being and being a “good neighbour”.

Benefits outside the system boundary of the host

Energy efficiency investments also bring benefits to the energy supply system such as the electricity distribution and transmission infrastructure.  Experience in the USA has demonstrated that investment in energy efficiency measures can result in avoiding the need to invest in the distribution system.  Regulators need to design systems that ensure these choices are examined and where viable the investment is made in efficiency rather than supply upgrades.  This also requires the sharing of some of the benefits with the host.

At the wider level, outside the domain of individual energy users, improving energy efficiency helps us address the stresses and strains on the global energy system.  The International Energy Agency’s World Energy Outlook 2012 feature on energy efficiency highlighted the huge macro benefits that could result from improved efficiency.  It’s Efficient World Scenario, in which all economic efficiency measures are realised would, when compared to its central New Policies Scenario:

• reduce world primary energy demand in 2035 by 14 per cent

• reduce the rate of demand growth from 1.2 per cent to 0.6 per cent per annum

• increase the rate of reduction of energy intensity from 0.8 percent per annum to 2.4 per cent per annum

• boost global GDP by $18 trillion in the period up to 2035

• result in global carbon dioxide emissions peaking in 2020 at 32.4 gigatonnes with a reduction to 30.5 gigatonnes by 2035

• this reduction in carbon dioxide emissions is consistent with stabilising atmospheric carbon dioxide at 550 ppm, which is consistent with a fifty per cent probability of staying below a temperature increase of 3oC.

Job creation

An additional benefit to the economy of improving energy efficiency is job creation.  Some controversy about the impact of energy efficiency programmes on job creation still lingers on but on the whole the case seems to have been proven. Given the urgent need to create growth and jobs, particularly in developed countries affected by the global financial crisis, this aspect of energy efficiency policy still has not received the attention it deserves in most countries.

So, In any decision on investments affecting energy use, it is critical that all of the system benefits, (and of course costs), need to be identified, valued and included in the investment case.

Having ensured we value all the benefits of energy efficiency what else do we need to do?

Most importantly we need to develop new structures of energy services supply that make it viable for third parties, who can accept a longer payback period than the hosts, participate in the benefits.  Here the model for exploiting shale gas, or indeed any other physical energy resource, contains an important lesson.

In the case of shale gas (at least in the US regulatory regime), a land owner who may have shale gas deposits under their land does not have the technical knowledge or the capital needed to access the resource.  A third party, typically a specialized exploration and production company, pays an access fee to the land owner for the right to tap the asset.  The third party uses its capital and technical resources to develop the project and unlock the value of the resource.  Typically the third party pays a royalty payment or profit share over an extended period of time.

Businesses need to think of energy efficiency in these terms.  In all of their buildings and facilities there is a level of available energy efficiency which is largely untapped but which has potential value – this is the energy efficiency resource.  The building owner or host typically does not have the capital or the technical skills needed to exploit this resource.  They would rather, and should of course, allocate their capital to their core business whether it is selling groceries or making widgets.  Building owners need to license their energy efficiency resource to third parties for mutual benefits.  Large and high profile hosts could auction their efficiency resource to the highest bidder.

Taking this approach, coupled with emerging energy services models, would increase the investment in energy efficiency – help bring the benefit of scale to specialist third party investors, and benefit the hosts and society at large.

This week, subject to court approval, Enron Europe moves out of administration – and presumably into history – twelve years after its collapse.  Even after this length of time Enron is still a by-word for corporate malfeasance but its legacy – both good and bad – is extensive.  Enron was nothing if not innovative.  Amongst other achievements Enron:

• drove deregulation of energy markets

• drove standardization of commodity contracts

• combined energy supply and energy efficiency deals

• pioneered online trading of energy

• introduced weather trading.

The Enron organizational culture was one of hard work and high energy as well as open-ness (at least at the operational level), with a big focus on creativity, education and training.  The Enron diaspora has gone on to inhabit significant positions in the energy markets in many energy companies and banks but most of us who worked there would agree that there was nowhere quite like Enron as a place to work.

Enron Energy Services used tools and worked on ideas that were ahead of the their time – many of which are only now starting to become better known – including:

• data driven design to right size plant and equipment, reducing both energy use and capex spend

• risk assessment of energy efficiency projects using statistical analysis and portfolio management tools

• big data (albeit small by today’s standards)

• measurement and verification of savings

• automated distributed demand response across large portfolios of properties

• conversion of traffic and street lights to LEDs.

The two deals I was involved in at Enron and then RWE – Diageo and Sainbury’s -were both very different but truly ground breaking.  The multi-utility outsourcing deal that Enron pioneered with Diageo led to very large energy savings (40% in the case of the Park Royal brewery) and was taken over and then replicated by the team at RWE Solutions (later part of RWE npower) in Diageo’s Dundalk and Dublin breweries.  The RWE – Diageo deal at St. James Gate in Dublin, (the home of Guinness), is still in place ten years after it started so it must have worked for both parties.   The Sainsbury’s deal which combined energy supply and energy efficiency (also originally sold by Enron but implemented by RWE Solutions), installed many hundreds (even thousands) of efficiency projects across the Sainsbury’s portfolio over five or more years, helping them to significantly reduce energy use and carbon emissions.

Right now in the UK (and Europe) we need a lot more innovation in the energy markets to disrupt the Big 6 – particularly around:

• transparency

• combining energy supply, energy efficiency, demand response, data and finance

• real customer focus.

We need an organization as innovative and as bold as Enron to disrupt the energy markets and to take market share from the Big 6  – but definitely one without the dodgy accounting!

EDF group has launched a global innovation awards programme called EDF Pulse and I am the UK “sensor” – which is the person who identifies suitable entrants and encourages them to enter – a sort of “hunter gatherer”. The purpose is to highlight the importance of innovation and help move EDF towards a more open innovation model.

The awards are for early stage businesses in the three areas of: home, mobility and health – each with a €35,000 prize.

Home – This category is for projects that contribute to making homes more intelligent, more communicative, more energy efficient, and more eco-friendly, whilst increasing everyday comfort and wellbeing.

Mobility – This category is for the most innovative solutions and services that meet our growing transportation needs: chiefly, projects based on sustainable development, communications, sharing, and multimodal transport, with the aim of easing travel, and better including people who are isolated and/or who have reduced mobility.
Health – This category is aimed at the most promising innovations to improve our health and quality of life. Issues include new “intelligent medicine” technology to discover more about the body and its environment, and connected health services.

The criteria are:

• companies with less than 50 employees
• innovations that are close to launch or have recently launched
• use some aspect of electricity – this is widely interpreted, particularly in the health category.

There are two additional awards:

• research on electricity storage from a University or research team (€150,000 prize)
• Access to electricity projects in developing countries (€50,000 prize for NGOs)

As well as prizes the programme offers the potential of global publicity, access to EDF’s R&D team and access to EDF’s venture funds (both only if the entrant wants it).

Entry is relatively pain free and part of my job is to help companies enter.

Entries have to be in by 31st December. Then there will be a period of selection leading to a short-listing by an international panel chaired by Henri Proglio, Chairman and CEO of EDF, followed by a public vote. The winners will be announced in Paris on 25 March 2014.

So, if you are a company, research group or project that might fit the criteria, or know of suitable companies, please put them in touch with me or let me know who they are ASAP. Although I am the UK sensor I can enter companies from any country.

The Pulse programme also has a website that features innovations of all kinds. I can also pass on suggestions for content for the web site.

steve@onlyelevenpercent.com
+44 (0) 7702 231995

http://pulse.edf.com/en/invent/
http://pulse.edf.com/en/edf-pulse-award/
#EDFPulse

For something different and for the first time I have a guest blog on onlyelevenpercent.  An earlier post of mine talked briefly about the problems facing traditional energy suppliers and we have recently seen news of RWE adopting a radical change in strategy.  This excellent piece by Gerard Reid of Alexa Capital goes into detail about Eon’s problems and was first published in Germany.  For obvious reasons it caused considerable comment.   Gerard can be contacted on: GReid@alexa-capital.com.

As stock markets across much of the Western world hover around five year highs it is worth noting that an investment in the Dow Jones European Utilities index would have caused you to lose 50% of your money over that same period. The sector, which was always considered a safe haven for investors with strong dividend payments and solid defensive business models, has been out of favour for many years and the question is whether now is a good time to get back into this sector or not.

At first glance you might say that valuations look very reasonable with Enel, Iberdrola, GDF Suez, EON and RWE all having market capitalisations below the levels of equity on their balance sheets.  However, first glances can be deceiving.

In the world of utilities much focus is put on what are called clean spreads and dark spreads (which are the differences between the wholesale power price and cost of gas and cost of coal respectively). Until recently, utilities have been very good at controlling the wholesale power price. When power prices fell they would simply close capacity to keep prices up. However, this was only possible because they had strong positions in the market with virtually no competition.

The first nail in this coffin was the extra competition caused by the liberalisation of the EU energy market and the interconnection of the continental European power markets. But the real game changer has been the proliferation of distributed renewable generation, owned by millions of individuals across the continent, who unlike utilities are incentivised to produce as much electricity as possible. This additional competition has reduced not only the baseload price, but more importantly the highly profitable peak prices. The impact has been huge, with both baseload and peak power prices currently at seven year lows across the German/French/Benelux region.

Still that being said utilities have been somewhat protected from these falling prices by their power hedges. Power generators generally sell forward a proportion of their power at agreed prices which protect them from the volatility of the market. These hedges enable them to sell power to their customers at prices above that market price.

Utilities can take different views on this. Take for example the Austrian utility Verbund; with its low cost fleet of hydro power stations, it has always taken the view of not needing to hedge its power sales, thereby giving it the flexibility to sell at higher prices if the market price goes up. Verbund has currently hedged 23% of next year’s power volumes. This is in contrast to say, EON, which is close to being 100% hedged. Verbund’s limited hedging strategy means that its average hedged price of €44.9/MWh for next year is well below EON’s €53 which is reflection of EON having signed more customers up on long term contracts when the power price was higher some years back.

The issue for both these companies is that German forward power prices (€36.55 for 2014) do not look like they are going to go up anytime soon which means that anyone signing a new long term contract with these utilities is doing so at much lower prices. The end result will be that, come 2016, the average hedging price will be very close to the current market price. These price falls will hit someone like Verbund first because they are much more exposed to the wholesale market price than a company like EON. This can already be seen playing out in Verbund’s recent results.   Not only did they making an operating loss of €89.3m in the first half of the year but they also announced impairment losses amounting to €659m for their combined cycle gas turbine power plants in Austria and France, as well as a further write-down totalling €371m on an investment in an Italian power business. EON has suffered less so far, but if prices stay low then they will face a much worse situation. Reductions in their average power selling price could mean that by 2015 the company will be generating little or no money from their currently expensive generating fleet. That could be worth circa €1bn in annual lost earnings for the company and would require a much higher asset write-down.

The problem with EON

EON’s problems are larger than most across the European power market. They have made large strategic blunders and have not understood the changes taking place in the wider energy markets, let alone the technology changes, such as cheap solar power, which are directly challenging their business models.

The picture was very different a decade ago. They were on the acquisition trail expanding across Europe with one of the most modern and clean power generation fleets in Europe. They embraced nuclear and invested heavily in new cleaner more efficient gas plants as well as pumped storage power stations and large scale renewables.

So where did it all go wrong? Well for one thing they did not understand, despite having an oil and gas exploration business within the group, the impact that shale gas would have on their business.  The huge shale gas finds in the US have caused gas prices in the US to fall but have had near zero impact on European gas prices. What is has done is have an impact on coal prices which have fallen as the shift from coal to gas in the US causes the demand for US coal to fall, and in fact Europe has been the major beneficiary of this cheap American coal.  Add to this the fact that most European utilities have long term power purchase agreements for gas with the likes of Gazprom that are tied to the oil price (which has now decoupled from gas prices), meaning that the European utility industry is now paying over twice for their gas than the US.

The results of the above are clear; in the first seven months of the year there was a 19% reduction in gas used for power production in Germany while hard coal usage was up by 8.5%. With the CO2 price collapse and the coal price drops, dark spreads are now positive, meaning the only fuel that companies like EON can make money with is coal. And they are closing plants like the two and a half year old combined-cycle gas power plant in Malzenice, Slovakia which has only operated 5,600 hours since it was opened.

Even pumped storage activities at EON are at best break-even. Their whole business model was based around taking cheap night-time nuclear power, pumping it up the mountain and then letting it down during the day when prices were at their highest. But now with all the extra solar capacity on the grid, peak prices have collapsed, peak power needs are almost all met by solar and the power price is often lower during the day than at night.

But EON did embrace renewables, but what it has not done is embrace the decentralised revolution that we are particularly seeing in Germany but instead large centralised renewable projects. They have thus heavily invested in offshore wind and wind in the US where the projects tend to be on average over 100MW in size. In the US, EON currently owns 2.7GW of wind assets. Meanwhile back in the domestic market, EON owns 196MW of non-hydro renewable power. Whats more they are also reducing their hydro portfolio in Germany which at the start of this year was 1GW in size.  But EON recently sold 8 run of the river hydro assets in Bavaria to Verbund in return for Verbund’s 50% interest in the Turkish utility Enerjisa Enerji A.S.

To add to these issues EON like all other European utilities is dealing with at best flat growth in electricity volumes going forward, when one of their basic business assumptions was that power demand would increase in line with the growth in the economy. This has clearly changed and demand across Europe fell by 4% between 2008 and 2012. Of course it was argued that this was all recession led but the reality is that the two strongest economies in Europe the UK (7%) and Germany (2%) have both seen demand reductions. Energy technologies as well as energy efficiency measures are and will continue to have an impact on demand.

One persistent problem that EON shares with almost all utilities is their relationship to their customers, seeing them as licensees rather than customers.  EON is trying to change but it is a slow process and the customer backlash against the large utilities is clear for all to see. This will probably only intensify as customers begin to engage more with energy be it through having solar on the roof or using energy management systems.

What does it all mean?

The utility business model is dying. Selling electricity at controlled prices is a thing of the past, and the problem is the likely write-downs that are coming the way of many utilities including EON which will weaken already stretched balance sheets, which will then push up the cost of capital thereby making new investments more expensive and the implementation of new strategies difficult.

That said, the financial market is somewhat already assuming that when you look at the valuation of the EON. The market capitalisation of the company is currently €23bn (down from €86bn five years ago) with equity on its books of €37bn so the financial markets are pricing in that the company cannot generate a significant enough return to keep its shareholders happy. It is also assuming a write-down of €14bn in value. Is that too much or not enough? Currently EON’s power generation portfolio is valued in its books at circa €25bn and if it will generate no money on those assets going forward then a very large write-off is a serious possibility. And these write downs are already happening amongst other utilities most notably Vattenfall and Verbund in recent months

Assuming such as write-down, EON would need a new injection of capital and would probably need to restructure some of its debt. Is that something to be afraid of?  In the US, Enron went bankrupt, and the lights stayed on but before that happens the German government is most likely to bail EON out by introducing a capacity payment mechanism which will enable them to generate money from assets they rarely use. But why should German tax and rate payers bailout a company that has made serious strategic mistakes, who has not committed itself to the German government goals of the Energiewende and who has instead committed its future strategy to investing in far off places like South America and Turkey ?

That’s the real problem with programmes like the UK Green Deal here and around the world. Energy efficiency is usually seen as one of those worthy things we should do for our own or the common good – but usually don’t – like eating the right food and exercising more.

Secondly, energy efficiency is all about technologies such as controls and insulation, all of which are pretty dull.

Thirdly, energy efficiency professionals tend to be technical types who are not good at marketing or developing winning customer propositions.  Often they have come into energy efficiency for good reasons based on doing something that is environmentally and socially beneficial – even the non-technical ex-investment banker types who have discovered the subject in recent years!

On top of all that energy efficiency is really abstract – energy itself is abstract enough but energy efficiency is SERIOUSLY abstract – savings are hard to measure.  All in all there is no way getting round it – energy efficiency is dull.

I had been thinking about how to highlight this point and outline what we need to do when I came up with the concept of the Energy Efficiency Cool Wall – which had its world premier at the Smart Buildings Conference in London on the 15th October and had a second outing the next day at Ecosummit London.

It was inspired by the Cool Wall that used to be on the hugely popular TV show Top Gear – (350 million views a week in 170 countries according to Wikipedia!). Jeremy Clarkson and usually Richard Hammond argued about whether a particular car was either Seriously uncool, Uncool, Cool or Sub Zero – and then placed them appropriately on the Cool Wall.

So here is my first take on the Energy Efficiency Cool Wall.  Everyone will of course have their own opinion as to what is cool – responses and suggestions are welcome.