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Toward a Distributed Power World

Renewables and Smart Grids Will Reshape the Energy Sector

Frank Klose, Michael Kofluk, Stephan Lehrke & Harald Rubner, The Boston Consulting Group

Europe’s power utilities are entering a period of great uncertainty and change, with seismic shifts transforming the energy landscape. Energy security concerns and related worries about price and political volatility are driving governments across Europe to reexamine the source of energy supplies. Meanwhile, the climate imperative has moved up the agenda, with European policymakers expressing clear political support for the move to a low-carbon society.

This paper focuses on a potential development for European power generation: prospects for a distributed-energy system in which decentralised and renewable-power generation eventually displaces conventional power plants, reducing the balancing role of the transmission grid and shifting intelligence to the distribution grid through the creation of local and regional energy systems. This scenario is disruptive because it transforms many of the industry’s common beliefs. It does create many more opportunities for business model innovation. However, it also presents severe challenges to the leading incumbents.

The regulatory landscape is evolving rapidly. European Union targets for 2020 aim at reducing greenhouse gas emissions by at least 20 percent from 1990 levels, applying energy-efficiency approaches to cut usage by 20 percent compared with projected levels, and having 20 percent of EU energy consumption come from renewable sources – collectively known as the 20-20-20 targets. With political will gathering behind these ambitious targets, renewable energy is entering the portfolios of power generators at a rapid pace. Promoted by a wide range of subsidies, renewable energy is claiming increasingly large proportions of the power supply. Solar power, as well as onshore and offshore wind power have emerged as prominent sources of energy, with many – such as solar – coming from distributed-generation plants.

Prospects for a
system in which
decentralized and
generation eventually
displaces conventional
power plants

At the same time, the old centralised systems that deliver a one-way supply of electricity to consumers will be increasingly displaced by localised generation, and the future power landscape will include a larger proportion of small-scale sources, such as cogeneration through combined heat and power (CHP) plants. Moreover, some energy will be produced by consumers themselves, through a distributed network of power that incorporates everything from rooftop wind turbines and solar panels to CHP microplants (micro-CHPs) in consumers’ cellars.

In the process, conventional power generation will assume a less prominent position in the hierarchy of energy technologies, with centralised power plants facing lower use as the demand for and availability of cleaner sources increase. Meanwhile, power utilities will be required to strengthen their role in balancing increasingly complex ranges of fluctuating energy sources, especially renewables and microgenerated power.

Utilities will also need to develop new business models to maintain the profitability of traditional power generation. These will include increasing the flexibility of their generation fleet, or power plants, to enable them to profit from price fluctuations and, potentially, from fees for providing backup capacity rather than from hours of power sold in the day-ahead market. Utilities must act to bolster revenues as their traditional-generation business model fades with the reduction in annual running hours of power plants. They will also need to invest in smaller decentralised technologies, smart flexible power plants, and sophisticated energy-management systems so that they can capitalise on the increasingly diverse range of power sources coming into play.

An increasing share of
renewable and other
forms of decentralized
energy is entering the
power supply

Furthermore, the IT sector is invading the energy sector’s territory, particularly through a further transformation in how power is managed – the implementation of smart grids. Smart grids (which use digital technology to allow greater visibility of energy use and power flows), supported by smart meters, allow bidirectional communication between utilities and customers, facilitating a two-way flow of electricity. Smart grids therefore create the possibility for more flexible pricing mechanisms and the opportunity for both private and corporate consumers to contribute to the power supply as prosumers, who switch between net production and net consumption of power.

What Will Disruptive Power Changes Look Like?
Today, the electricity value chain is structured as a sequential, centrally organised process – from generation to retail. Large power plants are scattered across Europe’s major centers of consumption, feeding power through the grid. Business models of utilities have been based on the premise that utilities provide a simple commodity, with operational strategies focused on reliability of supply, one-way flow of power from provider to consumer, and energy sales that use simple all-you-can-eat pricing structures for private customers.

This model is no longer sustainable. The political drive toward cleaner energy is creating barriers to the construction of new power plants. These barriers are driven both by resistance to new large-scale plants and the challenges to profitability resulting from fewer expected running hours. Furthermore, power companies are experiencing a loss in demand as factories cut their output in the face of recession. Demand is being further constrained by the continued focus of both governments and businesses on increasing gains through energy efficiency.

At the same time, an increasing share of renewable and other forms of decentralised energy is entering the power supply. We project major growth in wind power, solar-photovoltaic (PV) power, and CHP (especially small-scale plants) in the European Union’s 27 member states (the EU-27) by 2020, and that decentralised generation will account for as much as 40 percent of the installed base by that date.

BCG has developed a distributed-world scenario to demonstrate the impact on traditional power generation. This scenario illustrates one possible power landscape, as well as the technical advances, business model innovation, and political support required for its realization. The scenario is based on the following four assumptions:

1. By 2020, the EU-27 will be increasingly functioning as a single market for power. Northwestern Europe will be acting as a de facto copper plate (which assumes an unrestricted power network across Europe), with countries physically linked by high-voltage transmission lines, or interconnectors. The rest of Europe will become more connected, too.

2. Renewables and other forms of decentralised generation will be backed by strong regulatory support
in the form of feed-in tariffs for CHP and renewables, which, in the current regulatory environment, are systems often categorised as must-runs on the left of what is called the merit order curve – which ranks power generation technologies according to their production efficiencies. The associated costs have to be covered by consumers’ power bills.

3. Flat power demand will be driven by further deindustrialisation in Europe and concentrated efforts to increase energy efficiency.

4. There will be a moderate rise in commodity prices. As a result, conventional power generation will move to the right of the merit order curve. By 2020, renewable technologies and CHP units could jointly provide more than 50 percent of all electricity consumed within the EU-27. Nuclear plants would provide most of the remainder, with conventional fossil-fuel plants being replaced in the most valuable part of the supply curve by renewable sources and distributed-generation plants, which benefit from subsidies. This would put utilities’ conventional-generation business model under pressure.

What is clear is that business as usual is no longer an option. To sustain the status quo, vibrant growth would need to reemerge swiftly in Europe (something few economists are predicting), and governments would have to renege on their pledges to provide preferential feed-in tariffs to renewable technologies and distributed-generation developers. In most scenarios – even if this is delayed by a few years – the landscape is set to change dramatically, leaving only a very small role for utilities’ business models in their present form.

A critical tool will be
the smart grid – a
distribution grid that
can also actively
manage fluctuating
supply and demand
using grid and
IT-infrastructure and
optimisation software

Some of these renewable-energy sources present operational challenges, however. The forces of nature (wind power and solar PV) are intermittent, providing a variable energy supply with both predictable (day-night and seasonal) fluctuations and unpredictable fluctuations driven by medium-term weather conditions and forecast errors. Such intermittency will require complex power-balancing mechanisms that use alternative capacity – including conventional generation and energy storage – to fill supply gaps when production from renewables is low. Because the need for conventional power generation is inconsistent and often unpredictable, a highly flexible generation fleet will be needed until other balancing mechanisms are fully implemented. This will favour gas-fired power plants, which usually have much higher ramp-up and ramp-down speeds compared with, for example, standard coal-fired power plants.

A critical tool will be the smart grid – a distribution grid that can also actively manage fluctuating supply and demand using grid and IT-infrastructure and optimisation software – supported by smart meters, which allow for real-time bidirectional communication between the customer and the power supplier. Distributed generation will rely on upgrading the grid and applying digital technology to it, including monitoring devices to control and regulate voltage, smart switches that regulate production and consumption to avoid major breakdowns, communications and information devices that orchestrate virtual renewable- and nonrenewable-power sources, and, finally, smart meters to better align varying consumption with production volumes.

Applying IT to the system will be essential for managing the two-way flow of power and facilitating demand-side management, which encourages users to modify their own electricity use. Smart grids will also allow for local and regional supply-and-demand optimisation and the dispatch of local generation capacity to fill the supply gaps at times when production from renewable sources of energy is low. When it comes to managing new distributed sources of energy, most experts agree that the smart grid will be among the main enablers in a distributed world. However, the value of a smart grid will depend on business model innovations that accompany developments in this area.

The Hardware Needed
At one time, discussions about the infrastructure supporting the delivery of energy to its users were confined to large physical assets, such as transmission lines. Today, however, new and different forms of technology, such as energy storage devices, are part of the picture. At the same time, IT is making its entrance into the energy sector – a trend that is likely to radically alter the way power management is conducted.

In a world of wireless technology and cloud computing, transmission lines might look like old-world infrastructure. Yet they remain essential to energy delivery. On the one hand, the need for transmission grid capacity will be reduced as more and more energy is generated locally. On the other, huge generation assets such as those in the North Sea make sense only if the respective transmission capacity is available to transport the energy to the centers of consumption. This will require surrounding countries to make large investments in high-voltage transmission grids.

IT, which is one of the most significant forms of infrastructure supporting a low-carbon world, has not traditionally been associated with the power generation sector. Smart grids carrying data and communications serve three main functions:

Smart distribution grids are able to manage the increasing share of reverse-flow power resulting from a high proportion of electricity generated on a decentralised basis.
Armed with wireless digital technology, the humble electricity meter becomes a powerful tool in energy management, facilitating real-time monitoring of consumption and allowing utilities to use pricing signals to influence that consumption.
By dispatching and optimising distributed generation and consumption, smart grids can compensate for imbalances in the distribution grid.

If utilities do not
want to be crowded
out of the power
generation market
and marginalised as
mere downstream
commodity suppliers,
they need to act now 

Without the abilities of the smart grid, it will be impossible to expand distributed-generation capacity to include these microsources. As with renewables, distributed generation is accompanied by unpredictable short-term variations in the supply-demand balance of the distribution grid. Experience indicates that if the share of fluctuating power generation rises higher than approximately 20 to 25 percent of produced power, there could be problems for the stability of the grid. To operate a large-scale demand-side management business, therefore, requires that information about consumption be closely integrated with data about the grid status.

Despite its central role in facilitating demand-side management, the smart grid has its limitations when it comes to balancing fluctuating power sources. Pricing incentives can persuade consumers to shift some of their demand to off-peak periods, but most loads cannot be deferred for long periods of time. The success of demand-side management relies on human behavior and changes in consumption patterns, which depend on whether pricing incentives are sufficient to encourage consumers to use power at less convenient times of the day or night.

For this reason, another technology – electricity storage – will be needed to assist in balancing intermittent power sources. At present, few credible forms of the technology have emerged, largely because the financial incentives for aggressive investments are absent. However, the role of energy storage as a mechanism that can compensate for power source fluctuations is becoming clear.

New Business Models
As the traditional-generation business model fades and power plants’ run time decreases, utilities need to identify and design new business models that can deliver additional revenue. It is not yet clear what kind of business opportunities such developments as the smart grid present for utilities. Nevertheless, these companies must consider how they can participate in the new systems, because in the meantime, a new set of players is ready to enter the energy sector, capture value, and eat into market share.

New entrants to the power sector include players in the IT sector, with smart-grid and other energy start-ups joining established companies in the rush to capitalise on changes in the power landscape. These companies are focused on systems that provide the intelligence needed to facilitate smart-grid behavior, including power routing, flow optimization, and pricing for feed-in and consumption. Some of the new players are also managing power distribution between centralised and decentralised producers, enabling quick responses to load changes. The smart-grid playing field is different from that of a traditional grid, making the entry of new players very likely.

The question is whether utilities can build on their strengths and take a slice of this market. The abilities required to do so are not yet among the core competencies of utilities, so it remains to be seen how great a share of the value-added part of the power sector the utilities can capture. Meanwhile, particularly as value creation flows downstream, the next few years are likely to see nontraditional energy companies making further inroads into the power sector, putting pressure on incumbents that lack the flexibility needed to introduce new business models.

The emergence of a distributed-energy landscape will have important implications for all parties, from utilities, gas companies, and technology providers to transmission system operators and distribution system operators. They face risks in not taking action, but there are opportunities for those that move forward. If utilities do not want to be crowded out of the power generation market and marginalised as mere downstream commodity suppliers, they need to act now. The evolution of a decentralised power landscape will not only change the relationship of the different energy-sector players to the electricity value chain, it will also change the very structure of that value chain.

Excerpt from “Toward a Distributed-Power World. Renewables and Smart Grids Will Reshape the Energy Sector”, orginially published on www.bcgperspectives.com.
Copyright The Boston Consulting Group (29 June 2010)

Frank Klose is a partner and managing director in the Düsseldorf office of The Boston Consulting Group.
Michael Kofluk is a partner and managing director in the firm’s Stuttgart office and the leader of the Energy & Environment practice for Germany, Austria, and Central and Eastern Europe.
Stephan Lehrke is a partner and managing director in BCG’s Berlin office.
Harald Rubner is a senior partner and managing director in the firm’s Cologne office.

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