The energy world is changing fast. Investments in renewable energy are outpacing investments in traditional energy. But both traditional power providers and startups are struggling to find viable business models for an industry in transition.
Among the first to feel the sweeping changes in the energy sector were utilities in developed countries that have a high share of renewables in the electricity mix. But now, more industries that rely on traditional energy sources are feeling the heat.
For decades, oil companies have been the unassailable behemoths of the global economy. Yet they have been underperforming for investors over the past few years as the risks, costs, and complexities of their business rise. These companies are struggling to replace oil resources at competitive rates.
Large manufacturers of electrical components—such as GE, Siemens, and ABB—are concerned about how to maintain their central positions in the electricity industry as the energy mix around the world changes.
Automotive companies are being pushed outside of their comfort zones as well—not only because of the vast diesel emissions scandal that engulfed many auto manufacturers, but also because of the looming threat of disruptive innovation from electric mobility sources like the Tesla and Google cars.
Shifting Toward Sustainable Energy
The overall business environment is shifting toward a clean energy future. In April 2016, 177 countries signed the ambitious Paris Climate Agreement. In response, companies are beginning to improve their sustainability footprint and are adjusting product portfolios and corporate strategies.
Growing numbers of investors are making sustainability a part of their strategy, channeling trillions of dollars in greener directions. The United Nations-backed Principles of Responsible Investing initiative—signed by companies that collectively manage $59 trillion, or half of global asset wealth—provides a minimum code of conduct. Although some investors are changing in response to environmental concerns, most are acting out of sound business risk assessment: old energy has a big “license to operate” problem.
At the same time, political regulations around the globe are becoming ever more favorable to resource efficiency and renewables. As sustainable energy technologies gain in competitiveness, politicians, consumers, and businesses see them as a great opportunity. This trend has not been dampened even by the fall in oil prices, and we can expect regulatory support to grow.
Despite the enthusiasm and well-meaning political support, it still seems difficult for businesses to thrive in this global energy transition.
So far, the transition has undermined traditional energy markets without yet having created functioning new markets. Both risk-taking, disrupting pioneers as well as the asset-heavy, path-dependent incumbents are often at a loss.
“We haven’t totally figured out exactly what the business models are going to look like—who wins, who loses,” says Jason Bordoff, director of the Center on Global Energy Policy at Columbia University.
So, where are markets stuck?
1. Cost: Renewables and energy efficiency might not be cheap enough yet to radically disrupt the way people generate and use energy.
Energy storage at one-quarter of today’s cost would be a game changer. Solar energy, while competitive with grid power in many countries, still needs to be much cheaper to become an unbeatable option, despite it being an infirm power source. The same is true for energy efficiency solutions.
The new energy world will have different structures from the current one. It will be more distributed, smarter, and more versatile. This shift, while ultimately beneficial, has an upfront hassle and cost as societies, economies, and consumers change their way of operating. They will only overcome their inertia if the new option is much more attractive than the old. Maxine Ghavi of ABB once noted that new options need to be at least 30 percent cheaper—at the same or better functionality—in order for people to change their ways.
2. Size: New energy is still small in size compared to old energy. An oil company can spend tens of billions of dollars on developing a new oilfield. A utility can spend billions on a new large coal, natural gas, hydro, or nuclear power station. Renewables investments, however, are still counted in millions. General Motors, Volkswagen, and Toyota sell millions of cars. Tesla only sells in the tens of thousands.
Why does that matter? Because it makes it almost impossible for the old players to change toward new energy. They are simply too large. They employ hundreds of thousands of people and have management structures and corporate cultures designed for large, long-term investments. They would need to become much smaller to fit through the narrow doors leading to future growth.
3. Differentiation and technology: Renewables and power grids are conservative, debt-reliant industries. New technologies are difficult to finance. Take solar, for example. Photovoltaic technology dominates the market. It has become a commodity product with little differentiation among quality suppliers. As a result, solar is now mainly a financing game. Along the entire value chain, there are few unique selling propositions that could protect margins. As a result, very few companies are profitable.
Where Do We Go From Here?
Existing, large energy companies will find it difficult to succeed in the new energy future. They would have to risk a lot (but what is their alternative?). Yet their shareholders often seek stable, low-risk returns.
There are investors ready to bet on change makers: new technologies, new platforms and infrastructure, and new customer access. In a fast-changing world, who knows the many ways in which betting on disruptors can eventually be capitalized? This strategy can work, as in the case of Tesla (and earlier technology companies like Google, Uber, and Facebook). The payoff could be enormous. Or, as was the case for SunEdison, Abengoa, and Q-Cells, much money might be lost.
New businesses still face immense challenges in the transition. It might take too long for markets to change and for investments to generate a return. Companies and their investors might run out of money and patience. The early movers might not be the winners. While their spending on educating customers, fighting regulations, and building new organizations is essential for overall market development, it might not pay back for them. Many of the companies that will really benefit from the revolution in the way we generate and use energy are probably not around yet.
It will take great strategic courage to be a winner in the global energy transition.
Dr. Tobias Engelmeier is an entrepreneur and sustainability consultant. He runs www.tfeconsulting.com, and founded www.bridgetoindia.com and www.indiagoessolar.com. He also cofounded www.gridhub.com. Tobias now lives in Germany.