The electricity system is in a period of unprecedented transformation, which is likely to continue for some time.
Key changes in the electricity technology and policy realm have led us to where we are now, while there are others that will continue to drive change. These forces are changing the business models of the various electricity companies that form the electricity supply chain.
The first of the changes that impacted the electricity (and energy) utility space in much of the world is the deregulation of electricity markets and the creation of new market mechanisms to trade wholesale electricity. The United Kingdom kicked this off in the early 1990s. In Australia, this process culminated in the start of the National Electricity Market (NEM) in 1998 where NSW, Queensland, Victoria and South Australia were set up as wholesale pricing nodes in this market.
Subsequently, the gas network was also brought into this new framework, and we continue to refer to the entire bundle as the NEM.
This was an exciting and sometimes stressful time for many electricity industry professionals. Companies were created, broken up, merged, privatised and subjected to many reviews and restructurings.
Some downsizing occurred, particularly in Victoria where the State Electricity Commission of Victoria was separated into its generation, transmission, distribution and retail components that were then all sold separately to a range of mostly international buyers.
In Queensland and NSW, the assets were kept in government hands but traded and regulated as though they were private businesses. In South Australia, the privatisation happened a little later. For some reason, Western Australia’s energy system managed to avoid becoming part of the NEM and its deregulation occurred much later, in 2007.
The interesting and important features of this deregulation and disaggregation process that are now causing significant challenges to the shareholders and owners are as follows:
The respective state electricity commissions were separated into generation companies, or individual generators that were sold off separately. These generation entities were then required to compete against each other to sell electricity into the grid.
This mechanism was referred to as the wholesale electricity pool, because the source of electricity, like water, cannot be identified once it enters a common transmission or storage facility.
Transmission was packaged up as a single company per state, and distribution and retail and their respective assets and services were set up as yet another separate group of entities (two in Queensland, three in NSW, five in Victoria, and one in South Australia).
Retail customers were allocated to distribution businesses on a geographic basis with “ring-fencing” to ensure customers could switch to any retail entity owned by a different distribution asset owner, with the ability of the incumbent distributor to cross subsidize that customer in order to retain them.
It all seemed like a jolly good idea at the time to separate the entities along the supply chain. Here, generation could operate in a competitive market due to the ability of the grid to transmit electricity over long distances with minimal loss (the long range losses in the NEM average about seven per cent for an area stretching from far north Queensland to western South Australia.)
That meant the customers for the produced energy could be anywhere. There is, of course, congestion in the system, and therefore we needed a set of different pricing zones. State-based zoning turns out to be a reasonable approximation.
So with an appropriate price signal, generation operators would be incentivised to manage and invest in their assets as efficiently as possible while (mostly) ignoring what was going on in the rest of the system.
Similarly, transmission system operators needed to simply ensure they were maintaining and expanding their system as cheaply as possible while maintaining the reliability of their assets. Distribution (lower voltage) networks that take power from the high-voltage transmission grid and deliver it to customer such as large buildings, factories, and households, could do the same.
Transmission and distribution were deemed to be natural monopolies and not amenable to competition. Therefore, economic regulators run by the state or federal governments, such as the Australian Competition and Consumer Commission and the Queensland Competition Authority, would ensure that these monopolies operated as efficiently as possible by determining what a reasonable rate they could charge for their services.
If you think that all sounds pretty reasonable, you would unfortunately be wrong. There were two fundamental and often unspoken assumptions underlying this model. These are:
- Demand for electricity would always continue to grow. This would be driven by population growth and technological innovations in the home that would require electricity (read: computers, televisions and so forth).
- The technologies used to generate and deliver electricity would always remain the same. Fossil fuel generation would dominate (coal and natural gas-fired power stations), with a little hydroelectric power to liven up the mix. Furthermore, transmission and distribution networks would always look the same, as they would take power from a relatively small number of large, remote power stations to a very large number of relatively small consumers. This is becoming known as the centralised generation model.
Both of those assumptions were wrong. In fact, these assumptions were not wrong just in the details, but in their entirety. Demand does not need to grow. We already knew this from the example of California, which has maintained the same per capital electricity consumption since the 1980s while arguably having one of the most buoyant economies in the world due to Silicon Valley.
Perceived wisdom was that electricity demand was strongly correlated to economic growth. The problem is, it just isn’t, at least, not in the way economic growth is measured. In Australia, total electricity demand has actually been falling since 2009. In fact, the Australian energy market operator has had to regularly revise its demand forecast since 2011.
At the same time, new technologies have been appearing and will continue to appear that could be deployed at many points along the supply chain. These are:
- Large-scale wind generation: very mature and requiring relatively less government support now.
- Small scale photovoltaic solar panels: a relatively mature technology whose cost has fallen at least five-fold since 2009. Depending on how it's priced, solar generation can be said to be at grid-parity in many parts of the world including Australia. That is to say it is cost competitive with cartelised generation delivered to the home. Of course, the grid is still required when the sun doesn’t shine… until affordable batteries appear!
- Solar thermal generation: more suitable for centralised large-scale applications but it is more easily complemented with energy storage technologies such as molten salt.
- Small scale batteries: these technologies, driven by significant R&D dollars invested by the computer manufacturing community for laptop and smart-phone needs, are now advancing down the cost curve in the wake of solar panels, perhaps lagging five or so years behind.
And last, but not least, we have the slew of technologies and energy management paradigms collectively known as the Smart-Grid.
Some of these technologies are simultaneously squeezing fossil fuel generators out of the wholesale market while the others (such as PV and batteries) are competing directly with the poles and wires of the distribution grid to challenge distribution network operators.