ENERGY SERVICES IN THE COMPETITIVE ELECTRICITY MARKET

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1 Presented at the IIR Conference "Opportunities and Challenges for a Competitive Energy Distribution Market" Sydney March 1996 ENERGY SERVICES IN THE COMPETITIVE ELECTRICITY MARKET Dr David J Crossley Acting Executive Director Sustainable Energy Development Authority NSW Government This paper presents the views and opinions of the author only and does not purport to represent the views or opinions of any organisation with which the author is, or has been, associated. INTRODUCTION In the dim dark days of BR (before restructuring), that is 3½ years ago, the (late) Electricity Council of NSW commissioned a consultancy study on the feasibility and desirability of the electricity supply industry (ESI) expanding its provision of energy services. In those days, the term energy services was relatively new to Australia and therefore could be used to precisely describe a particular concept. In fact, the major contribution which the consultants made was to develop a practical definition of the term. This definition was based on a review of the market for energy services in Australia and overseas (North America, the UK and Sweden), with interviews being conducted with generation and distribution utilities, energy services providers and, in NSW, with a cross-section of industrial and commercial customers. In all, a total of 160 organisations was surveyed. Based on the responses to this survey, the consultants identified ten categories of energy services which customers actually wanted (see table overleaf). At that time, the ESI already provided some of these services such as tariff advice, energy audits and technology advice. Other energy services were provided solely by the private sector, such as energy management systems, contract energy management and environmental advice. In 1992, one service, project financing of energy efficiency projects, was not provided at all by anyone. The consultants found that in NSW, the provision of energy services was fragmented with no particular class of provider being in a dominant position. They found further that the market for energy services could be categorised into two segments: the energy efficiency segment, consisting of lesser value-adding services such as energy use monitoring, walk through energy audits, technology advice and tariff advice. This segment was characterised by off the shelf solutions, low capital expenditure, and typically low level end-user decision-makers; the productivity segment, consisting of higher value-adding services such as engineering services, environmental advice, equipment purchase or refurbishment, and process improvements. This segment was characterised by high levels of capital investment, higher levels of decision making and more substantive outcomes regarding energy use. page 1

2 Energy Audit CATEGORIES OF ENERGY SERVICES A review of energy-using processes to determine appropriate methods of improving energy efficiency by implementing better work practices and/or introducing more efficient technologies. Energy Use Monitoring Implementation of procedures to monitor the use of energy on an ad hoc or on-line basis. Energy Management Systems Implementation of control systems (hardware and software) used to monitor and control the use of energy. Contract Energy Management Assumption of responsibility by an external consultant for the design, implementation and management of a system to control and monitor energy use. Technology Advice Provision of current information on energy efficient technologies and their application. Engineering Services Design, installation and commissioning of energy efficiency programs, including feasibility studies. Energy Management Training Training of in-house staff in the implementation of energy efficiency programs. Project Financing Provision of third party financing for energy efficiency projects; may include the raising of capital or the implementation of creative financing schemes (such as payback via energy savings). Environmental Advice Provision of advice on the implementation of environmentally sound policies, procedures and technologies. Tariff Advice Provision of advice on appropriate tariff selection. In 1992, the ESI was providing some energy services in the energy efficiency segment but was not operating in the productivity segment. Customers in the survey indicated that they would like to see greater ESI involvement in both segments, particularly because of poor experiences with private sector providers in the past. The consultants proposed that the NSW ESI, acting as a whole, establish an energy services company (ESCO) to undertake the provision of energy services to customers on a commercial basis. The ESCO would have two operating units: a professional services unit operating mainly in the energy efficiency segment, and a financial services unit operating mainly in the productivity segment. Despite some attempts by myself to promote it, the idea of an ESI-wide ESCO never got off the ground. It was scuppered largely by the birth pangs of competition which were starting to make it difficult to implement initiatives which relied on co-operation between individual utilities. page 2

3 However, the idea did not fall on entirely infertile ground. Soon after the completion of the consultants report, an American entrepreneur did the rounds of major Australian utilities seeking a partner to establish an American-style ESCO in Australia. After being rejected by several large utilities, he found a sympathetic hearing at Sydney Electricity. Two years later Australian Energy Solutions (AES) was announced as a joint venture between Sydney Electricity and Intesco, a US company. AES is an ESCO which is intended to operate precisely in the productivity segment identified by the Electricity Council consultants. It provides packaged solutions aimed at increasing the energy efficiency of the operations of major electricity customers, primarily in the commercial sector. Importantly, the package also includes financing of the energy efficiency measures required. AES is intended to generate profits through sharing with the customer the cost savings achieved through the customer s reduced electricity bills. ENERGY SERVICES AS A NEW BUSINESS FOR UTILITIES AES took two years to get off the ground largely because the NSW government bureaucracy at that time seemed to find it incredibly difficult to deal with the idea of an electricity utility setting up a subsidiary to provide anything other than kilowatt-hours. In the meantime, other utilities, and indeed Sydney Electricity itself, had formed alliances with private sector energy service providers. For example, Prospect joined with Energetics and Sydney joined with Enman. The point about all these initiatives was that they were essentially operating in the energy efficiency segment, providing lesser value-adding services such as energy use monitoring, walk through energy audits, technology advice and tariff advice. This segment was characterised by the Electricity Council consultants as involving off the shelf solutions, low capital expenditure and, by implication, low profit levels. For the utilities, entering this area was really only an extension of the customer advisory services they had been providing for many years rather than the establishment of major new businesses. On the other hand, the establishment of Australian Energy Solutions was a significant departure from past utility practice through its provision of fully packaged solutions, including financing, and its reliance on shared savings contracts to provide an income stream. To date, AES has yet to sign a contract with a customer. However, I understand that several prospective customers have acknowledged the viability of the business concept by taking AES proposals for packaged solutions and providing their own financing. ENERGY SERVICES IN THE COMPETITIVE ELECTRICITY MARKET The massive changes in the electricity supply industry triggered by the introduction of the competitive electricity market provide substantial opportunities for utilities to continue extending the electricity market through providing energy services. In the competitive electricity supply industry, business strategies will be driven by customers needs. This implies a reversal of the current structure of the industry in which the large investments in generation assets drive business strategies. The primacy of the generation sector has been particularly evident in NSW where, in the past, the government has influenced the financial structure of the electricity industry so that most of the profit has been created within the generation sector. In the competitive electricity supply industry, those electricity businesses which have direct contact with end-use customers will be the prime movers in determining business strategies. Retailers, particularly, will establish the dominant business strategies which page 3

4 impact on customers. Transmission and distribution wires businesses will concentrate on efficiently managing their assets and providing the network services required by the retailers and customers. Generators will be price takers rather than price setters and generation businesses will contract to their core business of generating kilowatt-hours as cost-effectively as possible. Commercial Drivers Towards Energy Services The main commercial drivers for electricity businesses to provide energy services will be: cost reduction; product differentiation; business diversification. Cost Reduction Competition will establish cost reduction as the major commercial driver for those electricity businesses which own major assets, namely transmission and distribution wires businesses and generation businesses. Providing energy services which lead to utility cost reductions will be actively pursued by these businesses. For example, it will be in the commercial interest of wires businesses to promote increased energy efficiency by end-users as a cost-effective option to defer the need to build transmission and distribution lines. Product Differentiation For the competitive electricity retail and generation businesses, a significant competitive advantage may be gained by differentiating their products from those of competitors. One way to achieve product differentiation is to provide energy services, either bundled with the kilowatt-hours or provided separately as a value-added service, for example: retailers can provide a full range of energy services to their retail customers; generators may choose to bundle energy efficiency services into supply contracts with contestable customers. Business Diversification In the competitive electricity industry, retailers particularly will have the opportunity to diversify their businesses by establishing new business ventures providing energy services. As noted previously, the major electricity distributors in NSW are already doing this. Examples of business diversification based on energy services include: retailers establishing new business ventures to provide energy efficiency services and advice on a commercial basis to their customers; retailers selling renewable energy systems, such as solar water heaters and remote area power systems; retailers introducing green pricing where customers pay a premium to purchase electricity generated from renewable energy sources. In the future, electricity businesses may diversify into assisting their customers to meet their commitments under the Commonwealth Government s Greenhouse Challenge program which promotes the reduction of greenhouse gas emissions. page 4

5 WILL ENERGY SERVICES BECOME A NEW COMPETITIVE EDGE? The question which now arises is whether providing energy services will become a new competitive edge for utilities in the restructured electricity supply industry. Some of the signs are encouraging. Australian governments, keen to demonstrate the green credentials of their restructuring activities, have removed the bureaucratic obstacles which, in the past, have made it difficult for electricity utilities to do anything but sell kilowatt-hours. For example, the the NSW Government s corporatisation legislation for its restructured electricity businesses explicitly empowers the retail arms of electricity distributors to provide a range of energy services. This legislation was passed by the NSW Parliament just before Christmas last year and the newly corporatised bodies commenced operation on 1 March this year. On the other hand, evidence from other countries which have already restructured their ESIs is not particularly encouraging. In England and Wales the initial preoccupation with building gas-fired generation capacity and the more recent obsession with mergers and acquisitions seems to have prevented the regional electricity companies ( RECs ) from extending their businesses through providing energy services. There is also little evidence in New Zealand and Norway of a major increase in the provision of energy services by utilities. However, there are four significant differences between the restructuring process in Australia and those in other countries which I believe will make it more likely that Australian utilities will use the provision of energy services to extend the electricity market: the excruciatingly long process of developing the Australian competitive electricity market, now exceeding five years, has enabled far-sighted utilities to extensively plan their entry to the market and restructure their businesses accordingly; the policy development process accompanying the development of the market has included significant studies of the role of demand management and energy efficiency in the market. There have been no fewer than six separate policy studies of this issue and these have served to alert utilities to the commercial opportunities involving energy services; several Australian utilities have already made major investments in providing energy services and will enter the competitive market with well-established businesses in this area; the aggressive policy stances which Australian governments have taken towards greenhouse gas abatement have focussed attention on the ESI as a major source of greenhouse gas emissions. The ESAA played a major role in averting the imposition of a carbon tax in Australia by promising major action by the ESI to achieve greenhouse gas abatement. Governments will now make sure that the ESI delivers on its promises. Providing energy services is a highly effective method which the ESI can use to respond to these pressures. On balance, then, I am relatively optimistic that utilities will extend the electricity market in Australia through providing energy services to end-use customers. However, as with so many things connected with the introduction of the competitive electricity market, only time will tell. page 5