Energy markets are difficult to predict since there are so many new disruptive trends that utilities have to contend with: new sources of renewable energy, distributed generation, regulatory shifts and rising energy efficiency, and declining consumer consumption.
This high level of complexity and uncertainty makes it difficult to plan long-term.
Key indicators help decision-making
Utilities have to define and understand the full spectrum of future scenarios and then identify the key indicators that point to where markets are headed. These indicators include industry data and analysis.
Experience curves (which show when technology costs reach tipping points that change supply-and-demand dynamics) and substitution barriers (which show how long it will take for new sources of energy to penetrate the market) are key to understanding trends.
When these indicators are identified and monitored correctly, utilities’ decision-makers will be able to plan several years further into the future. As a result, the right decisions will be made more often.
Since there are many variables and possible outcomes, utilities should focus on a limited set of plausible extreme “corners”.
Indicators would include electricity generation, competition, regulatory possibilities and renewable technology. Within each of these, decision-makers should develop a detailed market analysis that points to potential new technologies and sources, as well as the relevant efficiency gains that help determine supply curves and clearing prices.
Utilities stand to benefit from this approach as they make strategic decisions in an industry that is grappling with significant disruptions. Scenarios and indicators can be powerful tools for understanding the evolution of the energy ecosystem at a time of grave uncertainty.
Scenarios and indicators
One of the biggest decisions that utilities face today is whether to substitute one source of fuel for another in power generation. For instance, the move from fossil fuels and/or nuclear power to renewables. They also need to decide where they will be in the value chain-from power generation through transmission and distribution and down into wholesale and retail.
Since regulations vary, scenarios will differ from one country or region to another. However, the process of identifying extreme outcomes will remain the same regardless of location. Bain and Company recommends a process for utilities to follow:
Identify the variables affecting growth and profit in the areas where you do business, including regulations (carbon taxes, renewable standards, and rate structures), technology changes (renewable generation, storage), and deregulation. A significant number of variable can affect the utility business.
Cluster together those variables that depend on one another. This models the actual complexity of the situation and helps identify the true corners of the business.
Develop indicators that reveal whether the environment is moving in the direction of one extreme or another. Set thresholds on metrics that indicate when disruptive change is imminent. For example, as the costs of battery technology drop, batteries will hit a tipping point that will make them competitive for voltage regulation, transmission and distribution, or utility-scale applications. It also makes sense to track campaign promises of politicians around carbon taxes or other regulations which can have a major effect on the power market.
The real value of setting scenarios and indicators is that the process gets executives talking and tracking the variables that really matter, as well as the interdependencies among them. While most companies do some scenario planning, they often fail to invest enough effort evaluating dependencies among variables and across scenarios.
Advantages of scenario planning
When putting a strategy in place, utilities need to weigh different scenarios instead of betting on one point of view.
By doing this, decision-making teams will see which strategies will help companies succeed under different conditions. They will then be in a better situation to respond efficiently since indicators will point to shifts in direction.
Understanding the interdependencies of variables and second-order effects lends confidence to “no regrets” moves that are advantageous across scenarios. Scenario planning also allows executive teams to take a more flexible approach, which differs from traditional strategic planning in the following ways:
“No regrets” moves. First, you begin thinking about strategies that are robust under several scenarios, and you can take “no regrets” moves that make sense, whichever direction the market heads.
Options in strategy. You begin to build option value into your strategy based on different scenarios.
Dynamic decision making. You can determine in advance the decisions you will make if certain indicators flash red. This will eliminate the need to be reactive and study alternatives when you see the market shift.
Foresight on tipping points. Metrics and indicators allow you to see three to five years further out than traditional planning. By tracking experience curves and regulatory trends, you can see tipping points long in advance.
Dashboard for executives and boards. This tool becomes an outstanding way to keep executive committees and boards apprised of changing markets. Once all the major variables are properly understood, it becomes easier to make changes.
Traditional forecasting is limiting in its very nature. The uncertainties that utilities face make it almost impossible to predict the future. But, utilities can build the capabilities to see further down the road by developing scenarios, identifying indicators and tracking leading indicators.
By following this path of analysis, utilities and their stakeholders will be able to make sense of the future landscape.