SAentrepreneurship and innovation

The revenue model on which utility businesses are based is under threat from the shifting industry norms. The 4th industrial revolution is underway and already utilities are witness to digitalisation, decarbonisation and decentralisation – all affecting their traditional business strategies.

This article first appeared in ESI Africa Edition 4, 2018. You can read the full digital magazine here or subscribe here to receive a print copy.

The Big Question we asked the experts is: What must utilities do to safeguard their relevance in the water and power market?

Vally Padayachee, Energy consultant, South Africa – responds

The fourth industrial revolution can be fundamentally characterised at its core as the “marriage of physical and digital technologies such as analytics, artificial intelligence, cognitive technologies and the internet of things (IoT),” according to Deloitte. Unlike the first three industrial revolutions wherein the impact of changes to society, businesses, and industries was relatively slow; the impact of the changes that are being, and will continue to be, generated by the fourth industrial revolution is going to be astronomical or exponential to say the least.

According to the IEA, “the pace of digitalisation in energy is increasing. Investment in digital technologies by energy companies has risen sharply over the last few years. For example, global investment in digital electricity infrastructure and software has grown by over 20% annually since 2014, reaching $47 billion in 2016. This digital investment in 2016 was almost 40% higher than investment in gas-fired power generation worldwide ($34 billion) and almost equal to total investment in India’s electricity sector ($55 billion)…”.

The impact of the 4IR on the electricity utility sector in particular is also being, and is still going to be, felt in the years ahead – so much so that the majority of electricity utilities will have to rethink their business models to remain inter alia viable.  At the SALGA Energy Summit held in March 2018 City Power Johannesburg reported:

  1. “Since 2009, City Power Johannesburg has seen a full 10% reduction in kWh sales, from 13,100GWh down to 11,780GWh per annum.
  2. Since 2002, City Power has connected up 60,000 new customers (largely in the low income residential sector).
  3. Individual customers are becoming energy efficient but still rely on the convenience of the grid for their energy needs.
  4. The metropolitan municipality utility economy seems to be becoming less energy intensive while businesses still need a reliable grid to prosper.
  5. Tariffs that are based purely on energy (R/kWh charges) will result in declining revenues.
  6. Tariffs that include a defined (fixed) charge component to be connected to the grid and a separate energy component are sustainable.”

Is our future power distribution utility business a transition from a commodity sales (kWh) based business to a commodity transport based business (i.e. kWh + network access), or somewhere in between? How much of the business is there to provide product i.e. just energy in the form of kWhs? How much of the business is there to provide network services i.e. access into or out of an energy highway?

The weighting and ratio of fixed network charges to variable charges of future tariffs will depend on how these questions are answered.

My view, which is shared by many industry professionals in South Africa and abroad, is that for a power distribution utility the so called “kWh” commodity business is a “dead business”. The PwC paper Looking ahead: future market and business models is an excellent article recommending eight business models for power companies to consider to inter alia remain profitable. PwC believes that “a greater emphasis will be placed on obtaining higher margin from prices/revenues rather than cost reduction to get higher earnings and profit growth”.

In respect of power distribution utility companies the following PwC business model recommendations are noted:

  1. A product innovator model – in this model a company that offers electricity as well as behind-the meter products to customers. The focus is on expanding the role of the energy retailer and changing the level of customer expectations.
  2. A ‘partner of partners’ utility model – here the company offers not only standard power and gas products and associated services, but also a range of other energyrelated services, from life-cycle EV battery change out, to home-related convenience services like new service set-up coordination, to management of net meteringdriven grid sell-back.
  3. A value-added enabler utility model – is a company that leverages its fundamental capacities for information management to expand the role that a utility can provide on behalf of its customers. 4. A virtual utility model – where a company that can aggregate the generation from various distributed systems and act as the intermediary between and with energy markets.

In light of this information, it is my view that power distribution utilities will need to give serious consideration to relooking at the current business models given inter alia the impact of the fourth industrial revolution on the power delivery sector business across the entire value chain.

Kadri Nassiep – Executive director of energy, City of Cape Town – responds

A rethink of the energy system’s model that has underpinned our development over the last 50 years is needed if South Africa wishes to attain economic growth targets last seen in the mid-1990s. Local authorities in South Africa are largely dependent on Eskom for the supply of electricity. The constitutional mandate of the municipalities extends to the reticulation of electricity and other services to their constituencies. Rising electricity prices over the past decade, sometimes with annual increases in excess of 20%, have had a crippling effect on local economies.

Some of the progressive municipalities have also adopted targets for cleaner energy supply but have seen their efforts to procure such energy stymied by a contested piece of legislation, namely the Electricity Regulation Act of 2006 – which gives the National Energy Regulator power over issuing licences. The drive towards renewable energy uptake at a national level has also resulted in a disproportionate regional and local allocation of resources. The financial results posted by Eskom for the 2017/18 financial year reflects a loss of R2.3 billion, attributed largely to lower sales revenue, maladministration, increasing municipal debt and a challenging governance environment. It is clear that the malaise that set in over a decade ago has culminated in the perfect storm for the utility and the country. It is impractical to believe that the nascent yet burgeoning renewable energy industry will be kept at bay much longer.

The narrative that focuses on the electricity supply industry in South Africa is currently dominated by two central debates; namely, the eventual but inexorable drive towards restructuring of the national utility Eskom and the liberalisation of the market that utilities at local government levels operate in. The old vertically integrated utility model that Eskom adopted requires unbundling, as both the generation and distribution businesses face mounting pressure from private and public fronts.

The transmission network needs to be strengthened locally and regionally, serving as a catalyst for growth into an expanded market in the SADC region. Eskom, largely through its unregulated business, should be opening new markets for its products using the wires business as its spearhead. Eskom Enterprises does have this mandate at present, but the uncertainty regarding the market operator should be clarified once and for all and allow Eskom to proceed with long term surety into these markets.

At local government level, Eskom faces pressure from the larger metropolitan councils that are flexing their muscles. A significant court challenge by the City of Cape Town, if successful, will allow municipalities to purchase power directly from independent sources, rather than through Eskom as is the status quo at present. To further entrench the constitutional rights of the municipality in respect of power generation, the Integrated Resource Plan (IRP) methodology needs to be reviewed and amended, which is currently underway. The current planning process does not factor in local economic needs and development priorities.

The IRP needs to be constructed from the bottom up, whereby the final plan is a consolidation of the larger metro’s own capacity expansion plans. Eskom could then well be tasked to provide for the shortfalls in the system at a national level. A procurement process could therefore be undertaken at both national and local level.

Bold and effective leadership is needed to alter the fundamental fabric of our electricity supply industry but the indicators all point to a death spiral for the national utility and industry unless decisive action is taken.

Ted Blom – Partner at Mining & Energy Advisory – responds

Utilities in their current form have been around for less than 100 years and evolved out of the pressure to tap into economies of scale offered by bulking up. In the South African context, the most recognised utility is Eskom, itself having been cobbled together from a number of smaller utilities by its founder, Dr Hendrik Johannes van der Bijl.

The rationale for the successful existence of Eskom has always been its ability to reliably supply very cheap electricity in bulk. With the advent of mass load shedding in 2008 and 2014, coupled with excessive price hikes since 2008, Eskom management has essentially destroyed the very fabric that justified its existence. In the process of collapsing Eskom from a world leading giant in power generation, corrupt leadership has also destroyed the trust and reputation that existed between the organisation and its key stakeholders.

With the advent of such relationship breakdowns, these organisations become very vulnerable to competition as was evidenced when a similar utility, Telkom, was subjected to competition in the telecoms market. Whilst monopolies are often needed to open up and develop a new market, their own poor behaviour often leads to their demise.

Utilities that wish to safeguard their relevance need to remain cognisant of the very rationale for their existence – once that rationale is breached, a point of ‘no return’ is reached whereafter it is impossible to maintain the status quo, and by necessity, competition is the most likely endgame. Given the abovementioned “Road to Damascus” it can only be a matter of time before our water utilities will face the same pressure and be opened up to competition. ESI

This article first appeared in ESI Africa Edition 4, 2018. You can read the full digital magazine here or subscribe here to receive a print copy.