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This article originally appeared in the above issue of our print magazine. The digital version of the magazine can be read online or downloaded free of charge.
9 December 2016

Is every kWh the same? Maximising utility margins through DSM

More than ever the electricity utilities of Africa are facing headwinds and challenges. These include shortages of generation capacity, growing pressure to electrify large numbers of customers, a financial squeeze, and generally a lack of capacity to deliver both as the supplier of last resort and to function as cornerstones of economic growth.

Unfortunately, the conventional utility approach to such pressures is to invest in more generation plants, connect IPPs, construct networks, whilst increasing tariffs in an attempt to balance the financial books. This mindset stems from the perception that utilities simply supply kWhs as a ‘commodity’ to a meter, which consumers buy and use in an unknown way, as long as they pay.

In parallel, a disturbing trend for utilities is how the ‘locus of control’ for energy use and costs has shifted towards end users. Consumers of electricity in response to rising prices and uncertainty of supply are now more enlightened than ever on what action to take. Their responses have been to:

  • naturally embrace energy conservation: “turn off the heater, it is costing us too much”;
  • listen to suppliers of energy efficiency products: “let’s retrofit the classrooms with LED light or add variable speed motor drives to our pumps”; and
  • take capital risks on renewable based solutions: “invest in a solar water heater, homeowner or office block PV panels for added greening reasons”.

This accelerating trend is catching utilities flat footed as the shifting sales patterns and associated revenue losses are only being realised once the customer has left.

Despite being around for years, Demand Side Management (DSM) is a misunderstood and even maligned strategy for senior utility management to deploy in resolving these utility challenges. In fact it could be said that utilities who do not embrace ‘beyond the meter’ or ‘demand side’ actions will not survive! This forgotten step-sister enables utilities to appreciate how their customers use kWhs, appreciate the profitability or margin on every kWh sold and then work towards managing customer usage to optimise returns and thereby profits. It is not an understatement to say that senior utility executives have a direct fiduciary accountability to shareholders and stakeholders to understand and apply the business principles described in this article.

Yet, such is the lethargy and entrenchment of utility thinking that it will require the full persuasion and drive of senior utility management to introduce and correctly harness the benefits of DSM. For too long, the driver for DSM actions has only been to manage generation shortages; it is now time to harness DSM as an essential and central utility financial tool. Without it, utilities will face increasing financial pressures, loss of margin, inability to understand their markets and revenue streams, and ultimately bankruptcy.

A central notion

To appreciate how financial benefits immediately flow from DSM programmes, a central notion is that every kWh supplied is not the same and has a different financial margin. The application of a basic financial formula to a kWh sold and delivered would be:

  • Contribution = Sales less Cost of sales
  • Profit/loss = Contribution less Overheads

Where in the case of each kWh generated and supplied:

  • Sales – function of tariffs, date, time, application
  • Cost of sales – function of wholesale tariff/generation costs, geography
  • Overheads – function of new build, staff, equipment costs etc.

In diagrammatic form above every kWh flowing through a utility network is different in terms of the generation source, date/day of use, exact time of use, geographic position on network point, customer type, tariff and application e.g. motor power.

It is imperative for utilities to embrace this notion and then to start managing the return on every kWh sold. The notion effectively shifts electricity away from being just a ‘commodity’ to a whole range of differentiated products. Rather utilities are becoming ‘energy supermarkets’, with racks of different goods for sale. For example, a kWh generated by a base load coal plant (supply side pricing variable), purchased by a remote large industrial customer (demand side variable) on preferential tariff in the early hours (supply side variable) of the morning or an upmarket household buying diesel-fired peaking plant power to run an underfloor heater on a weekday winter’s afternoon.

Application

This notion requires utilities to understand how every kWh is used through the following customer specific matters:

  • Cost of supply in terms of true overhead allocation. Costs of supply stretch from generation, perhaps wholesale tariffs, transmission lines and distribution network costs through to local service costs for call out. Plus the allocation of losses and revenue protection costs.
  • Customer attractiveness, margin and rating to the utility. Preferences for certain kWh sales need to integrate not only the current margin on a kWh, but also longer term returns, energy market trends and nature of the customer.
  • Appreciation of the services enjoyed by a customer through the supplied kWhs. Losing or gaining loads always relates to what energy service customers are prepared to gain or lose or switch to other solutions.
  • Purchase drivers, usage behaviour and switching options. In the end it is all about customer choice, why they will move, and what the benefits are from their perspective. Forecasting and customer trends – especially which loads are likely to switch away to other sources.

To maximise financial returns a utility then needs to strategically manage its market through the correct application of DSM. Asking questions such as:

  • Which kWh sales should be demarketed as they operate at a loss and have no possibility of being turned into profitable sales?
  • Which kWhs are really cash cows that need to be protected by reducing any risk of migration away?
  • Which service conditions could be altered to shift loss-making kWhs into profitable sales?
  • Which kWhs are helping to improve the load factor of utility infrastructure usage?

Once DSM objectives to retain, grow or reduce specific kWh sales are set, the last action is to develop and implement suitable market intervening programmes and actions to bring about the shift in sales. Techniques that a utility can harness include:

  • Demand response. An interactive process whereby customers are compensated to reduce loads during high usage times to circumvent running of expensive peaking plant. Here smart meters can play a role; however the straight removal of customer services is not recommended as it becomes the same as ripple control.
  • Tariff corrections. Under-recovering tariffs can be placed on a path whereby in a few years the real costs are deflected to customers. Alternative price incentives or reductions can be brought in to protect cash cow sales. Time of use tariffs can help as they reflect the true costs of different times of the day to customers.
  • Fuel switching. Support for customers to shift loss-making thermal loads away to other fuels or preferably to renewable sources.
  • Energy efficiency. Encouraging target groups to embrace energy efficiency to lower consumption as it may be cheaper than adding more generation capacity. This action can be implemented via sales teams.

While the concept of maximising utility margins through DSM is fairly straightforward, the devil, as always, is in the detail. Here utilities are going to need much help starting from the shifting of thinking or organisational development, as the old adage applies: culture always wins over strategy!

Next, analysis/decision making models and tools need to be developed or brought in to produce the levels of information needed to make decisions. Lastly, there is the very ‘un-utility’ matter of developing programmes to shift customer behaviour and sell the correct products.

The conclusion

Unless utilities across Africa start understanding and managing the financial margin on each kWh sold, they will get into greater difficulty. Cross subsidisation between different customers will be taking place without the utility’s knowledge and they will be failing to appreciate and protect their real cash cow sales.

Yes, utility professionals viewing electricity no longer as a commodity but rather as a supermarket shelf of different products is completely foreign. Yet all that is needed is for senior executives to embrace already known Demand Side Management activities with a different decision driver. Thereby shifting DSM from a generation saviour into a method for maximising financial returns on kWhs.

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