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New energy in the electricity sector

With new business models emerging, competition in the electricity sector is beginning to stir.

The rise of the digital economy has led numerous markets to experience radical innovation in business models. This has shaken incumbent firms and benefited consumers. Electricity is no exception, with green and distributed generators located in the workplace and home already posing existential threats to traditional mass supply-based businesses. And now a variety of new business models are emerging to disrupt retail too. With innovation needed to deliver on commitments to combat climate change and address fuel poverty, radical innovation in the electricity sector holds promising potential. 

Take the sharing economy. This offers the prospect of peer-to-peer (P2P) energy trading between producer-consumers, known as “pro-sumers”, and differs from the uber model in two important ways. Firstly, it does actually involve the sharing of spare capacity (à la Airbnb), and therefore unleashes a significant capacity expansion at zero marginal cost (in contrast to the smaller increase in supply that occurs when restrictive regulations are challenged). 

Secondly, secure blockchain technology could be a boon to this development, according to PWC. These timestamped distributed databases, which can’t be tampered with or revised, may represent an evolutionary step in the “sharing” business model. With its ability to provide accurate and certified records of activity, blockchain technology allows trust to develop between the buyer and the generator in both the transaction and the origins of the electricity, thus replacing the role of reviews on sharing platforms. Once the blockchain is functioning, the digital platform no longer plays as important a role, (and as an article in the Harvard Business Review suggests, may mean it is not required at all). This may therefore lower electricity prices and increase the incentives for generators to enter the market. 

There is, however, the sticky issue of pricing distribution grids for these pro-sumers. Consumers who purchase electricity from local generators may rarely, if ever, need the transmission grid. They will argue that they should not have to cross-subsidise it. However, aside from those local energy communities that choose to switch to their own micro-grid, each household generator needs to transfer its spare capacity to a local distribution grid to sell locally. This means they will need to make at least some financial contribution. 

This might be based on grid usage, but intermittency in local renewable generation that cannot be resolved through battery storage might mean pro-sumers still value access to the grid and perhaps “super-grids” that quickly transport renewable energy across continents even when they are not using it.

Some governments, such as in the UK, have encouraged consumers to form buying groups that use their collective purchasing power to negotiate lower prices. These demand aggregators are another challenge for traditional retailers. Right now, European consumers can choose to opt-in to buyer groups, but while research on behavioural insights suggest that the formation of opt-out buying groups holds more promise, the real innovation is firms offering further discounts to groups of customers that are prepared to have their usage reduced when the grid is experiencing high demand. The industry expects this will happen more often as grids rely increasingly on intermittent local renewable energy sources. Purchasing flexibility may therefore cut costs by reducing the need to “turn on” older high-cost, typically non-renewable, generators, and removing the need to replace them. 

Another challenge to traditional business models comes from firms seeking to de-commoditise electricity and sell it as a service. For example, in this model, Electricity Service Companies (ESCOs as described by the IEA) charge for lighting as a service rather than sell electricity in the form of kWh. To reduce costs and increase margins, ESCOs install sensors and use algorithms to turn off or turn down lighting when it’s not needed, or to manage heat production and retention. This model has been on the rise in large businesses for some time, but the “internet of things” makes it possible for households and small businesses, too. Firms may also bundle electricity with other utilities in “household services” contracts.

In the midst of this upheaval, competition authorities and regulators need to ensure that regulation keeps paces with the changes by removing or revising regulations that distort competition. They should allow firms the freedom to innovate without picking winners. They also need to distinguish between incumbents looking to innovate and price more competitively, and those manoeuvring to exclude innovative rivals.

For competition authorities, regulators and policymakers questions therefore abound. How should the grid be priced? Will capacity reward mechanisms hinder innovation? Are demand aggregators, pro-sumers, energy storage firms and super-grids able to sell flexibility to the grid? Can grid operators compete in these markets? Or would they use their monopolies to foreclose them? Is there a case for vertical separation of grid operators? Do off-network local energy communities mean the end of the grid operator’s monopoly? Would ESCO contracts with simple prices increase consumer engagement? Or should we accept the inertia of energy consumers and use opt-out energy supply auctions to generate competition?  

The disruption caused by technological innovation and new business models is competition in action. Competition authorities should therefore use their enforcement and advocacy powers to promote this competition and maximise consumer welfare. 

Note: Watch out for a OECD Competition Committee Hearing on 19 June 2017 on radical innovation in the electricity sector. Contact Chris Pike at the OECD for more information.

References and further reading

OECD Competition Committee Hearing on radical innovation in the electricity sector, 19 June 2017

Diane Cardwell (2017), “Solar Experiment Lets Neighbors Trade Energy Among Themselves”, New York Times, March 13, 2017

Matthew Crosby (2014), “Will There Ever Be an Airbnb or Uber for the Electricity Grid?” Rocky Mountain Institute

PWC (2016), “Blockchain–an opportunity for energy producers and consumers?” 

Primavera De Filippi (2017), “What Blockchain Means for the Sharing Economy”, Harvard Business Review

OFGEM (2017), “Local Energy in a Transforming Energy System” 

Teresa Hansen (2016), “The Rise of HVDC and Promise of Supergrids”, Electric Light and Power, 19 December 2016 

UK (2013), “Guidance on Collective switching and purchasing

BEUC - The European Consumer Organisation (2015), “Collective Energy Switch” 

Catherine Waddams (2017), “To switch or not to switch”, Competition Policy Blog

Smart Energy Demand Coalition (2015), “Mapping Demand Response in Europe Today

International Energy Agency (2016), “Energy Efficiency: Market Report 2016” 

Lynne Kiesling and Dick Munson (2016), “A Revolution in Power: Where We’ve Come from, Where We’re Headed”, Electricity Policy

Claude Crampes and Catherine Waddams (2017), “Empowering electricity consumers in retail and wholesale markets”, Centre on Regulation in Europe 

©OECD Observer No 310, Q2 2017