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The cost-paradigm shift in Hydro-generation

Hydro generation – a highly mature business where cost efficiency is moving up on directors’ agenda. Previously, costs were underprioritized as income dwarfed operating costs, and availability significantly affected revenues.

Costs are currently a major focus area due to their impact on safeguarding values and optimizing commercial potential. Paradigm changes have altered mindsets in hydro generation – reinforced by low electricity prices in Europe. Regulations are forcing managers to consider new business models and partnerships to reduce costs. While some are hoping for the negative price development to turn, outlooks indicate that the industry players have to face and adapt to low prices for a longer period.

The industry has allowed the cost-levels to increase to unprecedented levels

Despite the increased focus on cost efficiency, hydro operators find it challenging to understand their own performance compared to their peers. Best practice performance is obscured due to the unique nature of each hydro operation, which is affected by, among others, various asset types and configurations, income profile and risk, regulation hydrological factors, climate and more.

Together with Norwegian hydropower operators PA have developed a methodology that allows one-to-one comparison across different power plant portfolios. The approach – what we call the ‘weighted maintenance object’ (WMO) model – is an asset-specific measure that reveals the asset’s underlying cost drivers. WMO is established atpower plant level, allowing for a consistent view of the operator’s total assets and their associated cost drivers. This enables a direct comparison of assets and operators regardless of size, type, configuration, geography and other external factors.

Our benchmark includes more than 80 companies and over 2,800 unique power stations – accounting for more than 110,000 MW installed capacity. This represents around 10 % of the total installed capacity globally. Each year, we host an annual forum where over 25 Norwegian hydro operators meet to discuss performance in the industry. The graph below illustrates that despite focus on cost efficiency; the average cost level of participants is increasing – mainly driven by reinvestments. The red line shows the (sad) developments of market spot-prices.


Creating $multi-million savings

We are now witnessing how a large and growing number of hydropower producers are committing to reversing the trend and engaging in cost reduction. Statkraft, E-Co, Eidsiva, Østfold Energi are all examples of companies making dedicated efforts to reducing costs and adjusting their operating models.

Is the current focus on cost efficiency yet another example of the industry players acting like a “herd of sheeps”, more or less signing up at the same time to a state of general wisdom about the need of doing something? Alternatively, are we finally witnessing a 100-year-old industry acknowledging the new reality of reduced profitability that needs to be met by profound changes? Needless to say, our view is the latter.

By applying the insights gained from the benchmarking study, together with our team’s extensive experience in the hydropower sector, we have helped organizations to save an average of 20% of their total cost base. One hydropower company cut both operating expenses and capital expenditures costs by 35% during an 18 months period – accounting for $40 million.

The transformation of the industry is leading to several inspiring trends:

  • A strict, value-driven portfolio-strategy applied on the development of the asset-portfolio and the large investments/re-investments, including a revised appreciation of Technical Risk (lower risk due to lower power prices seeking to actively explore the optimisation of spend and un-planned failures.

  • Revised Operational Models being implemented catering for lower fixed cost, increased flexibility and a major shift away from the old logic of resource-based task-planning, avoiding to make the in-house available resources the “driver” for releasing projects.

  • Advanced and active technology-application and usage. Something which has been a strong suite of the Norwegian industry for decades, but may still be pushed further making big data in condition-monitoring the cornerstone in more precise predictive maintenance. The autonomous operation capacity of an asset will increase by enhancing the built-in intelligence in SCADA and control systems. Further, the use of technology-application usage will reduce delays and need for human intervention and travel.

Going forward, we believe we will continue to see noticeable differences between the companies and their owner’s willingness to change to a more radical mindset and way of operating. The biggest challenge at present is the small “relief” that many power-companies experienced from the slightly increased power-prices in Q4 2016, helping them create a much-needed improvement in the annual profitability than the previous year.

Unfortunately, fundamental problems in the industry are not going away by themselves. Today, strong leadership is about carrying on the change-momentum, undisturbed  by short-term market shifts.

Cost effectiveness per company
The figure illustrates the shift in a company's performance. In a period of 18 months, the benchmark participant managed to reduce its cost by 35%, equivalent to $40 million. From being among the worst performers compared to relevant peers, the company reached top 30% within only 18 months.

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