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Rising energy costs - threat or opportunity?

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Energy World

September 2012

The one certainty all organisations can count on is the rising price of energy.  The UK Department for Energy and Climate Change’s recently proposed Energy Bill highlights further upwards pressure on energy prices due to the £110 billion of investment required to provide the UK with low-carbon power generation. This will be exacerbated by higher fuel prices, existing plant shutdowns (partly as a result of EU Directives), more extreme weather patterns and economic growth in developing nations such as China, Brazil and India.

While the UK electricity market reform’s focus on maintaining supply and creating cleaner energy may be achievable, its third objective of keeping consumers’ energy bills down is likely to prove very challenging. But the news isn’t all bad – there are in fact new opportunities for all in the wake of rising energy costs.

Rising energy costs present challenges for business consumers and energy suppliers alike. For businesses, energy costs represent a significant part of their cost and competitiveness. Over the last 15 years, for example, the compound average annual electricity price increase for a medium sized UK business has been nearly 4 per cent, representing twice the rate of the Consumer Price Index inflation rate. Energy suppliers, meanwhile, face the prospect of increased competition and reductions in top-line sales.

To cope with the challenges associated with rising costs, both business consumers and energy suppliers should focus on the many opportunities that also arise in any such complex and changing situation. This means businesses using energy efficiency measures and government-backed initiatives to increase bottom-line profit. For suppliers, a number of opportunities exist for creating new revenue streams and strengthening customer loyalty by offering new services relating to enhanced energy management.

Business energy efficiency

The first opportunity for businesses is in realising outstanding financial returns by investing in energy efficiency initiatives.  The key is to recognise that they need to spend money to save money. For example, unless they invest in diagnostic tools so they can measure, monitor and recognise the benefits of their investment it will be very difficult to present convincing business cases for any substantial change. Energy intensive businesses already know this well, but the same rigour needs to be more widely adopted.

There are many excellent examples of UK companies achieving substantial benefits from their investment in energy efficiency. Marks and Spencer, for example, reported that its ‘Plan A’ initiative – a five-year plan to increase environmental sustainability at an expected cost of £200m – yielded a 23 per cent improvement in energy efficiency during 2010/11. This included £13.5m of energy cost reductions in stores and distribution centres and fuel savings of £2m.

Similarly, BT Group – after investing significant sums to accurately measure its energy use – saved over £18m in 2011 across its networks, data centres and buildings. Some of these improvements were from replacing ‘perfectly good equipment’ with less energy intensive models such as variable speed drives and low energy lighting. BT now plans to roll out their initiatives globally.

As well as investing in energy efficiency initiatives, business leaders have the opportunity to further reduce energy costs by increasing their awareness of usage patterns through the use of smart meters. The UK Government’s commitment to install 53 million domestic smart meters throughout the UK has the potential to be very significant for those smaller businesses and residential consumers that currently only receive one accurate energy reading every six to 12 months.

As smart meters enable them to view and analyse information online, energy management becomes far more straightforward. Expect forward-thinking energy suppliers to introduce new innovations that will provide further opportunity for saving.

BT Group’s investment in its smart energy control provides a good example of the benefits of becoming more empowered in the management of energy use. The company made annual savings of £6.2m in 2011 through the identification and resolution of wasted energy via real time smart metering data. While not all businesses have operations on the same scale as BT, or the resources to invest in their own smart energy controls, the principles are much the same and there are opportunities to make significant savings.

Demand side management

Another opportunity for businesses is to benefit from the incentives on offer from energy suppliers as part of demand-side management - the modification of consumer demand for energy through financial incentives. Today, many industrial customers already have contracts with their electricity suppliers (or with specialist demand side management companies) that give them a price break in exchange for being flexible about reducing load in times of scarcity.

In the future, this capability is expected to extend much further as smart energy and electricity market reform increase the number of incentives on offer. For example, one planned reform initiative is a new capacity market from around 2014. This is primarily designed to have flexible generation available for times of shortage, but will also increase the incentives for a wider range of businesses to contractually commit to reduce their energy use in times of shortfall or high market price.

Finally, for business consumers, there is the opportunity to save up to 15 per cent of energy costs simply by modifying behaviour through increased awareness and acting as though there already were a true energy crisis causing scarcity of supply.  This has an immediate effect on the bottom line and includes such simple energy-saving measures as putting office lights on timers, ensuring printers are switched off at weekends and adjusting heating levels.

In 1992, for example, in New Zealand, a serious lack of rainfall caused an energy crisis because over half the national electricity supply is generated by hydroelectric power. To avert a blackout and ensuing catastrophe, the government moved into ‘crisis mode’ and instigated a campaign telling New Zealanders they needed to reduce their electricity use by 15 per cent immediately.

It worked. Perhaps surprisingly to many, extra vigilance and innovative action enabled this level of saving to be achieved and the crisis was averted. Comparatively little was spent, but a huge amount was saved by business leaders adopting a sense of crisis.

Opportunities for suppliers

But what of the threats to energy suppliers in an environment of rising prices? Like businesses, they also have a number of opportunities to benefit during the ‘gathering storm’ of rising energy prices.

Firstly, by doing more to help their customers improve energy management, proactive energy suppliers have the opportunity to improve their profitability and market share. Evidence shows that many customers who install energy efficient devices such as heat pumps actually use more energy so as to enjoy more comfortable homes rather than banking the savings. Furthermore, the recent EU Energy Efficiency Directive will help matters as it has set a legally-binding target of a 17 per cent reduction in energy consumption by 2020. As part of this, energy suppliers will have to improve their energy efficiency performance with customers by 1.5 per cent a year from 2014 to 2020.

Secondly, suppliers are entering a period in which their customers will be empowered as never before. Smart energy infrastructure will put information into customers’ hands so their choices are much clearer and they have the ability to switch faster and smoother. The move to the digital age for energy will enable new supplier models that will further play into the hands of savvy customers. The need for greater energy efficiency also means suppliers need customers to change behaviour. If suppliers are genuinely concerned about what customers think and do, then that sounds like a situation where there will be big winners and big losers.

Thirdly, as we have found with banking, massive growth in available information and use of online tools can also improve customer ‘stickability’ and loyalty. The cynic may see this as becoming trapped in a maze of half hourly information and illogical websites, but more and more customers are seeking to access services via new mobile data devices and soon will demand it. Establishing this simply yet comprehensively, and thereby retaining valuable customers, must be a new priority for energy supplier service.

Finally, while demand side management should allow customers to gain from flexible use of energy, proactive suppliers will recognise the gains from including this in their portfolio, particularly as EMR takes hold. Having flexible supply will be increasingly important in a world with intermittent renewable supply, but a chunk of relatively inexpensive flexible demand could prove a godsend if prices sky-rocket, particularly as transmission constraints worsen and the value of load change near major demand centres increases further.

Energy suppliers that act decisively with the customer in mind stand to gain genuine benefits of customer loyalty along with sustainable results for their shareholders.

Contact the energy and utilities team

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