The future of electric power

Who would have thought ten years ago that E.ON, Germany’s largest utility, would one day split into two companies—one focusing on renewables, the other on fossil-fuel assets?

The move, announced last December, came as a response to a new reality in Germany, where renewables now account for 25-30% of power supply and decentralised generation represents 40% of total capacity installed. Competitors like RWE haven’t followed suit yet, but are not excluding the option either.

This restructuring of utilities and electricity markets in developed countries is, in part, driven by the obsolescence of business models and the inability to raise funds for necessary investments.

The transmission and distribution sector, for example, requires $100bn of annual investment over the next three decades in the OECD. Under the current market structure, however, a user of decentralised power represents a loss for the network operator despite the operator providing access to the grid should the user need it. Meanwhile, flattening of electricity demand, notably in the EU, puts pressure on utilities’ balance sheets, thus reducing their ability to invest.

Such market failures often result from pricing mechanisms that do not reflect externalities, be they negative ones such as carbon emissions or positive ones like capacity services from thermal plants or grid stability from network operators.

New business models and regulation can provide relief. Splitting assets based on their environmental impact and position in the value chain, like E.ON did in its recent restructuring, presents one recourse. Meaningful and predictable carbon-pricing regulation presents another approach: At a global average of under $12 a tonne, the price of carbon is nowhere near where it should be to drive on its own the decarbonisation of our economies.

The bigger goal of reaching climate objectives at an affordable cost will require the integration of electricity markets as well. In the EU, this could help deploy renewables according to optimal geographies, saving the region $40bn in subsidies over the next three decades. Greater interconnection capacity between markets could also help reduce wholesale electricity prices, which are expected to rise by at least 50% in the US and EU by 2040, according to the World Economic Forum.

Nations may hesitate to participate in such a coordinated approach to energy policy in light of energy-security concerns. Stemming the current trend where each passing year sets a new record in extreme heat, however, may require just that.

This article is published in collaboration with GE LookAhead. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Dr Elie Chachoua is an expert in strategic and multidisciplinary research

Image: An offshore wind farm stands in the water near the Danish island of Samso. REUTERS/Bob Strong.