How power generators can boost profits and beat odds
Ahn Soon is a partner and managing director of The Boston Consulting Group
By Ahn Soon
These days, it is not uncommon to hear news about the rapid and unprecedented shale gas boom. The media present blueprints on how it will become a future energy source and change the entire industrial structure. Even President Barack Obama declared his focus on shale gas development to boost the economy and create 600,000 jobs. Some might think this will only affect the industry in the future, but this has already been changing the current landscape of the sector.
In contrast to the extraction of natural gas such as shale gas, natural-gas liquids (NGLs) are produced as by-products. This process makes NGLs continue to grow despite the fact that it exceeds consumption. In these situations, by-products are ultimately in lower-value applications and markets. Given that these are interesting times and it is somewhat premature to open the industry’s new chapter, there is still a chance to rethink key strategic levers such as investment allocation, portfolio and contract balance, and feedstock flexibility. But, this is not the only problem that the independent power producers (IPPs) in the energy sector have. IPPs at the greatest risk need to find new ways to expand their revenue base and margins.
There are two main problems for power producers. Firstly, power generation is often regulated and pressured by political intervention. It is an inherently capital-intensive business with high fixed costs and distinct profit cycles. But electricity is a politically sensitive commodity, and when prices spike, local governments intervene ― effectively blocking profits at the peak of the cycle and virtually destroying the unique economics of the business. Secondly, the power-generation sector has fundamental structural problems such as a commodity product, low barriers to entry, a flat cost curve, and few technology or scale advantages.
IPPs have two options to resolve these issues.
The first is to focus only on projects that offer either a clear competitive advantage ― such as a load pocket or advantaged transmission access ― or an opportunity to differentiate the IPP from competing developers. For instance, when developers were bidding on a 400 megawatt project in Baja Mexico for a consortium of large power consumers, one developer had the foresight to propose running an undersea cable beneath the Sea of Cortez to a site in the middle of the Baja Peninsula where a copper mine under development lacked a power source. This incremental load allowed the developer to capture the benefits of scale, lower its unit costs, and submit a winning bid. Other players have consistently done well in spite of the structurally challenging nature of power development.
The second option is reinvention and expansion into related but higher-margin businesses.
First of all, think about transmission development. This requires skills similar to those needed for power-plant development but is typically even more complex and challenging because it covers multiple jurisdictions and hence provides even more opportunities for interveners to object. For example, in Wisconsin, the relatively noncontroversial Arrowhead-Weston project developed by American Transmission had more than 10,000 pieces of intervener correspondence.
Secondly, consider liquefied natural gas (LNG) plants. Like transmission development, this is a complex and challenging area. Further, it requires a new set of technical and commercial skills, such as the ability to develop international LNG off-takers. But as Cheniere Energy showed, it can be done.
Thirdly, rooftop Solar can be a high-margin business. The higher retail price of solar electricity relative to wholesale-priced utility-scale power makes this option more profitable. Players such as SolarCity and SunRun are finding success in this area.
Lastly, bio-fuel development is another option to approach. This option benefits from higher liquid fuel prices, with oil selling at approximately five times the price of natural gas on a BTU-equivalent basis, but it has more technical risk than electric-power-generation development given the embryonic nature of many new sources of bio-fuels such as lingo-cellulose-based fuels.
Although reinvention is challenging, many second acts propel companies to new levels of success. Monsanto’s move from commodities into agriculture and Apple’s ongoing transformation can serve as inspiration.