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PWC’s Jeroen van Hoof thinks the utilities space will look very different over the coming years
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Majors see opportunity in utility fragmentation

PWC sees value for IOCs as the traditional utility model becomes less relevant

International oil companies (IOCs) returning to the utility business has been a clearly observable trend over several years, with the European headquartered majors at the forefront.

Shell's installed generating capacity in North America is now above 10GW, of which one-third is from renewable sources, and it has also invested in Dutch offshore wind. In the UK, its acquisition of supplier First Utility sees it supplying 100pc renewable power, as well as gas and energy services, to domestic consumers, while, through MP2 Energy, it has also entered the US supply market. Shell has also bought into US and Asian solar, while it has made three investments in electric vehicle (EV) charging firms and three in distributed energy and storage.

Similarly, Total has a target of 5GW of installed solar capacity by 2022as part of an overall target of 10GW of gas-fired and renewable generation by 2023and has as many as four solar and power generation subsidiaries. It has also entered the French and Belgian domestic power and gas supply markets, targeting 7mn customers. It has also made three investments in EV charging firms, and has a subsidiary, Saft, focused on energy storage.

BP has the UK's largest EV charging station network through its Chargemaster subsidiary, as well as investment in three other EV charging firms. In solar, its main vehicle is its 43pc stake in Lightsource BP, while its North American wind generation business has installed capacity of over 1GW across 6 US states.

One major question mark is how IOCs justify investment in a space that has not previously offered comparable returns to their core hydrocarbon extraction activities. But Jeroen van Hoof, global power and utilities leader at consultancy PWC, argues that it is not a simple as comparing the historic returns on getting oil out of the ground to the traditional utility mode, given that both business models face disruption. 

PE: What, in PWC's view, is driving the IOCs' renewed interest in the utility sector, given less than successful previous ventures in this space?

van Hoof: What I think is different, compared to previous attempts, is that the world is changing rapidly. In the past what we saw were one-off acquisitions in a sectorsay, solar or offshore windto bolt on to an existing business. Now the renewed interest is driven, I believe, by the notion that the energy transition has really taken off.

In the long run there will be a lower carbon world, or at least the space for lower carbon in the total system will continue to grow. In addition, new technological solutions are emerging, digital opportunities will play a bigger role and there is also a sense that consumer expectations have changed. If you are looking to the future, from a strategic perspective, it is now more important than ever to start to invest in low carbon energies.

And there is a further angle around circularity kicking in. If you look at sectors adjacent to the IOCs, whether that is chemicals or the utility spacein effect the whole infrastructure of larger clientsthey are also undergoing transformation. Take the example of Thyssenkrupp in Germany, it is building a carbon-to-chem pilot where it will use off-gases from its steel production to combine with hydrogen and bring that back into the chemistry process. It will need large quantities of electricity for this as a feedstock, which is very different to the fuels and gases it would have used in the past.

So, the client side of the IOCs is changing, and we are also seeing the IOCs themselves re-focusing. If you think, for example, about OMV in Austria, it is looking, because of its refinery assets, at becoming as much a chemicals firm as an oil company. It is not just about entering a new market, it is also because the world around the IOCs is changing and will continue to change. In the medium-term, you need to think broadly about new opportunities and new business models. 

PE: What are the competitive advantages that the IOCs can bring to the utility space and to the other spaces into which they are moving?

van Hoof: The IOCs have strong balance sheets and low cost of capital, which is obviously useful when it comes to financing. And they can have technical edgesif you are looking at building large offshore wind farms, say, offshore construction and IOCs blend well together, that makes total sense.

On the other hand, it is not only the IOCs that are looking to disrupt the utility sector, especially when you look at client engagement and retail. The competition may not only be with existing utilities but also with other retailers entering that market. We are increasingly seeing newcomers which boast extensive retail experience, such as the Amazons of the world, or other service providers looking to combine energy with their other products. So, who would be better in that space?

In conclusion, there are elements where the IOCs have a competitive advantage, but others where I think it remains to be seen. It might be, of course, that the IOCs look to join up with others, especially when it comes to the retail side of the equation. 

PE: If you are moving from a model mainly based on upstream extraction to a utility model, you are looking at much lower rates of return on capital invested, potentially well down into single digits. What challenges does that pose for these companies with their investors who have grown used to much higher returns on capital?

Van Hoof: I think there is more than one way to look at this. If you take a defensive approach, you would say the business model in the long run is changing in any case, so comparing with what you are used to may then be of less relevance. The question becomes where you can make a decent return. If the traditional market is shrinking, then it could still make sense to do this.

The other option is to ask whether there can be profitable new business models created along the value chain that would actually increase revenues. And then it comes back to questions around customer experience, combining of products, if there can be economies of scale. This is a challenge not just for external shareholders, but also internallythe way to look at investment propositions must change.

There is to a large extent an element of finding your way in this new world. If you start to experiment now, the idea is that you can build up the strategy and the business case in the course of time. There are many ways and many pockets where returns can be found.

PE: Is large oil and gas firms' appetite not just to do gas-fired power, but to get into renewables too, a good sign that they are genuine about this change, that it is not just window dressing?

van Hoof: If you look at what the European IOCs in particular have done in the past few years, I think it is a real change compared to what we have witnessed previously. The investments are across a much wider area of the value chain, they are part of a bigger strategy to develop new business and business cases. So, for sure, it is not only a window dressing exercise. It does, of course, support the IOCs in showing that they are bringing down their carbon intensity, but I genuinely think the real driver is to reset their businesses as they recognise that, in the long run, things will change.

PWC's view is that IOCs need to nurture their existing assets as, if you look at all credible scenarios, fossil fuels will play an important global role for a long time to come. However, at the same time, you want to develop new businesses which will support your survival for the long-term. New energies do not always mean renewable energies, there may be other things that emerge. That the world is changing towards a more low-carbon world is undeniably correct, but I do not think that these companies are necessarily looking only at renewables. 

PE: By that, are you thinking about options like carbon capture, usage and storage (CCUS)?

van Hoof: Yes, exactly. If you think of hydrogen, for example, and the role it could play in the long run in meeting the Paris goals, you need vast amounts of green molecules to get to that point, and large-scale hydrogen from electrolysis is not a viable business case at this point. You will need to take a stepped approach; between grey and green hydrogen, there is blue hydrogen, which is dependent on CCUS. This is again an area where the IOCs could play a major future role, given that they have access to underground storage, to technical capabilities and to existing infrastructure that could be repurposed and have extended lifespans.

PE: Why do you think this is largely a European phenomenon and not really matched by ExxonMobil, Chevrons and the US IOCs?

van Hoof: I think in Europewith the German Energiewende and similar initiatives in adjacent countriesbusiness models, whether it is in the energy or utility or chemicals space, started to shift earlier than we perhaps saw in other regions. Moreover, shareholder and other stakeholder expectations, societal expectations if you like, of the European-headquartered IOCs have changed more rapidly.

Interestingly, PWC has recently published its survey on the largest 40 global utilities in terms of innovation, and you see the same trend there. European utilities are more innovative than in other parts of the world.

But I do think we are also now seeing US-based IOCs start on the same journeyperhaps driven more by market and consumer expectations, rather than government intervention.

PE: Has the fact that a number of the traditional European utilitiesdue in no small part to their delayed reaction to the rise of renewablesare in less rude health than previously smoothed the passage somewhat for IOCs re-entering the utility market?

van Hoof: No, I do not really think so. You could even perhaps argue that, if the utilities were not also subject, and reacting themselves, to a large transformation that it would be easier for the IOCs to enter the market alongside the new ventures and start-ups that are disrupting the market. Whereas now the large utilities are also rethinking their purpose and their strategy, and are swimming in that same pool to an extent themselves. So, no, I would not necessarily think the incumbents' current position has made it smoother, that they are easy pickings for the IOCs.

PE: Many of the IOCs' investments have not been in what you would call traditional utilitiesRepsol and Viesgo in Spain may be a notable exception. What does that trend tell us?

van Hoof: Again, it comes back to the changes in the IOCs' adjacent industries. In the utility retail space, we see newcomers, start-ups, digital companies, and different type of engagement with customers; in renewables, local generation is kicking in; in the chemicals sector, firms are re-thinking their future and the way they operate.

So, there are really many changes happening at the same time. A utility business is one of the potential building blocks to create a successful, future-proofed wider energy firm, but it is one of many. Thus, the question could become which part of a utility's business is most attractive. It could be retail, it could be power generation, it could be offshore wind as a pure merchant role. And there are also new strategies emerging from within utilities themselves, such as a move away from being entirely integrated.

PE : Coming from the Netherlands, what is your take on the majors' potential appetite to invest in Dutch utility Eneco?

van Hoof : Eneco is a good example of this traditional utility diversification. It obviously has clients and the infrastructure to access these clients in their homes. But it has also developed a very successful green image and a lot of new products to offer to its clients, which may fit well with IOCs exploring similar new business cases. So, it is not necessarily that Eneco is an outlier as an established utility attracting IOC interest, but perhaps more to do with specific elements of its business that Eneco has developed.

PE: So, is it almost worth forgetting about utility in the traditional sense and think about the different constituent parts?

van Hoof: Yes, maybe it is best to think of the different pieces of the puzzle you would need as a company to find new and successful ways to market in this new reality. The answer to that can of course be different for each IOC. I referred to OMV earlier, it has concluded, "Okay, let us move to the chemicals side of the equation." That is based on its existing assets and legacy. There is maybe a different answer for others like Shell or Total or ExxonMobil, and that then determines in what areas you want to play.

PE: In other words, the IOCs which, to a large extent looked broadly similar five years ago, may in five years' time look quite different from each other?

van Hoof: Yes, I guess so. And, at the same time, utilities will also look very different, when again they looked very similar in the past. We see that already, e.g. Germany's Eon and RWE developing separate businesses focusing on legacy generation assets and on the customer and renewables side.

For the IOCswhile I think their existing competencies and assets will remain important for many years to cometheir new businesses might look fairly different.

PE: A lot of the prominent innovators in the European utility space have been new entrants and start-ups, and a number of them have already seen investment from sources such as private equity. Do you think the IOCs have come in maybe slightly too late and are going to have to pay quite a high price to buy the assets that they need to fulfil the strategies that we are talking about?

van Hoof: You will probably only be able to tell this looking back in 10 years' time. If the IOCs, existing utilities or other new entrants, are looking at joint ventures or acquisitions, there are so many start-ups and new initiatives happening on the back of digital possibilities or successful new data-driven retail formulas. I have seen examples where innovation officers start with a long list of 800 start-ups, reducing that to 10-15 options of particular interest, and then moving towards a partnership or purchase with a handful.

So, the supply side is very large. But the long-term winners are not yet clear. I have not yet seen one start-up being so successful that you could say, "This is one that was acquired early by private equity or another investor and now has turned into a new major brand." It is still early days.

PE: So, we will have to wait and see?

van Hoof: Yes, which makes it very exciting for the whole energy industry. Some of the IOCs have new venture arms within their organisations that have been investing in this area for quite some time already. In IOC terms, it has been all small stuff, but they have been part of that early investor play to an extent as well.

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