Energy Insight: Future business models in electricity
As the UK moves towards a low carbon economy, technological, economical and societal developments lead to changes in business models, and vice versa, notably in the electricity system. In this Insight we will explore:
- The structure of the UK electricity system and the traditional business model operating within it
- Drivers of change that lead new business models to emerge
- Case studies on new and emerging business models.
UK electricity system explained
The UK electricity system can be analysed in four main supply-side functions: generation, transmission, distribution and retail. These four functions are unbundled, meaning that the ownership and operation of transmission and distribution systems are separated from generation and retail activities. In other words, a business can both generate electricity and sell it to consumers, but another legal entity is needed to transport the electricity in between.
There are two fully competitive markets of electricity trading in the UK. In the wholesale market, generators trade with retailers and large consumers. In the retail market, retailers trade with domestic and commercial consumers. Consumers in the retail market are free to switch who they buy electricity from as they wish but they will typically be subjected to a simple tariff that does not reflect price variations in the wholesale market.
Market arrangements in the UK electricity system – Competition & Markets Authority
Traditional business model explained
The dominant business model in the UK electricity system has traditionally been the corporate utility (Hannon et al., 2013). This model usually operates in a ‘vertically integrated’ way, with a single corporation selling the bulk of electricity produced by its generation assets to its retail business, which then sells the electricity to consumers in the retail market. The corporate utility can also trade in the wholesale market when its own generation falls short of or exceeds demand by its customers.
The corporate utility model has a relatively simple value proposition that depends on increasing the number of units of energy sold (Hall and Roelich, 2016). Historically in the UK, there were only a few large corporate utilities dominating the majority of the customer base (Ofgem, 2019), which created significant barriers for new and/or smaller players to enter and compete in the market. The route to market for services that can reduce final demand for grid electricity, such as energy efficiency and demand-side management, was also limited since business revenues were typically tied directly to the sale of more units of energy.
How is the UK electricity system changing?
The UK electricity system is going through a holistic transition driven by various factors. These factors lead to new business models to emerge that are fundamentally different from the corporate utility model:
- Data revolution and technological development: Digital technologies integrated in the electricity system from generation through to consumption activities continuously create data that enable to track electricity flows in real-time. 61% of UK energy professionals believe technological innovation is a primary driver for the development of new business models in the energy sector (Energy Barometer, 2017).
- Transition to low carbon: Climate concerns are making it essential to opt for low carbon energy technologies, such as renewables, nuclear power and carbon capture and storage. The costs of renewable technologies are falling dramatically where wind and solar are already at or close to cost parity with some traditional sources of electricity.
- Systems’ resilience and integration: Renewables are increasingly becoming the default choice for new generation capacity. The whole system faces challenges due to the inherent variability of weather-dependent renewables, which requires the presence of other technologies that can provide system flexibility to provide a reliable electricity supply. There is also an increasing overlap between electricity, transport and heat systems, especially with the likely rise of electric vehicles and heat pumps.
- Societal: The UK society is increasingly aware of climate issues and is actively demanding environmental action from energy industries and governments. Over half of EI members believe that consumer/citizen pressure and wider environmental concerns are driving the energy industry to transition to low carbon systems (Energy Barometer, 2019).
Meanwhile, efforts are ongoing to ensure these changes do not compromise on the sustainability, affordability and security of the UK’s energy supply.
How are the changes affecting business models?
The transition of the electricity system is changing where financial value lies in the market. Wegner et al. (2017) analyse the magnitude of different ‘value pools’ under a range of possible system scenarios. Their research suggests that by 2050, up to £21 billion per year of new financial value will arise from either avoided costs or new revenues available in the UK electricity system, manifested mainly in six areas: Plant and portfolio efficiency, energy service provision, local low carbon generation, large-scale low-carbon generation, flexibility optimisation, and carbon capture and storage.
With the changes to where financial value lies, the vertically integrated corporate utilities can choose to continue in a vertically integrated model or evolve in various different directions, such as owning and aggregating distributed assets (e.g. distributed storage, meters, electric vehicle charging points), growing large-scale low-carbon generation plants (e.g. offshore wind, nuclear), or providing connected services for externally-owned assets (e.g. demand side response).
Mahesh P. Bhave, PhD in his book The Microgrid Revolution: Business Strategies for Next-Generation Electricity:
“If it ain’t broke, don’t fix it” does not apply to the electricity industry. The system is environmentally, topologically and economically broken and obsolete. But it works—so did pagers when cellular phones arrived and horse-drawn carriages when the automobile appeared.
Case-by-case: New and emerging business models
Piclo (previously known as Open Utility) was launched in 2015 and is the UK’s first online renewable energy marketplace. The service they provide is commonly termed peer-to-peer trading (P2P) which means using a software platform to link consumers and generators to trade energy directly with each other. Consumers can choose a generator based on price, type or location of energy, and change the generator they buy from as often as they like. This is an exchange outside the incumbent wholesale trading market.
In 2014, Piclo received £500k funding to run a 6-month P2P trading trial in collaboration with the 100% renewable electricity supplier Good Energy. The following year, after the success of the trial, Good Energy rolled out the P2P service to their business customers under the name ‘Selectricity™’. Customers using Selectricity are able to pick the type of renewable electricity they want to buy (hydro, solar, wind) as well as which generator they want to buy it from. The platform also aims to facilitate the development of local renewable energy markets by improving the visibility of nearby generators and community energy projects.
Selectricity provides customers with an online dashboard that allows them to monitor every kWh used, through meter readings taken at half-hourly intervals. Piclo’s software splits out the distribution use-of-system charges for electricity consumed, giving insights into how shifting demand away from peak times can help to reduce electricity bills.
The success of the P2P business model relies on consumers’ willingness to change. In the 2019 Energy Barometer, P2P was expected to be the least desirable energy service offer to domestic consumers in the UK by 2030, with only 15% of respondents choosing this option.
Open Energi and Sainsbury’s (Demand Side Response)
Sainsbury’s and Open Energi agreed a 10-year deal in 2011 to work together to turn the existing stock of fridges and other heating, ventilation and air conditioning (HVAC) equipment across 200 of Sainsbury’s stores into a new revenue stream via demand side response (DSR) while helping the grid become more flexible.
DSR describes the ability of consumers to adjust their electrical consumption in response to grid signals in real-time. This is especially important to free up supply when the demand on the grid is high, reducing the need for peaking power and therefore saving carbon. According to a National Grid analysis, 600 tonnes of carbon dioxide can be eliminated for every MW of demand-side capacity made available. DSR also serves to perform frequency response – i.e. second-by-second adjustments to maintain the grid stable – which is becoming an increasing necessity due to higher proportions of renewable and distributed electricity connecting to the grid.
Sainsbury’s is one of the UK’s largest supermarket chains with over one thousand stores across the country. Using Open Energi’s technology, HVAC equipment belonging to Sainsbury’s is equipped with DSR ability to continuously adjust electricity usage based on grid requirements. This work is part of a broader initiative called the Living Grid aiming to create an ‘energy ecosystem’ that connects many large users of energy to provide a portfolio of flexible demand across the UK.
Provision of DSR can unlock value from incentives paid by the grid operator. Currently, large commercial and industrial consumers (e.g. retailers, factories) are better placed to access revenue streams from DSR as their energy usage is large enough to make significant impact. Through further development of smart metering, domestic consumers could also become an important provider of DSR as adjustments to individual uses could be aggregated to benefit the system at scale.
Upside Energy (Cloud-based energy storage)
Upside Energy is a start-up based in the UK who have created a cloud-based platform functioning as an energy store (Virtual Energy StoreTM) that provides flexibility to the grid. The platform is agnostic of the underlying technology and can connect to a wide range of existing devices installed in households as well as commercial and industrial sites, including battery storage systems, intelligent hot water tanks, electric vehicles, uninterruptable power supplies (e.g. in data centres) and heating and cooling systems. Upside Energy sells balancing services to the grid operator and shares the revenues it generates with the owners of the devices it incorporates under its cloud-based platform.
The Upside platform uses advanced algorithms and artificial intelligence to manage stored energy across more than 100,000 devices running in parallel. According to the company, the cloud-based platform was designed to scale to millions of devices and such a portfolio of many, small devices would inherently be more flexible than demand response from few, large commercial and industrial sites. Upside Energy is an example to business models of the future in which ownership of physical assets is increasingly replaced by digital solutions that support smart energy management.
Eigg Electric (Community micro-grid)
The Isle of Eigg off the west coast of Scotland is powered by a stand-alone grid that is operated and maintained by the community owned Eigg Electric. With no connection to the mainland grid, the electricity for the small island community of around 90 residents is supplied from renewable sources including hydro, wind and solar PV. The system was designed to provide a continuous, reliable electricity supply all year round, with minimal support from a pair of 80 kW diesel generators when renewable generation falls short. The island’s grid also hosts a bank of batteries that enables optimised usage of the renewable generation capacity while maintaining a stable grid frequency. Since the system was first switched on in 2008, renewable generation has provided around 95% of the island’s electricity.
To avoid the possibility of overload and to ensure that electricity is always available equally to all consumers, without the need for excessively running the diesel generators, supply at any one time is capped to each house at 5 kW and to each business at 10 kW. All consumers have energy meters to measure power consumption and indicate when their cut off point is approaching to optimise the community’s overall energy consumption throughout the day.
This business model will possibly but not necessarily result in lower energy costs, and it can have other benefits too, such as encouraging growth of local energy generation, incentivising optimal time-of-use behaviour and enabling any financial gains to be enjoyed internally by the community. In the absence of clear commercial benefits, such models could be difficult to replicate in areas with existing grid access since they require the whole community to buy in to reach an investable scale.
Energy Systems Catapult and Bristol Energy (Energy as a service)
An energy service company (ESCo) delivers energy as a service, such as illumination, warmth or refrigeration, rather than in strict units of energy – i.e. kilowatt hours (kWh) – like the traditional corporate utility model. This creates a significant commercial incentive for energy efficiency since revenues are driven by providing energy services using fewest units possible.
We see an example of this business model in the context of heat. As part of government-backed trials by the Energy Systems Catapult, 100 homes spread across the UK have become part of a ‘Living Lab’ where each property has been upgraded to smart home levels that are predicted to be common by the middle of 2020s. Households of the Living Lab will be offered the chance to switch to a newly-designed Heat Plan by Bristol Energy – this would mark the first time an energy provider has sold heat as a service in the UK.
The Heat Plans will provide ‘Living Lab’ residents with room-by-room, hour-by-hour control over their heating via installed sensors and a smart heating control system. Analysing usage data collected via the control system, the energy provider will be able to calculate a fixed monthly cost that is bespoke to individual homes and lifestyles without fluctuations due to the weather.
In the future, this business model can combine all energy needs within consumer lifestyles, including light, heat, mobility and entertainment, into a full package of energy services. However, there will be challenges around the required consumer mind shift from energy units to services.
By the numbers
- The market share of the UK’s ‘Big Six’ energy companies dropped from 100% in 2009 to 73% in 2019, due to increasing competition from a number of smaller suppliers (Ofgem, 2019).
- 66% of UK energy professionals believe the most likely future business models in the energy sector can be best described as more decentralised while 56% believe they will have increased customer engagement (i.e. data availability, participation in decision-making) (Energy Barometer 2017).
- Decentralised sources – generators not connected to the transmission network – were responsible for 29% of the UK’s electricity supply in 2018, and this proportion could potentially go up to 58% by 2050 (National Grid Future Energy Scenarios, 2019).
- 65% of the UK energy professionals think domestic customers mainly prioritise low bills when it comes to energy provision, followed by excellent customer service and price transparency (Energy Barometer 2019).
- Twice as many UK energy professionals believe energy service providers, as opposed to their customers, will financially benefit the most from the data revolution in energy (Energy Barometer 2019).
The changes in the electricity system give rise to business models with more complex revenue streams than the traditional corporate utility model and a role for consumers that is increasingly important and dynamic. Utility 2050 is a project which explores and stress tests how business models, consumer preferences and regulatory regimes might co-evolve in different low carbon futures to 2050. Their work informs the kinds of issues that need to be carefully addressed in the rapidly changing UK electricity system.
Policy and regulation
System rules and regulations need to be re-addressed, and in certain cases re-designed entirely, to allow new forms of business in the system to maintain their diversity and capability to innovate. The Utility 2050 project found that investors are stressing a need for regulators to design frameworks which can provide both clear, robust and predictable long-term signals while also allowing flexibility as the new business models will keep evolving. Policy and regulation also need to bridge the potential gap between the commercial interests of individual companies and broader targets that need coordinated system-wide movement, such as decarbonisation and fuel poverty alleviation.
Role of consumers
For many of the emerging business models, consumers will need to hold a more central role to business operations than they do for the traditional corporate utility model. This makes engaging with consumers an essential aspect of the business models of the future, especially of those businesses asking consumers to trust them to make some critical decisions on how they will purchase and use energy (e.g. energy as a service). Consumer preferences are also critical to enable the new business models to secure access to finance, since investors are likely to ask for greater evidence of market demand and customer base before an investment case can be made.
Data privacy and security
The development of smart home technologies makes it possible to collect the data required to further reveal how consumers use their energy, and tailor energy services to their needs. However, this opportunity also brings greater risks around data privacy and security which need to be addressed very carefully. The market needs clarity on who owns and benefits from data, enforced by well-thought regulation. Consumers and especially the most vulnerable and/or least tech-savvy to keep up with the changing energy system have to be protected. The development of the Energy Data Taskforce (set up by the Department for Business, Energy and Industrial Strategy, Ofgem and Innovate UK) is a crucial step for allowing the industry to unlock value from data, while ensuring greater data transparency and access as well as data protection and security.
Energy Barometer, Energy Institute, 2019.
Utility 2050 project, ongoing.
Future Energy Scenarios, National Grid, 2019.
Business model innovation in electricity supply markets: The role of complex value in the United Kingdom, Stephen Hall and Katy Roelich, 2016.