Power generation is changing. When energy was produced through the relatively straightforward and stable process of burning fossil fuels, companies could secure long-term, low-price contracts with energy producers, then run their equipment around the clock to maximize profits. But what do you do when energy prices depend on forces as unruly as sunshine and wind? You get really flexible, really fast. This special report from the Boston Consulting Group can tell you how.
- With fixed, low-cost energy contracts, 24-hour production was the best strategy, but price volatility inherent in VRE (variable renewable energy) will change that.
- Companies will need to take on an “energy trader” role to cope with the volatility.
- A flexible energy user sees electricity not as a cost, but as a value generator. When energy prices dictate it, they halt production to sell electricity back to the market.
With fixed, low-cost energy contracts, 24-hour production was the best strategy, but price volatility inherent in VRE (variable renewable energy) will change that.
The most profitable way of operating an industrial company has been clear from the beginning: Make the most of your equipment and facilities by running production around the clock. The transition to VRE will require a change in strategy. Flexibility will be crucial, particularly when it comes to using energy-intensive assets. The key is to trade maximum utilization for optimum utilization.
“This journey needs to be driven by the leadership and doesn’t happen overnight: Companies start with small changes and over time make more fundamental changes in the way they operate.”
South Australian energy markets offer a powerful example of how companies can profit from energy flexibility: If a company were to shift production to times when energy was cheapest (which accounts for about 55% of the time), that company would enjoy energy that was essentially zero cost throughout 2021. If a company simply avoided producing during periods of high-cost energy (about 20% of the time), it would save about 65% on energy costs when compared to companies that ignore price volatility completely.
Companies will need to take on an “energy trader” role to cope with the volatility.
Dealing with fluctuating energy prices will require industry leaders to shift from a “producer mind-set” to an “asset-backed trader mind-set” by changing their focus from unit cost to a focus on information. Consider the strategies used by oil and gas producers, or gas-fired power generators; at any given moment, does the cost of burning natural gas outweigh the revenue from selling electricity? Then the gas-fired power generator shuts down for the time being. Oil and gas companies similarly monitor market prices, and shift processing and refining schedules accordingly.
“Asset-backed energy traders make money by operating assets with built-in physical flexibility to create value in markets with volatile input and output prices.”
To adopt a trader mind-set, prioritize asset flexibility over maximum asset utilization, responsiveness over consistency and overall profitability over pure throughput. Where you used to select contracts for certainty, now you’ll favor optionality. Where you used to let unit cost drive major decisions, now you strategize according to information about outside variables. All investments are viewed through a flexibility lens, and the exposure you can tolerate from market prices depends on how quickly your company can physically adapt to market prices. Afraid your output will suffer? Build capabilities for a higher maximum production capacity for times when electricity is cheap or free.
A flexible energy user sees electricity not as a cost, but as a value generator. When energy prices dictate it, they halt production to sell electricity back to the market.
If you want price volatility to work for your company rather than against it, start by building physical flexibility in assets and across processes. This might look like isolating the more energy-intensive processes and upgrading equipment. Next, jump into the world of market fluctuations by seeking variable-price electricity contracts rather than fixed-price contracts. Seek to monetize your newfound flexibility across reserve markets, day-ahead spot markets and frequency markets. Then use digital technologies like energy usage meters and data analytics to move in step with external market signals.
“Constraints arising from asset design, technologies and processes can restrict physical flexibility.”
CEOs can ask themselves five questions to assist the planning process:
- “What is the value of the trader mind-set for my operations in my market?” – Start by modeling scenarios with varying degrees of physical flexibility, market variability and the price of various technological solutions. Invest accordingly.
- “What hidden flexibility do I already have in my operations?” – Before you invest in new equipment or assets, identify the flexibility inherent in existing systems.
- “What market exposure and flexibility do I have in my contracts today?” – Evaluate how much flexibility you have in current contracts. This will enable you to decide whether contractual changes are necessary to create value from flexibility.
- “How can I get basic information to operators in charge of production?” – Supply basic information, including daily electricity price forecasts, so operators can make informed production decisions.
- “What metrics can I use to track my organization’s energy flexibility?” – Performance metrics paired with relevant incentives are often your best means for helping employees adopt a trader mind-set.
About the Authors
Philip Hirschhorn (Sydney), Oscar Wilkison (Sydney) and Tom Brijs (Brussels) are professionals with the Boston Consulting Group.