The world of electricity is changing fast. It’s a transformation that is exercising a great deal of thought and action in the boardrooms of power utility companies whose traditional business models are under threat. Technological innovation is creating new choices for customers and new opportunities for a wider range of industry entrants. The combination of the ‘push’ of technology, the ‘pull’ of the customer and the threat that comes from new competitors poses questions that go to the heart of company strategies and the role of the CFO.
The chief financial officer (CFO) role is changing. It’s becoming more strategically-focused, more value-focused and more future-focused. But the role of the power utilities sector CFO is changing faster than most. The ambit of the power sector CFO is not only being reshaped by the overall transformation that is taking place in the CFO role but also by energy transformation, which is shifting the technological, market and customer context for companies in the sector.
Energy Transformation Challenges
Energy transformation is forcing power company CFOs to take a more strategic view in addressing business challenges with consequences for the nature of their role. Many power utility companies are now operating in conditions where the traditional core revenue stream is much more uncertain. For the first time ever, the potential for a power utility company’s business model to become eclipsed and left stranded is a real one.
Energy transformation is forcing CFOs to take a more strategic view in addressing business challenges. Specific Challenges include: Anticipating and leveraging the impact of new technologies; reassessing and restructuring the asset portfolio to optimize value; designing new ventures and commercial arrangements; achieving full recovery of prior investments; influencing policymakers and regulators; replacing declining revenues from traditional businesses; measuring enterprise performance as business models shift; and attracting capital through appropriate risk allocation. The degree to which each challenge applies depends on jurisdictional variations
- Anticipating and Leveraging the Impact of New Technologies
The acceleration of technologies such as digitalisation, combined with the expansion of the breadth of the ‘internet of things’, is creating new opportunities for utilities. Barriers to entry are being broken down and new entrants are taking up positions in the sector.
Internet-connected home devices of all types, premises-based distributed generation and higher-efficiency storage enable business-to-consumer and business-to-business relationships and have the potential to realign elements of the traditional energy value chain through the creation of new value networks.
Data directly from the proliferation of discrete generation and consumption points may become a commodity that can be monetized by new market entrants through new products and services, as well as enhanced grid ‘value’. Utilities need to assert their role in these new value networks to reduce the risk of losing revenue, market share or the ability to build new sources of margin.
Information technology has enabled transformation in every industry and flattened traditional hurdles to new entrants.
The effects of technology pose both an opportunity and a threat to utilities. It can help utilities meet demand loads while limiting capital commitments on generation through net-metering of the contribution from distributed generation and supporting smarter utilization of energy when it is necessary to be consumed. The same ‘beyond-the-meter’ technology also enables new market entrants to disintermediate certain customer loads from their traditional utility providers and to do so without costly infrastructural investments.
Challenges for the CFO to address usually include: Assessing and quantifying the business risk associated with the adoption of new technologies and making the right technology bets; utilising new technologies to create or enhance revenue streams; managing the costs of implementation and maturation, with good risk mitigation plans; advising on appropriate risk/reward incentives for new forms of technology partnerships; positioning communications with financial stakeholders as the business embraces technology; ensuring the business has effective cybersecurity protection in place and has robust business contingency, and recovery arrangements that will allow it to withstand cyber attacks.
- Reassessing and Restructuring the Asset Portfolio to Optimize Value
Regulatory policies, financial pressures and market outlooks are forcing utilities to look both at the appropriateness of their corporate structures and the parts of the value chain where they wish to participate.
As energy transformation expands, the need to introduce responsive capabilities increases and the need for new assets, delivery systems and execution processes lead to the reassessment of the capability to succeed in current business areas or to optimise the value potential of the portfolio.
Companies are being forced to make a choice – do I ‘hold or harvest’ certain assets or businesses? Companies will need to place greater emphasis on understanding business and financial risks and managing portfolios to optimize value.
Challenges for the CFO to address here include: The benefits of restructuring or ‘carve out’ of segments of the business to reflect new strategic goals and value optimisation; optimising the financial viability of any ‘carve outs’ from the core business; developing investment propositions with a risk profile that will attract new capital; alternative approaches to investment financing in an environment of more competitive markets; and the need to reassess the structure of transfer pricing agreements between different parts of the business.
- Designing New Ventures and Commercial Arrangements
The new business models we are seeing require new business partners, new skills and competencies and different kinds of commercial relationships.
The digital revolution is leading to customer access innovation at the same time that technology performance innovation is leading to grid parity across renewables. This trend is set to continue across both the technologies and solutions that will be offered to customers along the energy value chain.
If utilities are to maximize the opportunities arising from technology, they need to take a different strategic approach. The challenge is to determine which technologies to support, the type of services to offer to consumers and how best to harness the skills and competencies required to move from strategy to market delivery.
We see first movers appreciating the need to learn from the experiences of other industries, by entering into strategic partnerships and recognizing that the traditional self-contained utility mindset can actually constrain innovation.
Challenges for the CFO to address here include: Achieving congruence in partner strategy from the early stages of any formal relationship by aligning interests and appropriate sharing of costs, risks and rewards; maintaining adequate control of investments while giving leeway to business partners to enhance value; management and optimization of a portfolio of business relationships with non-utility partners; gaining comfort on the ability to risk assess new ventures – especially technical risk and optimism bias, and putting in place appropriate mitigation measures; in addition to the development of the right exit strategies when necessary to preserve value.
- Achieving Full Recovery of Prior Investments
In many markets, serviceable generation assets are being retired early. In Europe, this is driven by environmental subsidies and public policy initiatives; in the US expansive gas supplies, market structures and environmental policies; in developing countries, because of inadequate rates and non-payment.
Electricity markets have become less stable. Merit order dispatch has changed as a result of low carbon policies such as the introduction and removal of feed-in tariffs for renewable energy, relative fuel prices (gas vs. coal), market intervention such as capacity markets, the impact of technology on fuel prices (e.g. shale gas) and increasing levels of distributed and micro generation. With little prospect of change in the medium term, some thermal and renewable generators have found themselves unable to compete. The need to maintain shareholder returns has led to unexpected decisions being taken with impacts occurring in cost recognition, cost recovery and asset reinvestment.
Challenges for the CFO to address here include: Whether, how and when to take capital
write-downs given broader strategic and financial imperatives; understanding the value of the asset portfolio to drive rebalancing decisions and mitigate the impact of stranded assets; adjusting long-term capital spending plans to take account of uncertainties in supply sufficiency and demand projections; determining which new investments can achieve financing that will support maintenance of the utility’s target credit rating; and dealing with liabilities linked to specific assets in the portfolio.
- Influencing Policy Makers and Regulators
Balancing the energy trilemma of affordability, security of supply and decarbonisation is resulting in increased regulation and scrutiny from policy makers, leading to increased uncertainty for utilities and an unwillingness to make significant investments without support. Renewable portfolio standards and smart grid mandates are increasingly driving investment priorities. Utilities are under pressure from energy efficiency standards which reduce energy revenues, depress demand for new generation and can lead to excess network capacity.
Regulatory regimes are having a more intense effect on the nature of investments, including delaying expansion and replacement decisions. Increased regulatory scrutiny is necessitating additional reporting and data gathering, affecting processes, systems, staff and operating efficiency.
Challenges for the CFO to address include: developing investment and financial management strategies that recognise regulatory and policy uncertainties and their impact on the business; adapting the financial management of the business in response to regulatory obligations such as mandates for unbundling, smart grid or renewable programes; devising new regulatory mandates to address changes in current markets related to transformation; defining the right future policies to address ‘second stage’ effects from poor policy design; determining and defending the rate case or regulatory submission to regulators to incorporate the operational implications of technology, and transformational change.
- Replacing Declining Revenues from Traditional Businesses
Distributed generation and new technology threaten traditional utility business models. Customers can now self-supply, bypassing utility infrastructure and installing more inventive consumption tools, and challenging the role of utilities.
Traditional network utility business plans are based on regulated returns from long-lived assets. As technology leads to more decentralisation, the network businesses need to raise the same level of revenues from a smaller number of customers and reduced volume throughput. The necessary solutions will be guided by both strategic and regulatory solutions. To avoid a continuous decline, the utility sector needs to look at both how to deliver traditional services efficiently, but more importantly create the ability to backfill revenue erosion. This demands more innovation.
Challenges for the CFO to address include: Predicting, measuring and managing the impact of customer load reduction on revenues; defining the options and potential for new revenue creation and capture; design of alternative cost-recovery approaches given the decline in volume and level of potential unrecoverable costs; identification and development of other services that could be offered to replace lost revenues; in addition to the appropriateness of different business models to be considered for network ownership or operation to enhance derived value.
- Measuring Enterprise Performance as Business Models Shift
Changes to business models are driving new relationships with customers and suppliers in the energy value chain and putting additional pressure on the management of business performance in a more demanding market and investment environment. Changing business models exacerbate the stress to produce requisite financial results.
Customer behaviours are changing and they expect more information faster, increased transparency and digitisation, seeking higher value from their discretionary spend. Companies will need to find the right balance between pursuing aggressive strategic goals and ensuring that core operational performance is not only sustained, but also enhanced.
Challenges for the CFO to address include: Ensuring the execution models utilised by the company are aligned with the financial needs of the business; making sure that finance performs the role of an agile business partner to the operations and commercial parts of the business; ensuring that the KPIs monitored are effective at demonstrating quality outcomes against strategic objectives, balancing consistency, quality and efficiency; implementing a culture of continuous improvement and efficient change management; and developing a model for measurement of business performance that extends beyond common financial, operational metrics.
- Attracting Capital Through Appropriate Risk Allocation
The energy sector competes for scarce global capital with large infrastructure projects, regulated businesses and cross-industry retail investment opportunities. The unprecedented volatility and uncertainty in the energy sector is changing investor risk perception, placing additional pressure on utility balance sheets.
Attracting capital has always been a challenge, but the disruption caused by energy transformation has added a new dimension to the challenge for utilities. As the structure of the market changes and becomes less stable, both in the competitive and regulated sectors, the choices of where to allocate scarce capital become more complex. Investors have a vast array of infrastructure projects in which to place their capital and the advent of smart grids, renewable technology and beyond-the-meter services increases the risk profile above that of a traditional utility.
Companies need to balance the longer-term capital replacement requirements associated with traditional business models with the shorter-term capital return horizons that align with the new market fundamentals of the market.
Risk allocation to the party best able to manage the risk becomes ever more important in attracting investment.
Challenges for the CFO to address here include: Prioritisation of capital investment levels and timing to optimise financial outcomes; understanding the differences in risks related to capital projects across the company value chain; development of risk-adjusted returns to reflect the true level of risks associated with individual capital projects; management of capital deployment performance in a manner consistent with internal risks assumed; adoption of more stringent project evaluation business case methodologies to ensure optimisation of scarce resources; In addition to ensuring appropriate risk allocation and return on investment to attract financial investors for major projects.
The PwC CFO Checklist Identifies 10 Key Questions to Address
- Does the board have a clear view of the answers to the questions that need to shape your focus as a CFO – ‘where to play’ strategically, ‘how to play’ commercially and ‘how to win’ competitively?
- Are the requirements of the transformation being matched with the capabilities to analyze value and to differentiate activities that create clear market positioning value from those that merely draw resources and do not advance the strategic agenda of the company?
- Have you got the necessary tools and insights to judge the best financing and corporate restructuring options to deliver on the chosen future strategy?
- Do you have the right forward- and outward-facing data gathering and analysis capabilities in place that can turn data into insight and, more importantly, insight into foresight?
- Is your reporting keeping pace? Are you able to align and communicate about the energy industry transformation that is taking place with a clear and convincing value realization strategy – upwards at the board, outwards to investors, policymakers, regulators, customers and the public, and downwards through the organization?
- Do you know what impact different incubation, collaboration and partnering structures might have on value and on your options for venturing into new areas?
- Have you got processes in place that enable comparison of capital deployment options right across the business, not just within particular business units, so that capital allocation can be truly matched to the enterprise’s strategic outcomes?
- Do you have effective processes that enable alignment of the critical functions necessary to support quality financial stewardship and a distinctive strategic architecture?
- Are you gathering the evidence and insight that will enable you to have a proactive dialogue with policymakers and the regulator to ensure that the regulatory roadmap around energy transformation does not lead to unintended consequences?
- Do you have flexible risk allocation and mitigation strategies in place to enable the company to manage the impacts of energy transformation?
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DR. AHMED RASHWAN
PwC Director- Head of Oil & Gas
PwC Partner- Utility, Mining & Energy Leader
PwC Partner-Assurance Leader
PwC Director, Industry Expert