Evolution of the Energy Value Chain

mThink
by mThink
January 14, 2002

The energy industry continues its metamorphosis, driven in various parts by
business imperatives to enhance shareholder value, meet industry-restructuring
mandates, and realize the benefits of economic and technological advances. The
energy value chain, previously defined as a five segment model spanning extraction,
processing, wholesale, delivery and retail, continues to evolve, with new segments
emerging via the combination of previously separate segments and the splitting
of previously single segments into multiple segments (Figure 1).

Figure 1 – Evolution of the Energy Value Chain

For example, combining the processing and wholesale segments of electricity
into a generation and trading entity has emerged as a successful market configuration.
On the other hand, the delivery segment is splitting into separate transmission
and distribution businesses. This has been the case for gas, and is now impacting
electricity as well. Similarly, we are observing the retail segment split into
two to three markets, one focused on large customers, another focused on the
mass market (both typically involving choice of retail energy supplier) and
possibly a third market focused on the remaining regulated retail (including
utility provider of last resort) market.


During 2001-05, despite the recent slow down in deregulation and restructuring
efforts in the U.S. market, we predict a continued move toward separation in
each segment of the energy value chain as a distinct business. Although companies
may choose to operate in some or all of these segments, we believe the era of
vertically integrated monopolies has come to an end.

Energy companies will choose different business strategies to play across this
value chain. One strategy will be re-verticalization, where large players will
seek to participate in most or all segments of the value chain. Examples would
be oil and gas majors with subsidiary operations in extraction (exploration
and production), processing/wholesale (generation and trading), transmission
(big pipes and wires), distribution (little pipes and wires), large customer
retail (energy services) and mass-market retail (joint venture with non-energy
marketer).

Another strategy will be horizontal specialization, where companies will choose
to focus on one or two segments of the value chain and possibly extend their
capabilities to other similar industries (e.g., power generation extending to
other process manufacturing, energy trading extending to other commodities,
energy transmission extending to other network infrastructures, etc.) or expanding
geographically via mergers and acquisitions. Examples would be former utility
companies building large regional transmission or distribution operations, or
independent power producers building up a large fleet of generating plants complemented
by a wholesale trading operation.

Figure 2 – Primary values serve as the basis for strategy.

Other strategies, which could be combined with either re-verticalization or horizontal
specialization, include convergence (a focus on multiple commodities such as electricity,
gas, water, telecom, etc.) and geographic reach (global, national or regional).
Each segment will focus on a primary value discipline as the basis for strategy.

Since technology strategy is profoundly impacted by both market structure and
business strategy, and since changes imposed by industry restructuring will
be a constant feature of the market, we predict that an adaptable and scalable
architecture will be a competitive advantage for market leaders. Agility will
be a key differentiator for companies adopting customer intimacy and product
leadership as their strategic value discipline. Those adopting operational excellence
must also embrace agile approaches to transform and position the company for
a competitive future, albeit to a lesser extent.

Extraction

This segment of the energy value chain is focused on the extraction of hydrocarbons
(e.g., oil, gas, coal) from the ground. Typical business activities therefore
include oil and gas exploration and production and coal mining. Examples of
businesses in this segment include Conoco, Royal Dutch Shell, BP Amoco, TotalFinaElf,
Coastal, ExxonMobil, Chevron/Texaco, BHP, Arch Coal, Peabody Group and service
companies like Schlumberger
and Halliburton. These types of businesses may choose to operate on a regional,
national or global level to match the geographic scope of production fields.

We believe successful business strategies for extraction companies must focus
on operational excellence (for example, given the high cost of R&D, technical
collaboration between industry participants will be pursued and costly exploration
will be maximized through increased efficiency in drilling time and higher production
volumes). Other operational imperatives include accelerating time to market,
exploiting global markets and resources, and achieving cost/quality leadership.
Critical success factors for extraction companies include low cost producer,
reduction in unplanned shutdown losses, improvements in maintenance and increase
in overall equipment efficiency (OEE), improvement in volume, and net reserve
additions through:

• Continental integration
• Deep water development
• Optimizing exploration, gathering, separation and storage
• Waste management and reclamation
• Workflow and knowledge management

An appropriate application portfolio for extraction companies must, at a minimum,
include:
• Seismic data acquisition, processing and interpretation
• Geographic information systems including gridding, contouring and mapping
• Reservoir characterization and simulation
• Drilling applications such as well planning and well log analysis
• Economic applications for budgeting, decision analysis and risk management
• Knowledge management and collaboration

In addition, many of these applications can be horizontally leveraged for other

META Trends

During 2001-05, new energy industry value chain segments
will emerge (generation/ trading combination, transmission vs. distribution
split, large-customer vs. mass-market retail split). Players will choose
strategies based on convergence (electric, oil/gas, communications, water),
re- verticalization (exploration/production to retail), or horizontal
specialization (in each segment of the value chain). An adaptable and
scalable architecture will be a competitive advantage for market leaders.

Energy company performance management will change (2001-03),
but organizations’ ability to link performance metrics to critical success
factors and map information technology and solutions will sustain success.
Value will be derived more by agility than by operational efficiencies
and performance excellence (2003-05).

Industry consolidation will intensify via mergers and acquisitions (2001-05)
to help energy companies gain scale, diversify risk, and enter new markets.
Benefits will increasingly depend on successful exploitation of information
and technology.

mining and mineral and chemical extraction processes in other horizontal industries.
This segment is unique in that there is less information technology vertical
leverage potential than in other segments.

 

Processing and Wholesale

This segment is focused on processing the extracted hydrocarbons into refined
energy products and includes oil refining, gas processing, power generation
(including non-fossil generation, such as hydro, other renewables, and nuclear),
liquefied natural gas and coal gasification. Additionally, the segment includes
the buying and selling of energy at the wholesale level. Examples of businesses
in this segment include Enron, Williams Energy, Koch, Dynegy,
PG&E, Reliant, TXU, Duke, Mirant, AES, Calpine, AEP, Exelon, and Constellation.

These types of businesses may choose to operate on a regional, national or global
level to match the geographic scope of their processing facilities.

We believe successful business strategies for generators/wholesalers are driven
by operational excellence (for example, high volume, high speed, low cost per
transaction, highly secure systems). Critical success factors for processing
and wholesale include mass production to lean production, asset life extension,
asset optimization, low-cost production, and world-class trading through:
• Engineering and construction
• Production, fuels management ramping/automated dispatch control, process
efficiency
• Environmental monitoring
• Plant-predictive maintenance, risk-based maintenance, outage planning
and management
• Decommissioning and waste management
• Enterprise-wide asset optimization
• Controlling/mitigating financial exposure
• Integrating physical and financial portfolios
• Financial, analytical, and risk management

An appropriate application portfolio for generator/wholesaler must, at a minimum,
include:
• Plant process control systems
• Operational data warehouses and analytical tools
• Limited operational CRM and contract management
• Price, credit and volumetric risk management
• Security and audit
• Enterprise asset management

In addition, many of these applications can be leveraged as service offerings
to mass- market retailers, regulated retail and large energy end-use customers
in the form of energy management, insurance and risk management, bill management
(consolidation, aggregation), and electronic bill presentment and payment services.

Transmission

The transmission segment is focused on moving large amounts of energy commodities
(liquids, gas, power) over relatively long distances. Primary business assets
include oil and gas pipelines and electric transmission networks. In the previous
energy value chain model, electric transmission and distribution and natural
gas transportation and distribution were subsumed in delivery. However, electric
transmission and distribution are increasingly treated as distinct business
units in the ongoing unbundling of the energy industry (this has been the case
in liquids and natural gas for some time with market leading companies like
Duke Energy, El Paso Energy, NiSource, Williams, Equilon, Colonial, and Buckeye).
Examples of electric businesses in this segment include National Grid, Entergy
Transco, and the State of California. These types of businesses may choose to
operate on a regional, national or global level to match the geographic scope
of their authorized service territory.

We believe successful business strategies for transmission companies are driven
by operational excellence (for example, technologies, such as distributed generation
or superconducting magnetic energy storage, are deployed as low-cost solutions
rather than new product rollout, and promote open access and network development).
Critical success factors for transmission companies include strong asset management,
business process optimization, operating efficiency and reliability through:
• Engineering and construction
• Operations management, maintenance and work management
• Control, measurement communications systems and capital asset investment
integration
• Outage recovery

An appropriate application portfolio for a transmission company must, at a
minimum, include:
• Operational CRM and contract management (focused on partner relationship
management)
• Geographical information systems (GIS)
• Energy management systems (EMS)/ supervisory control and data acquisition
systems (SCADA), including advanced applications such as transmission scheduling
• Enterprise asset management
• Wholesale settlement
• Electronic bulletin boards

In addition, many of these applications can be leveraged as service offerings
to distribution providers in the form of network architecture and open access
tools.

Distribution

The distribution segment of the value chain is focused on the local network
of pipes and wires that deliver electricity and natural gas from the transmission
systems to the end-use customers, and includes electric and gas distribution
companies, but may also include truck-based delivery of fuel oil and propane.
Examples of businesses in this segment include TXU and Reliant T&D, Atlanta
Gas Light, Rochester Gas and Electric, BG&E, KeySpan, and Nicor. These types
of businesses may choose to operate on a local or regional level to match the
geographic scope of their territory authorized by state regulators, for monopoly
franchises, or by geographic scope defined by operational limits (delivery radius
miles), for non-economic regulated industries.

We believe successful business strategies for distribution companies are driven
by operational excellence. We believe that by 2003-05, an open access model
will emerge where the revenue will be driven by multi-flow pricing versus the
current model of leveraging vertical market power to support sales of other
vertical services and products. The distribution system will evolve from a hierarchical
model to a geodesic network model.

Critical success factors for distribution companies include setting the regulatory
agenda, increasing market share, increasing customer satisfaction, exceeding
performance-based rate indices, managing assets, decreasing costs per customer
while increasing revenue per customer through:
• Engineering and construction
• Operations management, maintenance, and work management
• Control, measurement and communications systems and capital asset investment
integration
• Outage recovery

An appropriate application portfolio for a distribution company must, at a
minimum, include:
• Operational CRM and contract management (focused on partner relationship
management)
• GIS
• SCADA
• Work management systems
• Distribution/outage management systems
• Automated meter reading and interval data recorder for large customers
on the system
• Mobile data systems

In addition, many of these applications can be leveraged as enablers of an open
access model, where the hierarchical system evolves into a network system that
will enhance the potential for energy management, alternative energy options,
and comprehensive customer solutions, with distribution being a commodity that
is incorporated into those solutions.

Large Customer Retail

This segment of the value chain is focused on the marketing and selling of
energy commodities and related services to large commercial, industrial and
institutional end-users where energy is a significant percentage of the cost
of goods sold. These are typically soph isticated energy users that not only
need commodity energy but also have requirements for high power quality or other
premium energy services. Examples of businesses in this segment include Enron
Energy Services, DukeSolutions, Avista Advantage, Equitable Resources, and Allegheny
Energy Solutions. These types of businesses may operate on a regional, national
or global level to match the geographic scope of their customers.

We believe successful business strategies for these retailers must focus on
customer intimacy and must provide multiple commodity supply and services (e.g.,
performance contracting, energy management, consolidated billing, commodity
management). Critical success factors for large customer retailers include being
a strong asset optimizer, maximizing sales margins, growing existing and new
markets, delivering performance, comfort, and convenience through:
• One-on-one CRM
• Commodity pricing and risk management
• Geographic reach
• Knowledge of customers’ markets
• Integration with customers’ business processes and applications
• Meeting customer power quality needs

An appropriate application portfolio for a large customer energy retailer must,
at a minimum, include:
• Operational CRM (contact/contract management, complex billing, sales
automation)
• Analytical CRM (cost-to-serve calculations)
• Meter data management
• Load profiling/demand forecasting
• Energy trading
• Risk management
• Settlement

In addition, many of these applications can be leveraged as service offerings
to customers in the form of energy management, customer self service, bill management
(consolidation, aggregation), and electronic bill presentment and payment services,
risk management and insurance.

Mass-Market Retail

The mass-market retail segment of the value chain is focused on marketing and
selling energy commodities and related services to small commercial and residential
customers. Examples of businesses in this segment include The Home Depot, 7-Eleven,
Wal-Mart, L.L. Bean. These types of businesses may choose to operate on a regional,
national or global level to match the geographic scope of their customers.
We believe successful business strategies for these retailers must focus on
customer intimacy (for example maximize value of customer interactions, leveraging
customer relationships and offering a broad range of products and services)
and product leadership (for example, green power or residential distributed
generation in the future). Critical success factors for large customer retailers
include:
• Partnering with other retailers or commodity providers
• Sales expansion with existing customer base
• Commodity pricing and risk management
• Strong brand-supporting business strategy
• Marketing

An appropriate application portfolio for a large customer energy retailer must,
at a minimum, include:
• Operational CRM: sales, marketing, service and field service
• Collaborative CRM: channel management, customer interaction center
• Analytical CRM: segmentation, behavior patterns
• Load profiling
• Energy trading
• Risk management
• Shadow settlement

In addition, many of these applications can be leveraged as service offerings
to customers in the form of energy management, bill management (consolidation,
aggregation), and electronic bill presentment and payment) services, and partner-customer
self-service applications.

Regulated Retail Market

The regulated retail market segment of the value chain is focused on providing
energy supply through a regulated entity (in the case of jurisdictions that
are open to competition, this includes utilities with provider-of-last-resort
responsibility) to customers for whom choice of supplier is not available or
where the customer chooses not to chose. Examples of businesses in this segment
include Southern Company, Cobb EMC, Colorado Springs Utilities, and Idaho Power.
These types of businesses will operate on a local or regional level to match
the geographic scope of their franchised service territory.

We believe successful business strategies for these regulated retailers must
focus on operational excellence (for example meeting regulator expectations,
while building for the competitive market future, strengthening the incumbency
and maintaining system reliability). Critical success factors for large customer
retailers include:
• Used and useful investments in CRM
• Setting the regulatory agenda
• Supply portfolio management
• Understanding cost structures

An appropriate application portfolio for a large customer energy retailer must,
at a minimum, include:
• Operational CRM (typically a vertically specialized billing system)
• Integrating CRM with operational systems
• Work management
• Outage management
• Metering
• Mobile data
• GIS

In addition, many of these applications can be leveraged as enablers of an open
access model where the hierarchical system evolves to a network system that
will enhance the potential for energy management, alternative energy options
and comprehensive customer solutions.

Linking Business Strategy With IT for Performance

We believe it is critical to link information strategies and investments with
business strategy. Our research indicates that companies have deployed a variety
of successful approaches.

While IT organizations “operating like a business” are still in the minority,
some ITOs have employed balanced scorecards to measure IT performance. Experience
with balanced scorecards has shown considerable diversity in practice with varying
degrees of success. Some ITOs use balanced scorecards to put their IT strategy
into a measurable framework; others use them to link their operational measures,
showing performance against industry levels. Still others use them to communicate
how IT products and services are contributing to business outcomes.

To manage IT performance against business objectives, balance must be struck
between cost and benefit, shareholder and customer, efficiency and effectiveness,
and long and short term. In addition, the ITO will often establish service-level
agreements to effectively manage the IT/business interface. We believe service-level
agreements should evolve from technology-based metrics, which are not linked
to business metrics to a business/IT measures correlation model to promote service
“value” agreements. This becomes even more critical as sourcing strategies to
meet line-of-business objectives are externalized. Second-generation SLAs (or
SVAs) are needed that clearly identify the service-level objectives that are
required by the lines of business to achieve key business goals.

We believe that energy companies have been struggling to bridge the gap between
business goals and implementation tactics. Energy companies must demonstrate
agility to improve efficiency, provide reliable service and grow revenues. IT
solutions and architecture must be equally, if not more, flexible. As companies
define their role in the energy value chain, it is even more important for the
lines of business to have a shared vision of the business and ensure that performance
to that end is enhanced, and not lost, through sourcing strategies. This business/IT
partnership must drive from a common value proposition that is unique to their
segment of the energy value chain, and understand the business strategies and
critical success factors (embodying the information requirements necessary for
success) Then it must deploy IT architecture, applications and solutions to
enable the strategies.

Business Impact: Lines of business must ensure that their value proposition,
business strategies, critical success factors and information requirements are
well defined relative to the energy value chain segment in which they operate,
and articulated so that IT organizations can begin to “operate as the business.”

Bottom Line: The information technology organization must collaborate
with the line of business to develop agile IT solutions that enable business
strategies and meet value propositions, ensuring that each are supported by
sourcing strategies.

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