Evolution of the Energy Value Chain by Chris Trayhorn, Publisher of mThink Blue Book, January 15, 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. Filed under: White Papers Tagged under: Utilities About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.