The Three Pillars of Energy Policy

Successful energy policy is about trade-offs between different and
divergent agendas that must somehow be reconciled. Energy
policy, whether in the U.K., in Europe or globally, fundamentally
rests on three pillars—the customers, requiring safe, affordable
and available energy; the environment; and, in the case of
investor-funded utilities, the investor.

Each pillar is, to some extent, protected by a regulator and
underpinned by a foundation, namely energy policy itself.

How we got here

So how has energy policy come to be defined by customer,
environment and shareholder agendas which are inherently in
conflict? In the U.K. before privatization and before the Kyoto
protocols on climate change and emissions—which committed
Britain and most of the rest of the world to reducing carbon
emissions from, among other things, power stations—there were
more certainties surrounding the energy sector.

There were no shareholders to satisfy, no Ofgem or Environment
Agency, no global warming agenda and plentiful North Sea gas
and a nuclear fleet with years of life left in it. There was no
competition either, so customers, with no choice, consumed what
they were given. Energy companies regulated themselves, within
the restraints of government policy.

Fifteen years after privatization all the certainties have gone. With
privatization has come regulation and competition, along with the
globalization of the energy market and multinational ownership.
Climate change and carbon reduction are cornerstones of U.K.
energy policy and the U.K.’s North Sea gas reserves and the
nuclear power station fleet are nearing the ends of their lives.

The first pillar – the customer

The starting point for the first pillar of energy policy is that ,
increasingly, the customer has choice. All over the world, energy
markets are turning to deregulated, liberalized and competitive
models. It is true that this does not prevail everywhere, but in
most Western economies the market and competition are seen as
the most effective mechanisms for an effective energy industry,
driving efficiency and empowering customers.

Even where there is less appetite for a private sector competitive
market politically, privatization is often the only economically
viable way for a country’s energy industry to move forward, with
the public sector no longer able to sustain it.

When a customer has the ability to switch energy suppliers, that
customer is empowered in a way that could not have been
imagined in the days of monopoly. Energy, though, remains a
commodity market in all but name, with little to differentiate
offerings—apart from price. Competitive energy, where it exists
today, is a price-driven market.

But this does not mean the energy customer holds all the power.
Competitive energy retail is at the mercy of wholesale electricity
and gas prices. Because these are in turn affected by the price of
oil, wholesale energy prices are subject to volatility. In the U.K., for
example, we have seen supplier after supplier increase the price of
electricity and gas to the customer.

Oil prices are also on the rise, and with current political and
economic instability not about to go away, wholesale energy
prices are set to stay high for the foreseeable future. This is driven
by long-term demand and geopolitical issues, as well as by new
short-term and localized issues, such as the effect of the recent
U.S. hurricanes on oil supplies.

The Holy Grail of competitive energy retail strategy in terms of
customers is to be able to add value in an otherwise commodity
market. This has been done successfully with dual fuel offerings,
but utilities that tried to bundle a number of utility services
together have now retreated from this position.

Energy companies may now try to add value to energy offerings
through tariff adjustments, billing frequency, energy saving advice
and services, and smart metering. Enhanced service offerings can
also be a way of adding value. Some suppliers have tried to add
value by offering ancillary services in conjunction with scheme
partners such as Homeserve, which offers householders a range
of specialist insurance services.

For the industrial, business and commercial customer the concept
of an “energy service company” (or ESCO) has long been talked
about as an evolution of an electricity and gas supplier into an
organization that is more of an energy management partner.

But above all, what do customers want? They want low prices,
security of supply with zero interruptions, and accurate excellent
customer service. While low prices and security of supply will
continue to be at issue for all utilities, it seems the future in terms
of building and sustaining customer loyalty may therefore be
doing better at the basics. Highlighting service quality as part of
the brand offering and then exploiting this to retain and attract
customers may be less dramatic than multi-utility services but is
more likely to be understood by customers and appeal to them in
an age of often remote call centers and uncertain appointment

Many utility companies are already shifting their service strategies
toward offering better customer service with the assistance of
service optimization technology. Service optimization technology
helps companies plan for service demand and schedule service
visits so that the utility is maximizing the productivity of its field
workforce. As a result, utilities are able to address customer
service calls more quickly than before and are often able to give
customers shorter appointment windows, freeing customers from
waiting at home all day long for a service engineer to arrive.

Companies such as United Utilities and Anglian Water in the U.K.,
Badenova in Germany, Antwerp Waterworks in Belgium and
Pacific Gas and Electric in the United States have all turned to
service optimization over the last year as a means of improving
productivity in their service organizations.

And the same technology that enables better productivity, and
thus happier customers, has tangible benefits for the utility
company as well. Service optimization technology works by
removing inefficiencies from the process. Thus, it helps companies
do more with the same amount of resources. It is a win-win
situation for both the customer and the utility.

But the question remains whether the customers’ desire for low
prices and high standards of service can be reconciled with
security of supply issues and environmental concerns. So let’s take
a look at the second pillar.

The second pillar—the environment

Energy companies are now at the center of the environmental
debate. Governments have set emissions targets and promoted
renewable energy as part of global and national policy to address
climate change and global warming, to which the power
generation sector makes such a significant contribution.

Trading in emissions between the rich developed nations and the
developing world has of course distorted this issue.

Emissions trading has enabled some economies to continue to
emit carbon, but ultimately there is still an overriding need to
reduce generation capacity that produces carbon—coal and gas
generation. It also means looking at energy saving initiatives, with
which customers will be comfortable, and pricing mechanisms to
manage demand, with which they will be less comfortable.

In recent months the generation debate has begun to swing away
from renewables as the one-stop answer to greener energy. The
problem is that while wind generation is the most widespread
new form of renewable energy, wind turbines work for only
around 30-per cent of the time when there is wind. Nuclear
generation, on the other hand, is also zero-emissions and is highly
suitable as baseload generation—in other words, with plants
being operational all the time.

Britain’s prime minister, Tony Blair, announced at this year’s Labour
Party conference that his government would at least consider
building -a new generation of nuclear power stations to replace
those built in the 1950s, ‘60s and ‘70s. These are currently due to
be decommissioned by 2014 and produce more than 20 per-cent
of the country’s electricity. At least one of these nuclear power
stations, at Dungeness, may now have its life extended by five
years or more.

Of course the argument against new nuclear is not just the
environmentalists’ argument about waste and safety—it is an
economic one too. Nuclear power was once going to be “too
cheap to meter”. In fact, as we have seen with the financial
difficulties of U.K. nuclear power generator British Energy, the
fluctuations of the wholesale electricity market can be crippling
for baseload generators, which do not have the operational
flexibility of, for example, gas generators.

On the whole, the environmental agenda for energy—away from
relatively inexpensive gas and coal generation—toward more
expensive and less reliable renewables, with uncertainty over new
nuclear, does not match the customer agenda of cheap electricity
whenever they want it. Moreover, the very fact that price has
been the prime driver in the recruiting and retaining of customers
in the developed economies is at odds with the central
environmental proposition, which is to cut energy consumption.

Populations in emerging economies want higher standards of
living and Western-style consumer goods and demand for
electricity is growing exponentially in such places as China and
India. On the whole, this electricity is coming largely through not
very environmentally friendly coal and gas generation, with some

-The huge demand for energy in China is not going to be
addressed by building wind turbines, however environmentally
friendly this may be. New coal-fuelled power stations are opening
there every few weeks, because China has massive reserves of
coal and this represents the cheapest source of energy, however
massive the environmental implications.

Can technology help? In the long term, technology could yet come
to the environment’s rescue. It may be possible to take carbon,
which is emitted through electricity generation, and bury it
underground, perhaps in voids left by natural gas or oil extraction
—this is known as carbon sequestration, or carbon capture. In this
way gas and “clean coal” plants would still be environmentally
acceptable, because carbon emissions would be managed.

Other technological breakthroughs, such as using hydrogen as a
fuel, could help establish a low-carbon economy in the future.
And there are other forms of renewable generation such as solar
and wave power that could ultimately be more reliable than wind.
Micro CHP at a domestic consumer level is another potential
option for future distributed electricity generation. But all these
developments need support from government and from investors.

Regulatory standards will encourage utilities themselves to
become more environmentally efficient. As well as reducing
emissions from power stations, these regulations also translate
into cutting pollution from the utility’s business operations. One
way to effect this change is by better managing the company’s
field labor force. Put simply, if a utility’s field force can make fewer
journeys in the field and make each journey more efficient, the
environment will benefit.

This is another area in which service optimization technology can
help utilities. Using optimization technology, a utility can
consistently schedule field engineers in such a way as to minimize
travel. By scheduling one engineer to several customers in the
same area, utilities can minimize drive time and thus fuel
consumption and exhaust pollution.

And lower fuel costs in the field will also benefit an energy
company’s bottom line.

In terms of transmission, the establishment of a “greener” field
force will reduce travel through optimized routing, reduce paperwork
through mobile communication, and help fast and
appropriate responses to environmental emergencies.

In terms of retail, facilitating the “educated customer” can
provide the customer with insight into his or her consumption,
using smart-metering capabilities and establishing a meter
replacement plan in an optimal manner. And appointment
booking online can increase the likelihood of a customer being at
home when the engineer arrives—again reducing unnecessary

The third pillar—the investor

In investor-owned utilities the ultimate aim is to deliver
shareholder value. And this third pillar of energy policy may not
necessarily chime with the customer or environmental agenda.

The investor’s main agenda is return on capital, preferably over
the shorter term. But carbon sequestration or building a new
generation of nuclear power stations is a long-term proposition.

Governments set energy policies, but increasingly it is expected
that the market will deliver them. Investors will choose to invest in
projects only if the returns are at a suitable level. That means—in
the case of a generation plant, for example—that it is worth
investing in a power station only if the wholesale price of electricity
is at a sufficiently high level to make the plant profitable.

Recently in the U.K. energy prices fell, and it was no longer
economic to build new plant. Moreover, old plants were
mothballed, and capacity was reduced, with resulting bankruptcies.

Switching from the energy sector was a good decision for
investors—but the resultant reduction in the generation capacity
margin was not necessarily a good decision for customers.

If the stalling of investment means stalling on building new
environmentally friendly or renewable generation plants, it is not
necessarily good for the environment either.

The investor’s view is inevitably more short term than an energy
industry engineer’s view. And the decision regarding when to
invest rests on when the return on the investment is deemed
appropriate rather than when customers or the environment
require that investment to be made.

It is also worth noting that different private sector investor groups
will tolerate and absorb different risks in the energy delivery chain.
Governments, in wanting to see their energy policies delivered, do
not always understand this.

But a workable energy policy can be reached only by
understanding what is commercially and practically possible.

One thing is certain. The role of the private sector investor in the
energy industry is going to be omnipresent and permanent. Few
governments can sustain state-funded investment in energy even
if they wanted to, although this does not mean that governments
should become disinterested in the energy sector. They will
continue to play a key role in shaping energy policy.

The plinth—security post-Kyoto

Customers, the environment and investors all need to have an
energy market that delivers optimal security of supply—within a
low-carbon context. Customers want the lights to stay on, the
environment needs carbon emissions drastically reduced and
investors do not want to see shareholder value destroyed by
blackouts and breaches of environmental targets.

Reconciling security of supply with low carbon is the fundamental
conundrum facing the energy sector in Britain, in Europe and
worldwide. This is particularly acute in the developing world,
where economic drivers for growth take precedence over
environmental factors.

To feed the rapidly expanding growth in energy demand, China
has turned to its plentiful coal reserves to ensure security of supply
and meet the needs of customers. This it can do—albeit at the
cost of the lives of thousands of Chinese coal miners every year.
And the cost to the environment is enormous.

Other countries, notably Denmark, Germany and Spain, have
made significant investment in wind turbine generation. This
clearly is totally in tune with low-carbon aspirations. But with
wind turbines, as we have seen, working only 30 per-cent of the
time, the contribution to security of supply can be only peripheral.
Indeed, any wind turbine capacity installed needs to be backed up
by a gas generation plant.

In terms of global security of supply, there is enough gas and coal
and enough potential nuclear generation, backed up by solar
power and wind turbines, to match demand for some time to
come. Unfortunately, take out the carbon-emitting generation
capacity and that picture starts to look different.

Security of supply in the U.K.

How can the three pillars of customer, the environment and the
investor be supported here in Britain? How can the trade-offs be
made between their different demands in a context of security of
supply and the desire to reduce carbon emissions?

In Britain today, 40 per-cent of power is generated from gas, 35
per cent from coal, 20 per cent from nuclear, 4.6 per-cent from
renewables including hydro and around half a per cent from oil.
As we have seen, the scenario for the next couple of decades or
so has to change.

The government has set an ambitious renewables target of 10
per-cent by 2015, with that nuclear power capacity of 20 per cent
set to decline as plants reach the end of their lives around 2012-

Many of the coal plants will have to be extensively and expensively
modified to meet new environmental regulations, while domestic
gas supplies are running out and Britain will become reliant on gas
imported through continental interconnectors or by ship in LNG
(liquefied natural gas) form from farther afield.

A decision on whether or not to embark upon a new generation
of nuclear power stations may be two years away, although the
government has promised an energy review in 2006. Even so, the
six new plants that might be built would realistically replace only
most of the lost 20 per cent (not all—Sizewell B will go on into
the 2020s).

With gas, the declining supplies from the U.K. Continental Shelf
can be sourced elsewhere, with new LNG terminal capacity at
Milford Haven in 2007 and 2008 and at the Isle of Grain in 2008.
More interconnectors will come on stream in 2007 and 2008.

The gas situation could be tight between now and then though.
High gas prices—driven by the strong gas price linkage to oil in
Europe and by the lack of competition, meaning that European
suppliers can link purchase contracts to oil—are an issue here too.

This leaves the coal shortfall. Clean coal and carbon sequestration
are options, but unproven options. Coal could be replaced by gas
plants, but while that would reduce emissions, it would not be
enough to meet Kyoto targets.

Conclusion—supporting the three pillars

So with these seismic shifts in the foundations, how can the three
pillars be kept standing? Reconciling the conflicting needs of
these three constituencies is the fundamental truth of energy

It must be remembered that technology and the workforce have
a key role to play. They are not the pillars, but they serve the
energy sector as opposed to making demands upon it.

For customers in the U.K., security would come through massive
reliance on imported gas. Prices would be lower if a proper
competitive market could be established across Europe that would
not only give customers more choice on price, but also reduce the
wholesale price of gas because suppliers would no longer link the
price of gas with that of oil.

So customers would probably vote for the dash for gas.

The environment would instinctively be best served by an
explosion in renewables. Yet as renewables would mostly be in
the form of wind, there is an environmental negative in terms of
visual impact, as well as the issue of connectivity, with hundreds
of kilometers of new overhead transmission and distribution lines
bringing electricity from remote offshore wind farms across tracts
of often beautiful countryside to where it would be needed.

The environmental lobby would vote for renewables but might be
swayed by the zero-emission option of nuclear new build.

Investors would be attracted to energy options that showed a
return. Investing in cleaner coal plants might prove attractive.

Nuclear new build is economically a somewhat unknown quantity
as of yet, with the disadvantage of being a baseload player and
with the added sting in the tail of decommissioning costs.

On the other hand, if gas prices stabilized but did not fall so far
as to bring about a collapse in the electricity wholesale price,
investment in proven CCGT gas generation might be attractive to

So the energy mix of the future will change. What is important to
the whole edifice is that energy security is hedged by not relying
on one energy source that could be hit by shortages or price
volatility. Nuclear could yet make a comeback—or be consigned
to history. Technology could yet come to the rescue of coal.

Gas could either be stabilized by a properly working competitive
market or be afflicted by high oil-bound prices and/or an overreliance
on imports from unstable places. And renewables will be
in there, but as an important niche, a part of the mix, but only
ever that.

Meanwhile, supporting the three pillars of energy policy as the
industry examines issues such as the energy mix must be a fully
optimized workforce. Customers, the environment and investors
demand an ever more efficient and optimized utility, and while
they are seemingly different and conflicting forces, the three
pillars are more in line in organizations that use service
optimization technology.

Workforce optimization reduces costs, which can be passed on to
customers in terms of power prices; reduces emissions, which
benefits the environment; and pleases the regulator through
better customer service—all of which will be good news for

In the end, properly functioning markets and new technology
under the guiding hand of government energy policy and an
achievable environmental agenda will light the way forward and
keep the three pillars of energy policy standing and in proper