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Smart Grid
July 2011
An investment theme for Gimv Venture Capital
The Smart Grid has high expectations to live up to. It is hyped as the answer to the energy and climate crisis since it will integrate renewable power sources and manage energy much more efficiently. It is punted as the internet of things, promising untold opportunities for entrepreneurs to develop innovative new services (similar to the way mobile network infrastructure has made possible the creation of new business models and entrepreneurial success). How much of this is true? Are we talking about a real paradigm shift that will open up high-growth opportunities for new entrants and startups, and thusby default create investment opportunities for venture capitalists like Gimv? At Gimv we believe so. Here is our thinking on the Smart Grid.
The Smart Grid defined
The Smart Grid describes a dramatic change from yesterday’s ‘dumb’ hierarchical grid to tomorrow’s ubiquitous decentralized grid. Think of the Smart Grid as a bundle of technology enabled new functionalities that will transform the entire energy value chain—a necessary transformation because the current grid simply cannot cope with the shift toward renewable and decentralized power generation.
In the past, power generation was predictable and hence had a stabilizing role in the network. Coal and nuclear power typically were relied upon for baseline power, and quick-firing natural gas stations to meet peaks in demand. With large-scale wind and solar installations now beginning to make a significant impact on total power supply, this straightforward model won’t cope anymore. Backup power generation and storage installations need to be built, national grids need to be interconnected, and we generally need to get a lot ‘smarter’ in the way we forecast and manage demand instead of simply managing supply as we did in the past.
Power supply hasn’t just become more unpredictable; it is also becoming more decentralized as homes and businesses start generating power locally, at present from solar and biomass but in the near future also from small wind turbines and combined heat & power (CHP) installations. That power is being injected into the distribution grid, which wasn’t designed for such complex “two-way traffic”.
Simultaneously to these structural shifts in energy supply, many countries have begun opening up their energy markets and unbundling the vertically integrated terrain of the traditional State-owned utility into separated generation, transmission, distribution, metering and retailing activities.
The energy value chain under pressure
The impact of these changes is being felt across the entire energy value chain. At the level of power generation we’re seeing a shift from a highly concentrated market dominated by large fossil fuel-based power producers toward a much more diverse and complex market, both in terms of power sources and the size of the providers and installations. To deal with the resulting complexity and unpredictability of supply, transmission and distribution networks need to move beyond their oneway ‘dumb cabling’ function toward the real-time management of complex electricity flows. Retail, which used to be dominated by vertically integrated quasi monopolies, is now increasingly competitive as regulators open up markets and disintegrate value chains. Finally, energy users will need to wean themselves off low energy prices.
The Smart Grid is essentially a collection of innovative new functionalities that will help optimize the energy system and give stakeholders the tools to address their specific challenges. Energy producers will be able to optimize their increasingly diversified generation assets to improve ROI. Network operators will automate the grid through real time monitoring, substation automation and condition-based preventive maintenance. Retailers will be able to offer variable tariffs that reflect changes in demand and supply in real-time. And energyproducing consumers (‘pro-sumers’) will be able to balance their own consumption and production more intelligently, on an automated basis, to reduce their energy costs and even earn additional revenues.
The perfect VC theme
The Smart Grid may be an exciting story from a technical and energy perspective but is it relevant to venture capitalists and innovative entrepreneurs? At Gimv we think so. In fact, the Smart Grid has many attributes of the perfect VC theme. For one, there are big numbers: millions of smart meters are to be rolled out to households and businesses. Secondly, huge investment programs in electricity grid infrastructure are being launched around the world. It is estimated, for example, that €6-13 billion will be spent in Germany alone, probably on the higher end given their recent decision to quit nuclear power. Thirdly, the Smart Grid is concerned with ICT innovation and the power of data, which on both accounts is familiar territory for VCs. Fourthly, entirely new business models will emerge where small can be beautiful – meaning that capital efficient solutions can unlock large value. The sector won’t be dominated by pure infrastructure players anymore; new entrants will emerge that offer highly specialized services in the value chain. Finally, and crucially for VCs, there are potent buyers out there such as utilities looking to secure their business and telcos who are keen to enter the fray, thus offering exit opportunities for early stage risk investors. As it stands, the energy market has already changed pretty fundamentally with some shining startups currently defining the market alongside blue chips.
Powerful regulator drives investment
The Smart Grid will happen, undoubtedly so, but exactly how this will all pan out from an investor’s or entrepreneur’s perspective will depend not only on technological drivers but also on regulation. For one, regulation is an important driver of the market; it sets ambitious goals such as the EU objective that 80% of all meters should be smart by 2020, and via the unbundling of the value chain it has created more competition and enabled the creation of new business models.
However, regulation could also stifle investment if it prevents specific stakeholders from reaping rewards on their investments. Conversely, it could create a tremendous dynamic if it enforces investment in the underlying network infrastructure and lets many of the gains be reaped by providers of new value added services, not unlike successful internet companies such as Google and Facebook are reaping rewards made possible by investment in fiber optic networks.
Why invest in the Smart Grid
All stakeholders in the energy system have pains that are unsolved by the current grid management. The good news is that new Smart Grid services can address these pains. In our view the main value propositions for the key stakeholders in the value chain can be described as in diagram 1. The X-axis represents the stakeholders in the market while the Y-axis represents the technology and service layers in the value chain, from data generation, to data collection, data communication, data analysis, leading on to professional services and consumer applications and services. The main opportunities for new services, outlined in diagram 1 (e.g. virtual power plants, demand response, energy storage, etc), can in turn be plotted on a hype curve for estimating the timing of their deployment (diagram 2). For example, we don’t expect home energy management solutions to make much of an impact in the short term because the drivers for such investment aren’t particularly strong yet. For one, it is not yet clear who will finance the technology – investment in smart meters and additional hardware in the home is required - and how the investment would then be monetized. Also, if consumers are to pay for this technology they’ll expect a decent return, but that isn’t possible yet with today’s energy prices and the lack of intra-day variability in those prices(which home energy management systems could exploit).
Three priority investment areas
At Gimv we’re keeping an eye on the entire spectrum of Smart Grid related opportunities but there are at least three areas where we’re proactively looking for near term investment opportunities.
Demand-response solutions for large energy users and grid managers.
These types of solutions address grid instability by managing demand at large industrial users, as opposed to managing supply. During moments of peak demand, participants in a demand response scheme react by temporarily reducing or deferring their energy consumption. The solution itself is typically offered by third-party specialists such as Enernoc in the U.S. These types of solutions show a lot of promise in the current market because both grid operators and industrial users have a strong incentive to invest. Grid stabilization is an increasingly pressing challenge for grid operators and industrial users can expect significant extra revenues from the grid operator. Furthermore, it is a proven business model in the U.S. but has yet to take off in Europe. And there is still plenty of opportunity for technology innovation to automate and speed up demand management.
Solutions for local generation.
These solutions enable optimized consumption of locally generated electricity. An increasing number of consumers and businesses are investing in their own power generation infrastructure, typically photovoltaic panels, CHP, biomass and small windmills. However, in most cases the electricity generated in this way is simply fed into the national grid even though it would often make more sense to consume the energy locally—either at the level of a household or business or as a local community. However, this is only possible if the local supply and demand can be matched intelligently. Beyond the financial gain, buyers of this technology are also gaining more independence from the grid and hence utilities.
Solutions for energy storage.
There is no way that demand-side solutions alone will be enough to cope with the intermittent energy supply of tomorrow. Energy storage solutions will be needed and lots of them too. In fact, the amount of storage needed will be so massive that probably no single technology will be able to meet demand. Some storage solutions are reliant on specific geographic features (e.g. hydroelectric, underground compressed air) while other technologies, such as batteries, are too reliant on scarce materials. Unavoidably we will need to rely on a mix of technologies. As a result, there should be tremendous opportunity for innovation in this area, with enough room for a variety of different off erings and technologies. The challenge will be to build viable business models because current solutions have difficulty competing based purely on standard electricity prices. At Gimv we believe that succesful storage ventures with diff erentiated technology will provide application specific benefits, a path followed by our portfolio company McPhy.
A great oppurtunity for new entrants ands startups
We have argued that the electricity value chain is undergoing a paradigm shift. It is an inevitable shift driven by deep and necessary changes in our energy system. Intermittent renewable energy production, decentralized energy production and deregulation are reshuffling the deck, while new technologies are enabling a myriad of new functionalities to manage the new challenges.
All this places tremendous pressure on utilities while opening up space for new entrants such as telcos, internet companies and independent technology startups. Unlike utilities, these new entrants are unencumbered by potential conflicts of interest (will people trust their utility to help them reduce energy consumption?). Often they already have strong customer relationships and connections into the home, both network connections and billing connections. Many are familiar with subscription-based business models that rely on subsidized hardware. And crucially, many already run data-driven business models. Indeed, the opportunities for new entrants, both large and small, are tremendous. Utilities will rapidly need to bring in new competencies if they are to retain their dominant position in the market. Ultimately, however, it is the regulator who will play a pivotal role because it is via regulation that drivers for investment will be created—or stifled. Traditionally, the energy sector’s primary business objective was the reliable and secure supply of energy. Today we are trying to bring in functionalities from the consumer internet world, where plenty of bugs and beta testing by end customers are the norm. The challenge for regulators is to create conditions where a reliable supply of electricity is maintained, while simultaneously opening up room for innovation and experimentation.
