European Energy Sector: how to foster innovation?
Earlier this year I was pleased to participate to the course European Energy Transition – Actors, Factors, Sectors, brilliantly hosted by the Florence School of Regulation and led by Susanne Nies.
by* Nuno Fernandes PedroMBA | Service Development | Regulation | Energy Transition | Power Systems
The course covered the key topics of the energy transition in Europe: the objectives of the European energy policy and its main stakeholders, with a focus on the EU climate policy as a driver of change; the active participation of consumers in the future of energy that will be key within the energy transition; the responsibilities of all stakeholders in ensuring the security of supply while ensuring flexibility of the electricity network; the effective development of electricity markets in Europe; and finally an interesting benchmarking with regions outside Europe.
Innovation will be a critical factor of the energy transition. I will transcribe hereby the article “Overview of Innovation in the European Energy Sector”, a coursework that I wrote with Janus de Bondt, Pedro Torres and Percy Chisanga. The article starts with an overview of the current efforts of the EU and European energy companies on innovation, evolving onto a view on how to incentivize innovation by network operators and it terminates with a proposal for appropriate tools to foster innovation in the energy sector.
1 INTRODUCTION – OVERVIEW OF INNOVATION IN THE EUROPEAN ENERGY SECTOR
It is commonly accepted that for the EU to achieve its energy decarbonization targets, deep and transformative innovation will be needed[1]. Through the ratification of the Paris Agreement, all countries, EU Member States, essentially committed that in around 30 years all Carbon Dioxide (CO2) emitted should be captured. This ambition was reaffirmed at the end of 2019 through the European Green Deal, which also recognised “Mobilising research and fostering innovation” as a key element[2].
1.1 IS EUROPE DOING ENOUGH?
For the period 2014-2020, European innovation support was governed (amongst others) through the Horizon 2020 Research and Innovation programme, implementing the Europe 2020 Flagship Initiative Innovation Union adopted in 2010[3] (goal is to spend 3% of GDP on innovation, no specific targets per sector). Of the total Horizon 2020 budget, approximately 7.7%[4] was budgeted to “Secure, clean and efficient energy” innovation initiatives. This is significantly less than for example the budget foreseen for “Leadership in enabling and industrial technologies” (17.6% of the total Horizon 2020 budget).
In its 2019 World Energy Investment publication, the International Energy Agency estimated the 2018 government spending on energy-related R&D in Europe to be lower than that in both China and the United States in absolute terms. When comparing the government R&D expenditure on energy with the national GDP the same conclusion can be drawn, placing Europe even behind the average of all major economies. Given the high European ambition, it seems European spending on R&D and innovation might not be sufficient at this moment.
Given the high European ambition, it seems European spending on R&D and innovation might not be sufficient at this moment.
The predecessor of the Horizon 2020 initiative was the Seventh Framework Programme for Research and Technological Development, covering the 2007-2013 period. Within its biggest pillar called “Cooperation”, approximately 7.1% of the total budget was foreseen for energy innovation[5]. The recognition of the necessity for innovation in the energy sector has significantly increased in the past decade. However, the increase in innovation support between both initiatives seems rather limited. Currently, no specific budget is known for energy innovation in the Horizon 2020 successor which is called Horizon Europe. However, it is expected that at least 35% of its budget will be allocated to climate action[6]; as this rule was already present in the Horizon 2020 budget as well, it does not seem like an acceleration of energy-related innovation support is planned.
1.2 ARE EUROPEAN ENERGY COMPANIES DOING ENOUGH?
Estimating objectively how much private companies have invested in innovation is very difficult due to the lack of data. With the support of the European Commission, an attempt to quantify such investment was made using patent data in 2019, estimating the R&D spending on climate change mitigation technologies at around €250bn for the period 2003-2014[7], or about €23bn per year. We could compare this to the approximately €330m per year which was spent by the Seventh Framework Programme for Research and Technological Development (which ran approximately in the same period) on energy-related innovation. Based on these numbers, one could argue that European energy companies are doing enough. However, due to the unavailability of good data, making a solid conclusion on this point seems difficult.
2 HOW TO REALIGN THE CURRENT EU REGULATORY MODELS IN ORDER TO INCENTIVISE INNOVATION FROM NETWORK OPERATORS?
Electricity, as well as gas, are network-based energy vectors, meaning transmission and distribution networks play a central role in the energy transition process: network investments are crucial for integrating European electricity and gas markets, a growing share of renewables, storage and P2X technologies, ensuring reliability, quality of service, technical and economic efficiency.
Because transmission and distribution systems are natural monopolies[8], regulation is required to achieve socially desirable outcomes – indeed, without regulatory intervention, operators (TSOs and DSOs) might not be fully encouraged to decrease their costs to an efficient level, deliver high standards of public service, promote energy efficiency or ensure a non-discriminatory access to the network.
Traditionally, the regulation of TSOs and DSOs has mostly addressed the short-term efficiency of the networks. However, and although the fundamental targets of regulation remain very important (e.g. level-playing field, cost efficiency, quality of service, financial viability, security of supply), the evolutionary role of network operators in a context of structural changes affecting the market and the infrastructures – such as decarbonisation[9] and digitalisation[10] –, may trigger the development of new regulatory solutions[11].
It seems already undisputable that regulation must adapt so to properly accommodate relatively new dimensions like sustainability, energy efficiency, whole system approaches, secure data management and customer privacy or innovation. In short, regulation for liberalisation was concerned with incremental capacity additions and with the efficient use of the existing infrastructure, whereas regulation for the energy transition shall be more concerned with infrastructure transformation and disruptive innovation[12]. Specifically, with regards to innovation, and once increasingly innovative solutions from network operators are needed to enable the energy transition, NRAs must focus on promoting a regulatory environment that removes barriers to the pursuit of those solutions – whenever they may create more value for money for customers and the system overall – without foreclosing competition.
NRAs must focus on promoting a regulatory environment that removes barriers to the pursuit of [innovative] solutions without foreclosing competition
The question arising is how to encourage innovation in network development and operation. Particularly considering the starting point:
- According to the EU R&D Scoreboard, energy utilities are much less innovative (e.g. lower R&D intensity), on average, than other companies (namely the ones that perform their activity in competitive environments).
- There are significant differences between transmission and distribution networks across EU and those differences, together with distinct environments (e.g. penetration of renewables), justify the existence of a wide range of regulatory models in place.
- Investments in electricity and gas infrastructures are often long-lived and irreversible, being important to avoid technological deadlocks and stranded assets for the operators (i.e., the customers).
- As smart grid technologies reduce the need for physical investments, and given the regulatory models in place, that means lower network operators’ financial return, creating a disincentive to innovative investment for TSOs and DSOs.
- Regulation must allow for innovation without disrupting the status quo.
Whilst market wide changes to regulation (and legislation) are necessary to set up predictable and stable long run outcome frameworks, these changes cannot move as fast as innovation does. That is why, in addition to direct public funding and/or remuneration regulatory support mechanisms[13] (whereas input[14], output[15] or mix based), and since much of the required innovation will for sure take the form of setting up new market roles and business models, regulators should proactively create conditions for network operators to experiment in untapped ground – the so-called regulatory experimentation.
Indeed, small-scale derogations from existing rules (temporarily and/or locally overriding the prevailing regulation) may contribute to a more responsive and dynamic regulation to allow for innovation. Several Member States already adopted or are adopting mechanisms such as exemptions, pilot projects[16] or, more recently, regulatory sandboxes to address it. Moreover, ACER suggested the provision of an “EU umbrella” for these mechanisms and the sharing of the resulting lessons between regulators in order to avoid replicating the pilots in each MS and to accelerate decisions on whether regulation (or legislation) needs to be adapted.
In conclusion, innovation is increasingly a crucial and widespread condition/enabler to achieve regulatory targets and accordingly incentives for innovation (which can be delivered both indirectly[17] and directly[18]) are a means to reach those targets. Moreover, despite the absence of unique solutions in terms of regulatory approaches, the regulatory framework shall promote (not impose) innovative approaches from network operators, giving them the freedom to choose how to meet the outputs through the most efficient investment (smart vs. not so smart), which means keeping regulation as neutral and unbiased as possible.
3 APPROPRIATE TOOLS FOR FOSTERING INNOVATION IN THE ENERGY SECTOR
As demonstrated above, it is essential that regulation and energy policy consider innovation as a key factor to achieve environmental, energy and climate targets and enable the energy transition. Amongst the actors that will play a major role in the energy transition, we will focus on utilities, start-ups and consumers. As mentioned before, the implementation of successful policies should not disrupt the status quo and it shall enable a smooth energy transition.
Energy utilities are much less innovative companies than the average (EU R&D Scoreboard). In other industries, large companies such as 3M set revenue targets based on innovative products and services and promote intrapreneurship with their employees. Energy utilities can enable frameworks and work environments that encourage initiative and creativity. The time given to their employees to design and develop new ideas could be considered in fiscal benefits for the company and employees alike. Connected with educational and thought leadership, those initiatives could have a significant impact on both sales and reputation near consumers.
There are now more start-ups than ever in the European energy sector. Although, the creation and scaling up of new ventures in Europe must be incentivised through better funding. We will focus on two major gaps: (i) lack of capital markets to support start-ups scaling up in early stages and (ii) the sustainability of start-ups in later stages. In 2015, investment in early and seed stages were nine times higher in US than in Europe and investments in later-stage ventures were 20 times higher in the US[19]. This means that the European start-ups, even after the first stages of development, lose “momentum” and the opportunity for exploring innovation further. Asian economies are also playing a major role in innovation, mainly in digitalisation. Adds to this that Brexit may have a significant impact on the EU startup scene, as the funding deals in the UK represented 40% of the total European funding in 2019. This results in two risks: despite its academic excellence, may Europe lose its core entrepreneurs to other markets? And do European start-ups attract investors?
Brexit may have a significant impact on the EU startup scene, as the funding deals in the UK represented 40% of the total European funding in 2019
There is encouraging news. In 2019, European start-ups raised a total of €32bn, a historical high[20]. The European Commission created the Entrepreneurship Act 2020 (The principle of “think small first” must become the cornerstone of European and national policies) and it just published a new strategy to promote small and medium enterprises (SME) on their role in enabling a greener European economy, based on three pillars: sustainability and digitalisation, reducing regulatory burden/improve market access and improve access to financing. But will these initiatives have a decisive impact on the energy business? We have identified potential improvements for start-ups in the European context (not energy sector specific), where the future trends are still under definition. Firstly, the use of blended finance brings clear benefits to sectors under significant change and thus with a degree of future uncertainty ([21]). This is already used to mitigate risks on large-scale investment in developing regions and it can attract private capital, raise investors’ awareness of disruptive technologies and mitigate the risk of investment losses compared to subsidies and grants. Innovative companies need to trial and test their new products from early stages, and this type of financing grants more opportunities for pilot projects. After the COVID-19 crisis, there is momentum for reshaping the economy via clean energy investments in solutions that will bring returns in the medium term. Secondly, regulation and energy policy could improve with the early participation of SMEs whose businesses are aligned with climate goals. This would sustain the business development strategies and financing options for SMEs.
The energy transition cannot progress without a mass adherence by consumers. Although, electricity lacks differentiating factors when compared with other products: price still plays the major role in consumers decisions. The behavioural change needs to be enabled by technological and market options which provide consumers with cost effective energy and products and services. A holistic approach is needed to implement synergies between the implementation of new technologies with an effective evolution in consumer behaviours.
In conclusion, we conceive five major tools to foster innovation:
- Incentivise utilities to promote innovation via fiscal benefits
- Promote a blended finance for startups and inclusive public-private partnerships for innovation funding
- Give innovation a voice in regulation
- Market access for decentralised resources and service provision
- Promote educational initiatives and thought leadership to enable behavioural change in consumers.
The 3 main drivers of innovation in the energy transition are digitalisation, decentralisation and decarbonisation. The end to end digitalisation of the value chain will facilitate the implementation of a “system of systems” that enable both decentralisation and decarbonisation. Priority shall be given to smart technologies with a significant impact in the short term and that provide sustainability for new technological solutions in the long term. For instance, implementing systems that increase network capacity such as SmartValve and systems that enable connection of more renewable energy sources by addressing technical risks such as per the objective of the HVDC Inertia provision project at Statnett. Also, systems that enable demand flexibility which ultimately address balancing issues resulting from the intermittency of renewable energy sources.
Although Digitalisation comes with risks such as cybersecurity, privacy and economic disruption (new jobs and skills needed), it ultimately paves the way for the empowerment of consumers and prosumers through democratisation, resulting in the implementation of a holistic strategy for the energy transition: technological, regulatory, policy and market evolutions shall be coordinated.
Notes and References
[1] Thomas Pellerin-Carlin (2019), Link to document
[2] The Green Deal, COM/2019/640
[3] Communication on the Europe 2020 Flagship Initiative Innovation Union, COM/2010/0546
[4] Additionally, 8.23% of the total Horizon 2020 was foreseen for “Smart, green and integrated transport”.
[5] European Commision Research DG (2017), press communication on F7
[6] Frédéric Simon (Euractiv, 2019), Link to article
[7] Francesco Pasimeni, Alessandro Fiorini, Aliki Georgakaki (2019) ‘Assessing private R&D spending in Europe for climate change mitigation technologies via patent data’, World Patent Information, 59(December 2019)
[8] Generally speaking, natural monopolies are characterized by steeply declining long-run average and marginal-cost curves such that there is room for only one firm to fully exploit available economies of scale and supply the market (OECD Glossary).
[9] Achieving decarbonisation requires additional investments in utility-scale renewables (wind, solar), transmission and energy storage capacity and electrification of transportation and buildings.
[10] Digitalisation enables decarbonisation and decentralization by utilizing data and analytics to enable the operation of transmission grids with high penetrations of renewable energy and by enabling higher hosting capacity for DERs on distribution networks while supporting the development of transactive / flexibility energy markets.
[11] As the EC itself recognizes in the Clean Energy for All Europeans Package. Regarding the uptake of innovative technologies, further improvements are necessary at the transmission and distribution level (Conclusions of the 2019 Energy Infrastructure Forum)
[13] Such mechanisms should include direct incentives for operational expenditures (the rollout of innovative technologies has a higher share of OPEX than capital expenditure – smart vs. copper).
[14] E.g., in Portugal an incentive mechanism encourages innovative investment through higher allowed revenues for those costs.
[15] E.g., in Portugal an incentive mechanism for LV DSOs is in place to foster smart grid integration of household customers.
[16] E.g., in Portugal, a pilot project is underway testing the participation of demand (DSR) in the regulation reserve market (installations > 1 MW).
[17] Meaning providing incentives on the underlying targets provides incentives for innovation.
[18] Meaning explicitly incentivise innovation, namely through incentive mechanisms.
[19] Iliyana Tsanova, European Fund for Strategic Invesment (2019), Link to article
[20] Gené Teare, Sophia Kunthara (2020, Crunchbase), Link to article
[21] Blended finance is the use of catalytic capital from public or philanthropic sources to increase private sector investment in sustainable development.
[22] Nies, Susanne, The European Energy Transition: Agenda for the Twenties, 2nd Edition, Claeys & Casteels, 2020
*The Authors
Nuno Fernandes Pedro is an enthusiast in energy transition and Service Manager at Coreso SA. Nuno leads the development of the Coordinated Security Analysis service and the strategic partnership with TSCNET. He holds an EMBA degree and a MSc in Electrical Engineering.
Janus De Bondt is a Power Systems Consultant at Elia Grid International (EGI), where he is part of the System Development practice. His main topics experience are long-term scenario planning, generation adequacy analysis and electricity system development studies. He holds a BSc in Computer Science and Electrical Engineering and MSc in Mathematical engineering.
Pedro Torres is an energy expert at the Energy Services Regulatory Authority (ERSE) where he works mainly on markets and consumers’ related topics, such as markets supervision, renewables and self-consumption, network connections, metering (incl. smart), smart grids and electric mobility. He holds a BS degree in Power Systems Engineering and a MS degree in Engineering Policy and Management of Technology, both from the University of Lisbon. Contact: ptorres@erse.pt
Percy Chisanga is Chief Engineer at ZESCO, Zambia’s largest power company.
