How should we prepare for the future of energy?

As the global energy landscape undergoes massive transformations, it should look to Germany’s Energiewende, or energy market transition, to provide a secure, sustainable and affordable energy supply for everyone.

We need to acknowledge that electricity supply is one of the biggest global challenges, especially for a world growing at an extremely fast pace. While emerging countries are in dire need of electrification and modernization of electricity supply, markets in mature economies struggle to transform their energy landscape into a more sustainable and efficient system.

According to the US Energy Information Administration, global electricity consumption will increase by 93% between 2010 and 2040. To meet this growing electricity demand, an estimated US$ 17 trillion of investments are needed in electricity supply infrastructure in the next 20 years (IEA World Energy Outlook 2013).

Stable industries, those with reasonably predictable demand and low volatility, offer investors certainty and reduced business and financial risk. Consequently, investors require lower expected returns. The utilities sector has traditionally been one of these stable industries, and has benefitted in the past from a relatively low cost of capital.

The stability of the utilities sector comes from the investors’ belief in a regulatory model that grants investors the opportunity to earn a fair return on their investment. However, the recent emergence of a number of disruptive challenges –  such as skyrocketing subsidies for renewable energies apart from market mechanisms or the need for smart technologies in the grid to integrate volatile renewable electricity production – are radically testing this model. The rapid pace of development and adoption of new technologies, along with regulatory, social and economic factors, are having a deep impact on the traditional business model of utilities.

As the pace of change accelerates, both the investment profile of utilities and the types of investors who invest in electricity infrastructure will evolve. The regulatory model will also have to adapt to the emerging electricity landscape. A deterioration of the credit rating quality of utilities will result in higher costs of capital, limiting their capacity to attract investments.

Yet regulation has not caught up with the changing dynamics and needs to be refreshed. Given the long-term investment cycles and the need for long-term planning, regulators need to provide a long-term stable policy framework in a sector that is rapidly evolving under a situation of uncertainty. The changing dynamics of the electricity sector mean investors in electricity infrastructure remain wary of the future. Predictable regulation can help to decrease this policy risk and, therefore, the cost of capital, as well as increase investor money flowing to the sector. On the contrary, unforeseen or poorly justified regulatory changes can lead to investor scepticism, increase costs and deter new investments.

There is enough capital available globally for meeting the energy investment challenge. To use it efficiently, it is crucial to assign the right tasks for the right players. The financial market is best placed for providing capital and making it available. But with new technologies, there is always a market risk – and utilities are well placed to manage this. Market signals are crucial to distribute the risks to those players best suited to manage them.

To reach the goal of a secure, affordable and sustainable electricity supply, regulators need to keep up with the rapidly changing energy landscape and provide stable long-term frameworks in which functioning markets can allocate the financial resources to the most efficient technologies and projects. Then, the electricity sector will become an attractive field for investments, underpinning the much-needed Energiewende.

Author: Peter Terium is Chief Executive Officer of RWE and Co-Chair of the World Economic Forum’s Governors Meeting for the Electricity System.

Image: Lightning strikes over a pier in Haifa, Israel, 25 October 25 2012. REUTERS/Baz Ratner.