Innovation and the energy sector

The last few weeks for me seem to have been focused on innovation.  First I spent a day in Paris with the EDF Pulse awards team pitching to a jury chaired by Henri Proglio chairman of EDF and more exciting for me, Claudie Haigneré, the first French woman in space.  (She visited the Russian Mir space station in 1991 and became the first European woman to visit the International Space Station in 2001.  Having met astronauts and cosmonauts but never a French spationaut chatting to Mme. Haigneré was a great bonus on an interesting day.)  However – back to energy matters.  EDF Pulse is a global innovation award started last year as part of EDF’s open innovation programme and the team of eight “sensors”, of which I am one, gathered more than 90 early stage companies with technologies in home, health and a mobility into the competition.  The finalists in each category will go forward to a public vote and the winners will be announced in April.  After the EDF Pulse day I spent a day teaching a module on innovation and financing at the Westminster Energy forum course for new graduates in the energy industry.  Then RBS asked me to join the panel and attend two events to launch their Innovation Gateway, an innovative programme designed to bring new innovations that can improve resource efficiency into RBS’s 2,500 building portfolio.

All this led me to summarise a few thoughts on innovation and the process of technical change, specifically in the energy world.  This isn’t designed to be a definitive article on innovation in the energy industry but rather a collection of observations that are often forgotten or discounted.

We need to start by saying that innovation is a greatly misused word.  Strictly speaking it means the first commercial use of a technology but in every day use it is often used to mean the process of change and the massive differences between a concept, a prototype, a pilot plant, a first commercial plant and a standard off the shelf, well proven piece of technology are forgotten or confused.  A glossy presentation or a graphic showing “a new technology” is not an innovation (and probably not even a technology) – it is a concept, possibly a great concept that will change the world and possibly a concept with no hope of ever making it into reality.  A small-scale prototype plant is just that, it isn’t a proven technology that can be rolled-out globally and change the world.  In reviewing a “new technology” or “innovation” always remember the hype cycle. We should also not forget that process innovations and business model innovations can be just as important, if not more important, than shiny new pieces of technology – however seductive they are.

Making innovation happen, whatever the sector, is inherently difficult. New ideas and concepts abound but only a small percentage of ideas ever make it into reality and have any significant effect on the world. This is because turning an idea into reality or bringing about change, the role of the entrepreneur, is fundamentally difficult.  As Machiavelli said in a famous quote; “There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things.”  Making effective and persistent change happen requires human energy and determination, a thick skin, a range of technical, financial and managerial skills, availability of finance, good timing and a lot of luck.

Innovation in the energy system is harder than other sectors for a range of reasons.  Firstly of course energy is a massive industry, global energy sales are $6 trillion per annum and account for 7% of global GDP.  Global investment in energy is about $1.2 trillion.  Even a small energy investment in the energy sector is usually big compared to other sectors.  The rate of capital replacement is slow, energy system assets tend to last a time, typically twenty five years plus – there are plenty of power stations out there which are forty years old or more.  A 2008 survey of 500 electricity industry professionals in the USA referenced by the NorthWestern Energy Stakeholders Group  reported that more than half of electricity distribution assets are at or beyond their intended life.  The Black & Veatch 2012 Strategic Directions in the US Electric Utility Industry survey reports that aging infrastructure remains a major concern for US utility managers.  The US Department of Energy reports that the average large-power transformer in the USA is now more than 40 years old.    Another important factor is that the application of industrial energy has significant health and safety risks, it can and does kill people.  This goes some way to explaining conservatism in the industry.  Next, the energy industry is heavily regulated and in all countries there are strong links between energy supply and politics.  (I wrote about the link between electrical power and political power here.  These and other factors make change in the energy industry even more difficult than in other sectors.

Despite these difficulties of course the energy industry has always innovated.  In electricity we moved from Faraday’s first primitive generator in 1831,  (if you haven’t seen it go straight to the Royal Institution in London and see it along with Faraday’s original lab – one of the best free exhibitions in London), through the world’s first public electricity supply in Godalming in 1881 (powered by water wheels), to Edison’s first steam powered power station in Holborn in 1882, (note this was several months ahead of the more famous Pearl Street power station in New York), to the London Power Company’s “super power station”, the 400 MW Battersea Power Station A in 1934 which included Europe’s largest generator set of 105 MW, through to Drax in 1974 with a 660 MW generating set.  In fuel we have moved from burning wood to coal to oil and then to gas, with each transition reducing carbon intensity.  The first commercial oil well was drilled in 1859 in Titusville to a depth of 69 feet and now we have remote, steerable wells drilling under the ocean floor for more than ten kilometres horizontally at a depth of more than twelve kilometres.  After the first oil crisis in 1973/74 the energy industry establishment believed that there was a shortage of natural gas in the United States and persuaded the US Congress to pass laws stopping use of gas for power generation.  Now on the back of the shale gas revolution led by entrepreneurs who, if they got any attention at all were originally considered crazy by the energy establishment, the US is heading towards exporting natural gas.

Although it is tempting to think that they had it easy we should remember that Edison and the other energy pioneers also had to raise capital to develop and deploy new technologies and had their own difficulties raising money.  The sophistication of financial models and techniques may have changed dramatically but the basic truth that the inventor or developer usually has to persuade someone else to invest in their company or project remains the same – and the fundamental risks are similar.

Venture capitalists (VCs) often talk about the valley of death for early stage companies, the period between the initial funding round and generating revenues.  In energy technology investing there are really two valleys of death.  The first is between moving from research to pilot plant and the second is between successful demonstration of a pilot plant (assuming this is actually achieved) and mass roll-out.  A lot of research projects are measured in the millions of dollars, pilot plants in the tens of millions (sometimes hundreds of millions), and roll-out is measured in hundreds of millions and billions.  Many of the venture capitalists moving from the software/IT world into energy technology development did not appreciate the difficulties, as well as timescales and expense, involved in even demonstrating a successful pilot plant.  In some cases they also forgot that utilities don’t buy mission critical equipment from small VC backed companies, they buy from the likes of GE, Siemens, ABB and Kawasaki Heavy Industries who have decades of experience in the energy sector and very large balance sheets which can guarantee performance.

Just to illustrate how hard bringing innovation is to commercialise consider the AiM market of the London Stock Exchange.  AiM was created to support growing companies and became the darling of clean tech and new energy companies.  In the period 2004 to 2007 there was a flurry of activity, a bubble really, of such companies coming to the market and raising money and at one point the highest value company on AiM was a wind turbine company.  Analysis by Adam Forsyth of Arden Partners shows that as of September 2013, of the 75 new energy and clean tech companies that came to AiM only 11 made their investors more than 20% (since their IPO), 4 made between 0 and 10%, and 60 have lost money.  12 of the companies lost 100% of the money invested and 42 have lost more than 50% of the original investment.  This means that if you had spread your portfolio and put £1,000 into each new energy and clean tech IPO on AiM by September 2013 you would have lost £38,500 so your £75,000 would have been turned into £36,500 – not a good outcome.  Of course if you had put your £75,000 into the top performing company you would have made £146,000.  Technical change and innovation comes at a real cost to investors!  The progression of the AiM market (and all other markets were the same) for new energy and clean tech exhibits all the signs of a classic investment bubble and demonstrates the hype cycle in action.

While I was with EDF I was reminded that in January EDF issued 100 year bonds with a 6% coupon and that the proposed reactor at Hinkley Point is designed to have a 65 year lifetime.  Just think how much even the conservative energy world has changed in 100 years.  Any energy executive in 1914, no doubt thinking that the “safe” Edwardian world would continue pretty much as it was, lived in an energy system dominated by coal and by gas lighting.  The Royal Navy had experimented with burning oil from 1903 (with the first tests failing miserably) and at the behest of First Lord of the Admiralty Winston Churchill was building the new Queen Elizabeth class dreadnoughts powered by oil, although most of the fleet remained coal fired.  The British government established Anglo Persian Oil (the forerunner of BP) in 1914 in order to exploit newly discovered oil in Persia and fuel the Royal Navy.  Although the Wright brothers had first demonstrated controllable flight in 1903 the aeroplane was still a new and exciting technology, Bleriot had only accomplished the first flight across the English Channel in 1909 and in 1914 the world’s first commercial airline, the St. Petersburg-Tampa Airboat Line, was launched in Florida with one fare paying customer.  Now 8 million people fly commercially every day.  Although radioactivity had been discovered at the end of the 1800s (Mme. Curie received the Nobel Prize in 1903) it was still widely regarded as a curiosity with little or no application.  It wasn’t until the late 1930s that the idea of using nuclear energy to generate electricity was proposed.  In 1913 UK coal production peaked at 300 million tonnes with the coal industry employing 1 million men.  In 2013 the UK produced 16 million tonnes (and used 64 million tonnes) and employed about 6,000 people.  In 1914 gas lighting accounted for about 90% of all lighting systems.  Telephones were still reserved for the rich and it was not until 1915 that the first transcontinental telephone call was made in the US.  This year we are going to see the number of active mobile phones, at 7.3 billion, exceed the human population.  On the road Henry Ford launched the Model T, the car that brought motoring to the masses, in 1908 but its effect was only just starting by 1914 and motoring was still largely reserved for the rich.  In 1909 143,000 private vehicles (53,000 cars) were registered in the UK, compared to 34.5 million private vehicles (28.7 m cars) today – of which 1.4 million were Ford Focus and 1.3 million Ford Fiestas.

Whatever your views on the direction of progress and economic development, or on specific technologies, the last 100 years of innovation really is amazing.  It was of course driven by “cheap” fossil fuels, mainly coal and then oil – as well as two world wars.  The next hundred years may be defined by greatly improving resource efficiency by focusing on end-use rather than energy supply, the deployment of “smart” technology into dumb systems, and possibly the supply of unconventional gas and truly cost-effective renewables using technologies that are not commercial yet (and I don’t mean silicon based PV or wind turbines). The only certainty about the energy system of 2114 is that it won’t look like that of today.

To finish, some quotes on innovation that are worth remembering.

“Drill for oil? You mean drill into the ground to try and find oil? You’re crazy.”

Workers whom Edwin L. Drake tried to enlist to his project to drill for oil in 1859.

“Electric lighting is a completely idiotic idea”

Chief Engineer, Post Office, 1881

“The substitution of oil for coal is impossible, because oil does not exist in this world in sufficient quantities.”

Lord Selbourne, First Lord of the Admiralty, 1904

“Any sufficiently advanced technology is indistinguishable from magic.”

Arthur C. Clarke, science-fiction and science writer

“We over-estimate what we can achieve in the short-term and under-estimate what we can achieve in the long-term.”

Arthur C. Clarke

“For a successful technology, reality must take precedence over public relations, for Nature cannot be fooled.”

Richard Feynman, Nobel Prize winning physicist

“..as we know, there are known knowns; there are things we know that we know. There are known unknowns; that is to say, there are things that we now know we don’t know. But there are also unknown unknowns – there are things we do not know we don’t know.”

Donald Rumsfield, US Secretary of Defense