Thinking the Unthinkable: Strategy Options for an Age of Disruption in the Energy Industry

October 19, 2015 | 00:00
The Oil & Gas industry has been remarkably stable throughout its 150 or so years of existence. While the technologies applied to finding, developing and processing the products that are the core of the industry have indeed changed substantially, the core products themselves have never been seriously challenged by outsiders, by new solutions for humanity’s energy need. Coal, crude oil and natural gas have remained king, today providing 82% of the world’s energy needs.

Since the global business environment is changing ever faster, as evidenced by the fact that the average lifespan of companies is shortening, there is a lot of discussion about how much longer this status quo in the energy industry will remain. Much less discussed, however, is the question what Oil & Gas companies can do strategically to ensure they remain successful, even if disruption were to hit.

Extrapolations of the present don’t prepare for the future

When comparing the publicly available energy outlooks, what really stands out are the similarities between them. The most recent outlooks of the International Energy Agency, ExxonMobil and BP all foresee continued global economic growth in the range of 3 – 4% annually, the majority of which coming from Asia. All three also foresee energy demand to increase in response, again mostly coming from Asia, but not in a linear manner due to reductions in overall energy intensity. The IEA forecasts a 37% increase in total energy demand by 2040, ExxonMobil forecasts an increase of 35% for the same period, while BP sees the IEA’s 37% increase in energy demand occurring by 2035. Again all three foresee fossil fuels making up the bulk of the necessary increase in energy supply, with natural gas being the largest overall contributor while renewables show the fastest growth.

The reason for these similarities is that they all assume that the future of the energy industry is “more of the same”. Global economic growth has been in the 3 – 4% since the 1970s, for example, and so far this century largely driven by Asia. Across the world energy intensity has shown to decrease as economies develop. And natural gas has been supplying much of the recent growth in energy demand.

There is nothing wrong per se with predicting the future through extrapolating the current trends. It is even good business to know and understand what would happen if nothing fundamental were to change. However, because history has a habit of being formed by disruptive events, this approach is not sufficient for companies that want to manage for the future.

Strategies for future success need to consider not just extrapolations of current trends but also possible disruptions of these trends. Effectively, a range of possible futures needs to be developed, some more likely than others, each based on a unique set of assumptions. This, namely, enables an organization to develop not only a strategy for the future scenario that appears most likely, but also alternative strategies that could be executed rapidly if potential disruptions actually materialize.

An alternative future for energy

When thinking about what could potentially disrupt the current trends in the energy industry, renewables come to mind.

So far, three obstacles have prevented renewables from really taking on oil, natural gas and coal in the energy industry. The first is cost, as hydrocarbon sourced energy remains (substantially) cheaper to produce. The second is intermittency or variability, as renewables can not yet provide the steady, continuous flow of energy that modern economies require. The third is mobility, since the average range of a vehicle powered by internal combustion remains substantially higher than that of electric vehicles. These obstacles have lead to renewables playing the role of additions to the overall energy mix rather than competitors for hydrocarbons. This situation, however, will not necessarily remain.

For example, continued research into solar power coupled with industrial scale production of solar panels has lead to the cost of solar power for electricity generation dropping much faster than anticipated earlier. Apparently, in parts of the United States utility-scale solar power generation capacity can now be delivered at a price below that of natural gas based power generation plants. A similar milestone is expected to be achieved in Europe within another 10 years.

For as far as the issue of intermittency is concerned, battery innovations over the last 20 years have lead to an increase in capacity and a decrease in cost, making energy storage a much more viable option today than it was say 10 years ago. Tesla’s recently launched Powerwall, a wall-mounted lithium-ion home battery system designed to store energy from rooftop solar panels, is not yet entirely economically competitive today, but Tesla is betting mass production will get it there and enable it to capture the home and grid energy storage market that is estimated to be worth some $50 billion once fully established. A number of other companies with venture capital backing are furthering alternative battery technologies to beat Tesla to it.

Tesla is also leading innovation to address the issue of mobility. The batteries in its S-series are said to provide a driving performance pretty much at par with BMW, for a range of some 250 miles.

For the future of renewables, just as important as the recent technological innovations are the incentives currently at play for further innovation.

Three of the key energy markets continue to press ahead with their support for renewables, with China setting itself a target of 200 GW of wind and 150 GW of solar by 2020, India of 100 GW of solar by 2022, and the United States introducing a Clean Power Plan with a Clean Energy Incentive Program (CEIP). Carmaker BMW believes this, together with other forms of state-support for renewables, will simply force the automobile industry to switch to electric almost completely.

Other important incentives that will drive continued technology improvements are tied to the fact that millennials, the consumers of the future, have a stated preference for renewable energy. This “customer insight” means that companies can give themselves a competitive advantage in the marketplace by switching to renewables. This is why companies like Apple, Facebook and Google are taking renewables very seriously, in the process making renewables even more “cool”. It also means that renewables can penetrate and disrupt established markets faster than their technological progress would predict, since millennials are willing to accept some inconveniences (as compared to hydrocarbons) associated with renewables. The resulting economies of scale in manufacturing will facilitate and speed up further innovation.

Clearly, therefore, renewables have a real (and growing) potential to disrupt the energy industry. But what exactly would be their impact?

The conventional energy outlooks foresee growth in overall energy demand slowing down, from above 2% per year over the last two decades to around 1% per year after 2025, due to energy efficiencies. Because they assume hydrocarbons will be providing the bulk of this growth, their conclusion is that hydrocarbon energy industry will continue to see growth at least until 2040.

Technological progress in renewables weakens the link between energy demand and hydrocarbon demand, however. As time goes by less and less of the growth in energy demand will be met by hydrocarbons, meaning that less and less of the growth in the energy market will translate into growth for the hydrocarbon energy industry. A possible scenario for the future is that somewhere between now and 2040 this link is entirely broken, growth in energy demand is met by renewables 100%, and growth in the hydrocarbon energy industry comes to a halt.

On top of this, continued progress in renewables will at some point in the future lead to renewable solutions for conventional needs crowding-out traditional, hydrocarbon based solutions. Panasonic has bet its future on exactly this taking place, with a strategy for growth that is about offering eco-friendly solutions to customers. (Which is why Panasonic decided to become a partner in Tesla’s Gigafactory in Nevada for the production of lithium-ion batteries for electric cars). This could cause the hydrocarbon energy industry to start shrinking even while the overall energy market continues to grow.

Strategy options for an age of disruption

There exists a possibility that sometime in the future, due to developments outside of their control, hydrocarbon energy companies find themselves in a position similar to the coal companies today – exceptionally challenged to deliver the growth that shareholders expect because of a shrinking market.

Of course, this would not happen overnight since a real switch to renewables would require massive changes in the global energy infrastructure. For certain in the short term (<10 years), and most likely also in the medium term (10 – 20 years) also, hydrocarbons will continue to dominate the energy mix.

This means that Oil & Gas companies should at this stage continue the “Find it, develop it and bring it to market, effectively and efficiently”-strategy that has served them so well in the past, possibly focusing on “niches” that exist within the industry and aligning capabilities and resources accordingly to achieve superior returns.

However, to manage the risk of being overwhelmed by disruptions, Oil & Gas companies should not be overly focused. This is actually a lesson from history. Companies that have thrived over generations are typically tolerant of minor activities on the margin of existing businesses. This enabled them to learn, early on, about the potential of new ideas, inventions and businesses, both in terms of how they could threaten the existing businesses and how they could be leveraged to further the overall objectives of the company. Eventually, this provided them with an advantage over competitors when such ideas, inventions or businesses achieved a breakthrough and became mainstream.

To achieve this, Oil & Gas companies could pursue the following strategy options:

Firstly, establish a venture fund with the task of investing in promising companies in industries that have the potential of disrupting the energy industry. Run this fund as far removed from the existing business as possible, however, otherwise one runs the risk of the fund thinking and operating as a guardian of the Oil & Gas business rather than as a true disruptor – defeating the purpose of its own existence.

Secondly, expand the internal innovation horizon. Don’t focus the innovation effort solely on optimizing practices in exploration, development, production and/or processing, but have at least some of the brightest minds look at potentially disrupting technologies. This requires building a culture within research & development that is tolerant of people who go against the grain.

Andreas de Vries works as a Strategy Consultant in the Oil & Gas industry, helping companies to not only develop strategies but also execute them.

Image: Several Smart electric drive cars charging at the Potsdamer Platz in Berlin. By: Avda, CC-BY licence.
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