Types of Energy Business: Risks, Efficiency and Features

Leonard Pokrovski
Moderator
Ingresó: 2022-07-25 12:14:58
2023-12-13 20:08:43

Types of Energy Business: Risks, Efficiency and Features

The energy business, which is very prestigious in any country, is at the same time characterized by high complexity, social responsibility and riskiness. In a broad sense, the energy business is any commercial activity in the sectors of the fuel and energy complex, including the use of energy resources. The choice of the type of business is made on the basis of economic assessments and subjective preferences. does it contribute to its attractiveness to investors? What are its features, risks and forms of organization?

In a broad sense, the energy business is any commercial (entrepreneurial) activity in the sectors of the fuel and energy complex, including the use of energy resources. Its end results are a variety of energy products and services — goods destined for sale in the relevant markets. Its products should be considered electric and thermal energy produced at power plants and various heat sources.

Energy services are divided into two types: energy supply services and services. The first covers the activities of suppliers for the transmission of energy through the main and distribution electricity and heat networks, as well as for the sale (trade) of energy resources. The latter (services) include many types of a wide variety of ancillary services in the areas of generation, transmission, marketing and useful use of energy.

This includes, but is not limited to, maintenance services, energy rationalization services (energy efficiency), engineering (technical solutions and modernization projects), and billing (measurements and calculations).

Depending on the adopted models of energy markets, the forms of organization of the energy business may also differ. For example, certain business functions can be concentrated in independent energy companies: generating, grid (trunk and distribution), sales, and service.

In energy holdings, they will be carried out by subsidiaries coordinated by the corporate center (management company). In vertically integrated organizations, specialized business functions are performed by production structures with varying degrees of economic autonomy and responsibility.

It should also be noted that the business in question is based not only on private ownership of energy assets. After all, in a market economy, federal and regional executive authorities, as well as local self-government bodies, can act as an entity deriving profit from economic activity.

Under the condition of effective public control, they make decisions based on generally accepted commercial criteria and even enter into competitive relations with representatives of private business. At the same time, they can lease their property to private operating companies, which take over the management of the relevant assets and ensure the highly economical and reliable operation of power facilities. Finally, to a greater or lesser extent, they can participate in the share capital of energy companies, up to and including the ownership of controlling stakes.

 

Attractiveness of the business for the investor

It is known that energy facilities are initially particularly capital-intensive, repair-intensive, and investments in the electric power industry have relatively long payback periods. Moreover, in this industry, there will always be a very unfavorable ratio for investors between the selling price of electricity and the cost of fixed capital.

The attractiveness of business in the field of electric and thermal power is determined by the owners' (investors') assessments of the potential opportunities for realizing their interests (mainly financial goals). It is expressed, inter alia, in such indicators as:

  • inflow (outflow) of investments into the industry;
  • frequency of change of ownership in the main businesses (generation, transmission, sales);
  • Share of private business in electricity turnover.

 

The choice of the type of business is made on the basis of economic assessments and subjective preferences. Among the latter, they consider their financial and organizational capabilities, experience, education, ambitions, attitude to risk in business and other individual characteristics.

Attractiveness assessments are differentiated by type of business and are formed taking into account the following main factors:

  • requirements for products (services) – functional purpose and quality characteristics;
  • expected return on invested capital;
  • the nature of demand for the product (service);
  • type of activity (monopoly, competitive);
  • market entry conditions;
  • Risks.

 

Let's consider the above factors in relation to the main types of industrial energy business.

Products (services). Electric energy and thermal energy are products of general consumption, possessing standard quality parameters (frequency and voltage, pressure and temperature). Therefore, the markets in which these energy resources circulate are characterized by colossal capacity, powerful financial flows and a virtual absence of product innovations, which increases their structural stability.

All these features together undoubtedly contribute to the comparative attractiveness of the energy business as a whole. Changes in the range of products that are very worrying for business, motivated in other industries by non-price competition, often quite tough (cellular communications, computers, etc.), are not possible here.

However, it should be borne in mind that although there is indeed no alternative to electricity as an energy carrier in the vast majority of cases, this does not mean that it will be bought at any set price. After all, if the price exceeds a certain acceptable level, then some will consume it, but will stop paying; It should be taken into account that energy companies, in fact, lend to their customers, since production and consumption coincide in time, but do not coincide with the established payment terms.

The other part of consumers will react in a more civilized and adequate way – they will switch to self-sufficiency in energy and power. It should be noted that, as a rule, these are the most profitable customers for the electric power industry - large energy-intensive industrial enterprises.

Profitability. The amount of profit received per unit of invested capital depends on many factors: the cost of fixed assets of the object; selling prices (tariffs) for energy resources; fuel prices; capacity and technical and economic efficiency of power plants.

Due to the current correlation between energy tariffs and the capital intensity of energy facilities as a whole, the return on invested capital in the electric and thermal power industry is below the industrial average. But it varies significantly within the energy industry, in particular depending on the types of power plants that power plants, boiler houses and other energy enterprises are equipped with.

For example, today the profitability may be relatively higher for small-capacity gas turbine and combined-cycle plants than for large power plants, and the profitability of heat sources is greater than that of electricity generating facilities.

Quite naturally, private capital is rushing to those areas of the energy sector where financial efficiency is currently at the level of maximum values. However, this is not always in the long-term public interest.

Demand. The dynamics of energy demand has a great impact on the efficiency of the business in question. As you know, energy enterprises are characterized by a high level of capital intensity and a significant share of fixed costs in the cost of production. For such industries, any change in sales revenue always generates a larger change in profit (the "operating leverage" action). Moreover, the higher the share of fixed costs, the greater this effect.

This leads to an important conclusion: in conditions of steadily growing demand, the efficiency, and therefore the attractiveness of energy business of almost all types, increases sharply, and when demand falls, it decreases just as intensively. Moreover, in the latter case, the business will face losses if they cannot be compensated by prices or diversification of activities.

If demand begins to grow at a consistently high rate, then the efficiency of this business will be maximized. Otherwise, even the bankruptcy of energy companies (especially those with a large share of borrowed resources in the invested capital) cannot be ruled out.

Type of activity. In competitive types of business (for example, power generation), prices are not regulated by the state, but are formed under the influence of supply and demand. Free prices attract business and motivate technological investments, since all the profit received remains with the owner and is not subject to any restrictions. However, it should be remembered that the owner assumes the entire investment risk (of course, in the conditions of real competition between producers). It is clear that the weaker the competition, the more attractive the entry into the market becomes.

In monopoly activities (energy transmission), prices are regulated, and therefore certain profit limits are imposed, for example, for an electricity distribution company. In this case, it is possible to shift (at least partially) the investment risk to the consumer, since the tariff set must guarantee a return on investment. As a rule, tariffs in such a market are more predictable than in a competitive one, and it is always possible to justify a more acceptable price to the regulator.

Market entry. A person (legal entity or individual) who has passed the qualification selection and entered into ownership of the energy facility receives a license to participate in the energy market. Further, the business entity gets access to the network infrastructure and enters into contractual relations with other market participants.

It should be emphasized that, under certain conditions, the owner may experience serious difficulties in entering the market. For example, the reason for this may be the oligopolistic structure of the wholesale market, formed as a result of the merger of companies, as a reaction to the intensification of competition.

At the same time, a few large suppliers are not interested in the entry of new companies into the market and will try to block it, for example, through coordinated price manipulations. From the above, it follows that the absence of discriminatory barriers at all stages of entering the market is an important additional incentive for energy business entities.

Risks. When assessing the attractiveness of the energy business, it is recommended to pay attention to the following types of risks:

  • investment;
  • price;
  • financial;
  • technical;
  • Adjusting.

 

Risk analysis is designed to answer two questions: (a) how significant is the risk? (b) How can it be neutralized?

Investment risk is the risk of loss of profit during the implementation of an investment project. It can be significantly reduced if we switch to the construction of combined power plants of small capacity using advanced gas turbine technologies. In the case of large projects, state guarantees of the profitability of the project are required (provided, in particular, to the winners of investment tenders).

Price risk. It is caused, firstly, by irregular daily fluctuations in electricity prices on the organized (exchange) wholesale market. As a result, it is extremely difficult to organize the production planning process in the company, even in the short term.

The solution to the problem lies in the development of a powerful (over-the-counter) market for bilateral long-term contracts and insurance of price risks in the organized (exchange) markets of financial contracts; Secondly, the uncertainty of the future dynamics of natural gas prices. However, much depends on the policy of reforming the gas industry.

 

Financial risk is associated with non-payment by consumers, as well as violations of financial obligations by various participants in the energy markets. The risk of non-payment falls on energy supply companies, which prompts them to pay special attention to the fight against commercial losses (theft) of energy.

In particular, it is recommended to identify "risk" groups among consumers and set more stringent conditions when concluding an energy supply contract. It is expedient to introduce special insurance of financial risks of power supply organizations.

Technical risk is the threat of equipment failures, reduced technical reliability of electricity and heat supply, and interruptions in the supply of energy to consumers. Technological processes at energy enterprises are characterized by high complexity, which requires highly qualified, and therefore very expensive operational, repair and management personnel.

In addition, power enterprises operate in a complex system of multi-channel external relations with designers, builders, installers, suppliers of fuel, equipment, repair and other services. A large number of different contracts and strict requirements for the quality of the listed services objectively make the energy business more risk-taking than any other.

Radical neutralization of this risk requires the company to have an appropriate technical policy and highly qualified technical management. At the same time, it is expedient to introduce a differentiated fee for reliability in the retail and wholesale markets, i.e. to consider reliability as a special type of targeted energy supply service. Reliability can also be considered as an object of insurance.

Regulatory risk is generated by unexpected and unfavorable business actions of energy regulators. Moreover, it can take place both in the competitive and in the monopoly sector. It manifests itself in many aspects: pricing, environmental regulation, tax regulation, standards for the reliability of energy supply, and rules for working in markets.

It should be noted that this is the type of risk that a business entity cannot influence in practice. Therefore, owners tend to react to it particularly painfully, and its impact on the attractiveness of the energy business is significant.

Therefore, it is necessary that all decisions of regulators are as transparent and predictable as possible. If the actions of the regulator, taken in line with the public interest, cause economic damage to private business, then it must be compensated in one form or another.

 

***

Thus, as a general conclusion, it should be concluded that the energy business, which is very prestigious in any country, is at the same time characterized by high complexity, social responsibility and riskiness in many aspects. Moreover, in connection with the management of the risks considered, the participation of the state is crucial:

  • firstly, legal support for the actions of business entities to neutralize risks;
  • secondly, a system of financial guarantees for investors operating in high-risk environments and companies specifically involved in national energy programmes;
  • Thirdly, an effective mechanism for business regulation that minimizes external risks for the owners of energy facilities.
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