Shell, Limejump, Gridserve & business model evolution

Two deals were announced at the end of February that highlight two structural trends transforming European energy markets:

1. Small players driving innovation &
2. Large incumbent players looking to diversify business models.

Deal 1: Gridserve sets out a new model for unsubsidised solar + batteries

UK based developer Gridserve has agreed a deal with a local council (in Warrington) to build a large unsubsidised solar plus battery storage project.  The project consists of 60 MW of latest solar farm technology and 27MW of battery storage, with construction financed via private capital.  The council will own the assets once operational, but Gridserve will operate and maintain them.

Deal 2: Oil & gas major Shell acquires power aggregator Limejump

Shell announced its acquisition of Limejump, a digital platform based aggregator of decentralised flexibility (e.g. engines, batteries, DSR). This deal follows Shell’s acquisition of German residential battery producer Sonnen (earlier in Feb) and UK retailer First Utility (in 2017).

The first deal is one of many current examples of innovation being driven by smaller players. The second deal reflects a growing desire by large incumbents to diversify portfolio risk and look for new growth opportunities.

Small player innovation

European gas & power markets were dominated by large vertically integrated utilities in the 2000s.  Boardrooms were focused on acquisition and aggregation as a way to gain scale. But the financial crisis left the balance sheets of many companies overextended.

This decade has seen a steady erosion of utility dominance, coinciding with a rapid growth in the role of smaller players and new entrants, particularly in the power sector.

These companies tend to be innovative, nimble and unconstrained by the rigid structures of large utilities & producers.  They are particularly well suited to developing more effective customer relationships in increasingly decentralised markets, typically with lower cost overheads than incumbent players.

Examples of areas where smaller players are making inroads:

1. Aggregators: smaller companies such as Limejump, UKPR and Flexitricity are leading the aggregation of flexible distribution connected resources such as engines, batteries and demand side response.
2. Retailers: Growth in new entrant retailers (e.g. Smartest Energy, Ovo & Octopus) has been particularly prominent in the UK, although not all of these have survived the ‘risk management 101’ test.
3. Developers: Gridserve is only one example of dozens of smaller innovative companies & funds developing power assets across solar, gas peakers, storage, DSR and onshore wind.

But as these smaller companies grow, they become prime targets for acquisition by incumbent utilities and producers looking to diversify portfolio exposures and access new growth opportunities. Some examples of this are set out in Table 1.

Large player diversification

Europe’s incumbent utilities and producers have large centralised asset bases, focused in most cases on production and consumption of hydrocarbons.

The hydrocarbon based businesses of these companies may remain profitable for decades, particularly gas & LNG portfolios as demand grows in developing markets. But boardrooms are increasingly focusing on three key risks to long term margin and growth potential:

1. Decarbonisation
2. Decentralisation
3. Rapid technology innovation

These risks are driving large incumbent players to gradually transition their business models. This is happening via a shift in focus to new growth areas including renewables, distributed energy, trading, LNG, hydrogen and energy services. Four case studies of business model transition are shown in Diagram 1.

The diagram also highlights the important role that the acquisition of small companies is playing in facilitating business model transitions. Innovative smaller companies represent relatively ‘cheap options’ for large incumbents looking to diversify and grow. Acquisition can also provide an accelerated ramp up in customer relationships, technology & software and specialist expertise.

But successful acquisition & integration can be challenging. The more rigid governance structures and bureaucracy of large utilities & producers can often undermine the innovative success of a standalone smaller player. It can also be difficult to integrate the management, culture and skill sets of new business areas with the much larger existing core businesses, as evidenced by the previous attempts of oil majors to break into renewable energy.

If these integration hurdles can be overcome, large incumbents can provide three key things that unlock value: (i) access to capital and corporate resources to facilitate scaling (ii) the commercial capability to manage market risk and (iii) the ability to influence policy makers. It is those drivers and a continued appetite for diversification that are likely to support a continuation of the current acquisition trend.