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Fair Profit is Fundamental to a Future-proof Power Industry

Profitability is a contentious subject when it comes to an essential good like electricity. Reliable power is an inescapable need in any modern economy, and an essential part of sustainable development for citizens across the world.

Under Sustainable Development Goal 7, the United Nations commits to the goal of ensuring access to affordable, reliable, sustainable, and modern energy for all. That perhaps raises questions of why companies should be financially incentivised to not just deliver on this promise, but is being treated fairly.

The issue is undoubtedly complex, made more so by the fact that despite a UN commitment to achieving universal access to electricity by 2030, an estimated 770 million people globally still lacked access in 2019. Achieving that target will require a projected USD52bil in annual investment, requiring significant private capital alongside public funds.

Investing in electricity

Modern investment is increasingly global, but it remains largely focused on the imperative of achieving financial returns. While investors are increasingly concerned by questions of ethical and sustainable operations, the consideration of profit remains central to their fundamental business model. That means investing in an electricity supply system in order to achieve our shared goal of universal electrification must come with adequate returns.

There’s no doubt that affordability of electricity is a critical consideration in all of this. Providing affordable, secure, and sustainable energy is the central goal of any power system. If utility prices are beyond those which consumers can afford, then access to electricity becomes somewhat redundant.

Investing in an electricity supply system in order to achieve our shared goal of universal electrification must come with adequate returns.

Significant difficulties can emerge however when the price of tariffs become disconnected from the true cost of energy. In Argentina in the early 2000s, government intervention established mandated utility prices that placed power tariffs far below the true cost of production. Over roughly a decade this regulatory intervention saw domestic utility rates become significantly disassociated with fuel prices and the cost of supply.

This created a huge deficit for the national energy ecosystem and ultimately risked undermining the sustainability of the industry. Such intervention also creates a burden on the public purse, as government, and ultimately taxes, must bear the weight of the price difference. As an added concern, artificially low utility prices also mean consumers are less incentivised to reduce electricity use, creating concerns around energy efficiency and consumption. These uneconomical frameworks also significantly de-incentivises third-party investment.

Profitability is a fundamental incentive of investment. Without the potential to realise returns, capital is less likely to be committed, and necessary investment falls short. That not only undermines electrification generally, but the core elements of reliability and security that define a functioning energy ecosystem.

Affordability backed by security and sustainability

Total investment value is clearly a big consideration for ensuring access to a vital resource like power. Yet profitability plays an equally important role in delivering it in a sustainable and reliable way.

Power is an industry which requires constant investment to maintain, manage, and optimise. This is particularly true during our current energy transition, as renewable energy grows to play an increasingly important part in the global energy ecosystem. This investment isn’t just about improving physical infrastructure but ensuring that service for customers remains reliable and up to a relevant standard, while also reducing the carbon burden of our power system.

In Malaysia for example, incentive-based regulation (IBR) was introduced as a framework to steer the electricity supply industry. It enables companies such as Tenaga Nasional Berhad (TNB) to generate reasonable profit from its operations, but mandates critical elements such as customer service and efficient, reliable power networks.

That is higher than the average CSI score of American and UK utilities over the same period.

The IBR system incentivised the operator to focus on reliability and customer service, delivering a Customer Satisfaction Index (CSI) score of 8.6 in its latest review. That is higher than the average CSI score of American and UK utilities over the same period. It has also led to consistent improvements in reliability, with the System Average Interruption Duration Index (SAIDI) falling from 48.22 minutes in 2018 to 44.95 minutes per customer per year in 2020.

These benefits are not unique. A review of the energy liberalisation in the UK revealed that a competitive market-based system with fair profitability for operators had seen poorer customers benefit overall from lower tariff pricing, with market innovation providing new tariff options. Even in markets where competition isn’t as mature as the UK, profitability still motivates innovation and boosts fair investment. The more an operator optimises its business, the more it optimises its profit margins and shareholder returns.

Profits not only incentivise investment and give fair return to shareholders, but they also actually promote efficient operations that then generate further investment capital. That means funding for critical infrastructure such as grid investment, innovations such as solar power, and even research into the next generation of power technology. Research has even shown that those utilities which more ambitiously invest in renewable energy generation and adopt new technologies outperformed those with less ambitious transition commitments. That creates a powerful incentive to move forward with the vital energy transition.

Profits also promote efficient operations that then generate further investment capital.

All of this is not to say that companies that control power should operate without limitation. A healthy electricity supply industry is based around a framework of regulation that empowers stakeholders to act in the best industry of the people. It should provide the guidance to ensure that sustainable, affordable, and secure power can be provided, with the freedom to generate profit that ensures continued investment in maintaining that goal.

Electricity is a fundamental need for nations across the world. Ensuring that provision requires a complex balance, but one where fair profit provides a catalyst for efficient, optimised, and future-looking operations.

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