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Electric Power & Natural Gas

A new age for energy and commodity

trading

Traders can employ five levers to tap new sources of value.

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By Joscha Schabram
Advises clients on energy markets and trading as well as smart grid, digital, and renewable
technologies across the value chain.

By Xavier Veillard
Advises clients in gas, power, and commodities markets on strategy, investment, growth, and
transformation.

June 2, 2021 ‑ Commodity traders crave volatile markets, and they’ve had
their fair share of them recently:

A snowstorm spurred dramatic price spikes in electricity in Texas in

February, with clearing prices up to $9,000 per megawatt-hour (MWh) for
three days, more than 300 times the average February price of $21 to $27
per MWh.

The grounding of a giant container ship in the Suez Canal produced a 6

percent jump in daily oil prices. The cost of renting tankers from the Middle
East to Asia also rose by up to 47 percent within three days, with ships
immobilized or taking longer trade routes.
 In Asia, liquefied natural gas (LNG) prices reached about $20 per million
British thermal units (MMBTU) in January 2021, a record, compared with a
2020 average of about $6 per MMBTU, prompting large Asian buyers to
explore new long-term contracts to avoid overexposure to the volatile spot
market.

In Germany, increasing supply of prioritized renewable energy has led to a

surge in hours of power supply at extremely low prices, from about 200
hours with prices below €5 per MWh in 2016 to about 600 hours in 2020.

Volatility is normal in commodities markets. But energy and commodities

companies, including utilities, industrial firms, and trading houses, are now
dealing with higher frequency of extreme events. They face four big
fundamental changes in the markets.

First, energy markets in particular are becoming more globally

interconnected. For example, LNG prices are increasingly connecting major
global gas markets to each other1. Similarly, European power and gas trading
hubs are increasingly correlated from north to south and west to east,
progressively transforming what used to be to a collection of local trading
hubs into a more regional market.

Second, markets are trading in real time more than ever; for example, power
and gas can now trade in slots of only 10 minutes in a number countries
compared with daily a few years ago. As a result, companies are rolling out
new intraday trading teams and algorithmic models to cope with this new
market structure.

Third, markets are more and more automated; day-ahead and intraday power
and gas trades are increasingly the result of automated algorithms rather
than human intervention, employing similar techniques used in equity and
fixed-income markets.
Fourth, the energy and wider environmental transition is giving rise to new
commodities (for example, biofuels, renewables guarantees of origin
certificates, lithium, and cobalt). These commodities, while initially traded on a
bilateral basis, very quickly evolve into over-the-counter (OTC) trading
markets with limited liquidity that require strong price risk management.

At the same time, commodity trading has become much more competitive.
For example, big industrial companies that purchase large volumes of power
and gas are setting up trading desks to procure these products directly on
wholesale markets. Energy companies are also expanding across multiple
commodities. Oil and gas companies are developing power and carbon
emissions trading desks, increasing competition with utilities. New,
independent companies are trading power and gas as a service for smaller-
scale producers or buyers. Other niche players are also trading new
commodities such as biofuels and carbon certificates.

What can energy and commodities firms do to stay ahead of the competition?
Five developments are allowing industry leaders to create new sources of
value:

expanding into rapidly growing niche commodity markets

launching trading-as-a-service offerings

deploying advanced analytics to automate short-term intraday trading

rolling out the next level of performance management to optimize risk

capital allocation

adopting best-in-class trade-to-cash processes

The first three levers focus on promoting growth in trading; the last two
describe fresh approaches to drive efficiency. Heads of trading business units
and chief commercial officers should actively pursue these levers to sustain
margin growth in light of strong competition and rapidly evolving markets.
How to spur growth in trading

We have identified three new strategies to promote trading income growth.

Understanding commodity markets

fundamentals and targeting new niche

markets

During the past 10 years, a significant number of commodity markets have

come onstream, often linked with the transition to renewable energy, and the
rise of new sources of energy. Examples include European Union emission
allowances (EUAs); guarantees of origin (GoOs); first-generation biofuels
known as fatty acid methyl esters (FAMEs); used cooking oils (UCOs) acting
as a feedstock for second- generation biofuels; white certificates such as
certificats d'économies d'énergie (CEE) in France, reflecting energy efficiency
credits; and cobalt and lithium for batteries, and many more.

Energy and commodities firms’ trading-desk operations could benefit from a

more active presence in these markets, given higher margins than in more
mature markets. However, limited liquidity will trigger a need for strong risk
management practices. It’s critical for companies to continuously adapt their
strategies as markets evolve along the maturity curve. (Exhibit 1)

Exhibit 1
A number of companies have recently accelerated development of trading
desks focused on these commodities, which offer higher trading margins.
Also, a direct presence in the market can help industrial companies gain a
better grasp of the price discovery process. For example, a number of major
global and niche trading firms have recently announced the creation of
carbon renewable certificates and biofuel-ticket trading desks. Oil and gas
companies have developed biofuels trading desks dedicated to feedstocks
such as vegetable oils, UCOs, and other waste oils, as well as products such
as FAMEs and hydrotreated vegetable oils (HVOs).

Launching trading-as-a-service offers

Energy systems are becoming more decentralized, with large-scale power

plants replaced by small-scale renewable energy producers (Exhibit 2). Most
smaller-scale companies lack the financial means, risk appetite, and
capabilities to manage the marketing of their production, exposure to volatile
power prices, and the hedging of future production. As a result, they often
look for external partners to provide these kind of services. This is a key
opportunity for energy companies with trading desks that can scale their
activities to offer power purchase agreements, risk management solutions,
and market access services to third parties. Many utilities are rapidly
expanding into this area.

Exhibit 2
Harnessing the power of advanced

analytics

Advanced analytics are transforming the trading landscape. Traders are

deploying these tools as markets become more real time to keep a
competitive edge and to maintain or increase trading margins. They are able
to do so because of increasing availability of market data as well as satellite,
vessel tracking, and weather data; talent skilled in machine learning and
statistical algorithms; and computing power, including the cloud, that runs
predictive analytics fast enough to identify market signals and then triggers
trades.

In our experience, using advanced analytics, especially in volatile short-term

markets such as intraday power trading, can make the difference between
profitability and risk to exposure of significant income shortfalls. That’s
because humans cannot process data fast enough to make rational decisions,
especially when large amounts of data must be dealt with and interpreted
rapidly.

For example, deployment of advanced analytics can lead to a reduction of

more than 30 percent in costs by optimizing bidding of renewable assets in
day-ahead and intraday markets. At the same time, we found a productivity
gain in intraday trading of 90 percent as a result of employing an end-to-end
automated process using advanced analytics engines. As part of the
transformation, the role of traders progressively shifted from taking decisions
and executing trades toward focusing on market analysis and improving
advanced analytics models on a continual basis.

A successful analytics transformation in trading includes:

Achieving early momentum with a successful use case. Try to self-finance

the transformation; early success will contribute to a positive mindset and
encourage the rest of the organization to get behind analytics.

Making business value explicit for each use case and clarifying
performance expectations. Companies that start with IT infrastructure and
data enrichment tend to invest a lot but not capture the value.

Changing the way companies recruit new talent and different trader profiles
are needed, and creating an attractive workplace for digital and analytics
talent is key.

Finding new sources of efficiency

Finding new sources of growth is important, but so is making a continuous

effort to improve performance management in trading and to ensure scale
and development are not pursued at the expense of efficiency. Traders can
look to the following two approaches for additional sources of value.
Rolling out the next level of trading performance
management
In this new age of commodity trading, the leaders will be those that allocate
working and risk capital more efficiently to attractive trading activities and
ensure decision transparency. Continuous performance management is
critical to optimize risk capital allocation between trading desks and structure
incentive schemes that truly reflect risk-adjusted P&L contributions.
Optimizing trading performance must be underpinned by a set of key
efficiency ratios such as return on value at risk (VaR), risk utilization
percentage, trading P&L incorporating cost of capital, and front-office to mid-
office and back-office support (Exhibit 3).

Exhibit 3
Adopting a best-in-class operating

model

Traders should strive to adopt a best-in-class operating model and

associated processes to maximize economies of scale and synergies as they
scale into higher volume of transactions and branch into new commodities.
Four key tools to achieve such efficiency include:

creating a lean front-to-back operating model optimizing the so-called

trade-to-cash processes that follow the trading transaction cycle from the
time a trade is made through its final settlement

merging middle-office activities across desks as much as possible to create

synergies in daily P&L and risk analytics production

Developing the right interface with production and marketing assets (for
example, power generation plants or B2B sales portfolios) for trading to be
able to best optimize the overall company portfolio and monetize
optionalities embedded in assets

Adopting a lean trading IT backbone (from trade execution to settlements)

that embraces the latest digital and analytics innovation (for example,
transactional data available in a data lake and connection of a
commodity/energy trading and risk management (CTRM/ETRM) system to
portfolio simulation engines).

***

It’s imperative for trading executives to stay on top of the large structural
changes taking place in commodities markets. Pursuing these five levers can
best position them for growth: entering new commodities markets to avoid
being a price taker but rather a market maker;, launching trading-as-a-
service offerings; investing in developing and scaling up trading analytics;
institutionalizing a strong performance management framework; and
optimizing the trading operating model and associated IT landscape.

Joscha Schabram is an associate partner in McKinsey’s Zurich office, and

Xavier Veillard is a partner in the Paris office.
 1 For example, the Dutch title transfer facility (TTF) gas market is increasingly connected to the Asian

LNG Japan/Korea Marker (JKM) spot gas market.

Transforming people and organizations in

heavy industries

HR executives are often overlooked as strategic partners, but their impact can be
transformative. We spoke to heavy industry HR leaders to discuss how they can
drive value amid organizational change.

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By Alexander Weiss
Alexander leads the Electrical Power and Natural Gas (EPNG) Practice globally, and spearheaded
McKinsey’s global contracting initiative. He has worked extensively in the EMEA’s in power plant
construction optimization and operational improvement.

By Anna Wiesinger
Advises public-and private-sector clients, with a focus on digitalization processes and
transformation management for education, employee, job market, and manager development

By Julian Kirchherr
Delivers skilling-at-scale transformations across industries in Europe and beyond

By Sandra Durth
Drives stronger business performance by helping develop and guide transformational programs
that inspire leaders and employees at all levels to adopt new ways of working, organizing, and
leading

By Simon Knapp
Supports companies in the global energy and materials sector with holistic transformation
programs on operational efficiency and effectiveness as well as capital-project portfolio
management and execution

By Damian Klingler

June 14, 2024 ‑ HR and people leaders understand that the labor market
fundamentally impacts a company’s ability to achieve its strategic goals. HR
can help companies achieve these goals, but executives sometimes
underestimate the function’s power to be a strategic business partner.

Earlier this year, McKinsey hosted a roundtable discussion in Germany with 15

HR executives from heavy industry sectors (materials, energy, oil and gas, and
chemicals).Currently, the heavy industry is facing volatility and complexity—
and productivity in Europe is lagging behind the United States.1 In light of
this, we met to discuss key themes emerging from McKinsey’s research in
the State of Organizations and State of Energy Organizations reports.

The discussion produced rich insights from HR executives on four key

themes: “new” leadership, talent transition, the implications of applied AI, and
reimagining HR.

Developing ‘new’ leadership capabilities

“Developing new leadership skills is like training a muscle—you must train it

to be able to do the heavy lifting on the spot.”
—HR executive

Heavy industry organizations, like many others, are facing stakeholders that
demand leaders be accountable for profitability, sustainability, performance,
and direction and empowerment. Frequently, leaders fall short of such
ambidexterity—but organizations that address this leadership gap proactively
could gain advantages over their competitors.2

New leadership styles focus on inclusivity, resilience, and transformational

leadership, with leaders moving beyond profit to impact, creating an
environment for collaboration. At the roundtable, HR executives highlighted a
dual challenge: role modeling new leadership from the top while investing in
the frequently underserved “magic middle.”3 Middle managers possess
granular knowledge and are key to shaping and operationalizing
transformation agendas.

HR can play a pivotal role in creating the space, time, and resourcing required
for sufficient leadership development as a key organizational priority—from
the board to the frontline.

Navigating the talent transition

“The massive transformation toward sustainability provides a unique chance

for us to attract talent—no industry has more leverage to reduce carbon
emissions, and that is a true value proposition for new talent.”
—HR executive

The emergence of majority millennial workforces and the changing employee

preferences after the COVID-19 pandemic, have shifted employee
expectations of employers. Many current heavy industry employee value
propositions (EVPs) are outdated—heavy industries’ EVPs are ranked sixth
out of seven compared to other industries, and are lagging behind on career
opportunities, culture, and senior management.4

We heard from HR executives that organizations can adapt by developing

robust EVPs that bridge the gap between workforce desires and corporate
requirements. Topics particularly top of mind included:

Improving branding toward purpose: Potential employees often perceive

heavy industries in a negative light. However, this sector’s role in
decarbonization or the energy transition presents an opportunity to connect
the workforce to a meaningful societal goal.

Addressing diverse, global talent: To counteract the sector’s traditionally

male-dominated culture, organizations can foster inclusivity, promote
 gender equality, and develop a compelling EVP to recruit and retain talent
such as female engineers or nonlocal talent.

Improving additional benefits: Employee benefits, such as affordable

housing; good schools close to the workplace; or flexible work options, are
vital for attracting and retaining talent and fostering a positive work–life
balance.

Augmenting roles with technology: Manual or technical workers hold

critical, highly specialized positions in heavy industries. These cannot be
automated or replaced by current technology solutions; however, everyday
work can be improved significantly through technology—as can many other
roles.

Focusing on skill potential and development: As technology becomes

more integrated into the workforce, technical skills are seen to hold equal
importance as people and commercial skills.

Creating a supportive work environment with inspiring leadership:

There can often be a disconnect between experienced employees and the
younger generation, and investing in leadership development and programs
such as reverse mentorship can help bridge the gap.

Applications of AI

“Some companies are at risk of only piloting AI use cases; they also need to
get into application and rollout to reap the benefits—we need leaders to
make this happen.”
—HR executive

Embracing automation potential from AI has always been crucial for efficiency
and productivity gains.5 Now, generative AI (gen AI) has brought with it
additional use cases focused on reinvention, innovation, and augmentation.
Gen AI offers significant potential for heavy industries: creating more diverse
and engaging work environments; enabling theautomation of repetitive and
coordination tasks; improving efficiency and effectiveness; and enabling rapid
data-driven decision making. Yet, companies in heavy industries report the
lowest gen AI usage compared to other industries.6

During the roundtable, we heard that HR leaders can help integrate AI into an
organization, specifically calling out aspects around risk management
(guardrails, privacy protection, and personal data), talent (including building
the required enterprise-wide backbone of people data), and facilitating
broader adoption and change.7

Given the perceived “lagging” of heavy industries, many leaders saw gen AI
not just as necessary for survival, but as a potential source of true competitive
advantage.

Reimagining HR models for the future

In McKinsey’s 2022 report, HR’s new operating model , we identified five HR

operating model archetypes emerging in response to dynamic shifts in the
world. At the roundtable, people leaders reported that:

Half see their functions in the Ulrich+ model, with business partners
developing functional spikes and assuming more center of excellence-like
responsibilities.8

They have or are trying to adopt agile elements and the integration of
machine-powered elements.

When reimagining HR operating models for the future, all heavy industry
representatives saw convergence toward a more "leader led" model. This
emphasizes the alignment of HR with business strategy, where people
leaders’ tasks include full responsibility from line management (including
hiring, onboarding, and developing) to budget responsibility.

This transformation calls for an HR mindset and capability shift—a pivot from
self-focused circles to active contributors to business strategy.

The future of HR is strategic: it seamlessly integrates business goals,

empowers leaders, is technology- and data-driven, and embraces a
multifaceted model for organizational success.

Organizations that are reluctant to adapt to these shifts could lose talent and
performance to their competitors. Those that are able to pivot toward
operating with HR as a strategic thought partner could unlock huge
opportunity—with senior leaders building a thriving organization of global
talent, purposefully navigating transformation and technology adoption.

The authors wish to thank Tobias Berner, Daniel Gayk, Christopher

Handscomb, Fabian Lensing, Anna Lieser, Sarena Lin, Ulrike Sander, and
Jutta Bodem-Schrötgens, for their contributions to this blog.

1 Sandra Durth, Bryan Hancock, Dana Maor, and Alex Sukharevsky, “ The
organization of the future: Enabled by gen AI, driven by people ,” McKinsey,
September 19, 2023.
2 Aaron De Smet, Arne Gast, Johanne Lavoie, and Michael Lurie, “ New
leadership for a new era of thriving organizations ,” McKinsey, May 4, 2023.
3 Emily Field, Bryan Hancock, and Bill Schaninger, Power to the Middle,
Harvard Business Review Press, July 18, 2023.
4 Patrick Guggenberger, Dana Maor, Michael Park, and Patrick Simon, The
state of organizations 2023: Ten shifts transforming organizations , McKinsey,
April 26, 2023;based on ratings from employee reviews (Glassdoor) in the
United States from 2018–2023; reviews are gathered for the top 100 largest
 companies (by head count) per industry; total sample includes 475,000
reviews across 900 companies within the nine peer industries; denotes the
percentage difference in ratings for companies within a specific industry and
the average sentiment across the nine peer industries.
5 Harnessing automation for a future that works , McKinsey, January 17, 2017;
The future of work after COVID-19 , McKinsey, February 18, 2021; The
economic potential of generative AI: The next productivity frontier , McKinsey,
June 14, 2023; Jobs lost, jobs gained: What the future of work will mean for
jobs, skills, and wages , McKinsey, November 18, 2017.
6 “ The state of AI in 2023: Generative AI’s breakout year ,” McKinsey, August
1, 2023.
7 For more information see, “ The state of AI in 2022—and a half decade in
review ,” McKinsey, December 6, 2022.
8 For more information see, Sandra Durth, Neel Gandhi, Asmus Komm, and
Florian Pollner, “ HR’s new operating model ,” McKinsey, December 2022.

The potential of hydrogen

To get ahead in the energy transition, energy players should take advantage of the
growing momentum for hydrogen.

  

By Suzane de Sá

By Thomas Geissmann

By Jesse Noffsinger
Works with organizations to understand, drive, and prepare for the global energy transition,
bringing deep insight into renewable and flexibility technologies and integrations into the energy
economy

By Rim Rezgui
 By Jesús Rodriguez Gonzalez
Supports leading power transmission and distribution utilities with strategic and operational
challenges, and brings particular expertise in digital and advanced- analytics issues

June 8, 2022 ‑ Download "The potential of hydrogen"

 Want to learn more about integrated planning? Contact us here .

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The role of the electric grid in

Switzerland’s energy future

The Swiss power sector is phasing out its nuclear capacity, which means the
country will need to rely on alternative energy sources. Four potential pathways can
help.

  

By Tamara Grünewald
Helps clients navigate the opportunities and challenges resulting from energy transitions with a
focus on scenario thinking and value pools across the energy value chain

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Leads McKinsey’s Global Energy Perspective and advises energy and industrial companies on
strategy and digital to navigate the energy transition, drive growth, improve performance, and
build operational excellence
 By Alexander Klei
Leads our industrial sector in Switzerland and helps companies develop winning strategies,
effectively manage and integrate M&A, design effective operating and organizational models, and
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By Stefanie Stemmer

May 13, 2021 ‑ Industry forecasts show that the Swiss energy system is
expected to face a growing energy-supply gap in the decades to come. Given
the dynamics of the country’s energy-producing industries, utilities and
power providers will likely need to increase imports from other countries,
such as France. While this may be easy in theory—Switzerland acts as a major
hub of power flows—it will not be easy in practice. All matter of hurdles, from
evolving regulations to changing energy sources, must first be overcome.

Switzerland currently relies on hydro and nuclear power to meet the bulk of
its energy demand. However, it’s unlikely that a reduction in expected energy
consumption and a buildup of domestic renewables would suffice to fill the
energy-supply gap, which could potentially begin as early as 2030. The gap
could be further widened by an accelerated decarbonization agenda, which
would see higher shares of electric vehicles (EVs) on the road and increased
production of hydrogen by electrolysis. Additional challenges include the
growth of renewables, a higher share of intermittent electricity, a limitation on
imports, and a potential peak demand-supply gap.

On January 27, 2021, the Federal Council adopted Switzerland’s long-term

climate strategy 20501, an energy act made up of ten strategic principles to
guide the country’s climate policy in the years to come2. The act focuses on
the energy sector and outlines four potential pathways for Switzerland to
meet its increasing power-supply needs while achieving net-zero carbon
emissions by 2050 and maintaining high energy security3.
The following article outlines four potential pathways that could enable
Switzerland to meet its increasing power-supply needs by focusing on the
role of the electric grid, factoring in the economic and regulatory feasibility
and the time required for implementation.

A snapshot of the Swiss power sector

The Swiss power sector—as well as the broader European energy system—
features a relatively stable equilibrium, with loads having been mostly flat for
the past ten years. While the energy production mix in Europe is slowly
changing from fossil-fuel plants to renewable-power plants, the electricity
mix in Switzerland has been nearly carbon-free for decades. In fact, more
than 60 percent of Switzerland’s annual energy generation stems from
hydropower, with the remaining share of the mix mostly generated by nuclear.

That said, the Swiss energy system is expected to change rapidly in the years
to come. The country plans to phase out its remaining nuclear capacity by
2044. Further, Switzerland is a central European hub for power transmission
and therefore highly interconnected with the electric grid. In 2019, the
country imported, exported, and transitioned around 40 TWh of electricity,
with up to 60 percent of total produced power exported in the summer and
the same share imported in the winter4.

This high level of interconnection makes Switzerland dependent on power-

market developments and regulations on a European level. On this point, the
expected power-market evolution is likely to result in an increasing gap
between supply and demand; electricity demand could increase by up to 30
percent by 2050 (46 percent if power demand for green hydrogen is
included).

With the potential for increased reliance on hydropower somewhat limited,

and the construction of nuclear power plants prohibited since 2016, it’s likely
that additional capacity won’t close this gap—at least not in a trivial way.
When the Swiss electorate voted in favor of Energy Strategy 2050, the
correct approach to balancing supply and demand had not yet been
determined5. Finding this correct approach is complicated by the ambitious
Swiss decarbonization targets; the Swiss Federal Council targets net-zero
emissions by 20506. While solar and wind can potentially help resolve this
issue, imports are increasingly likely to play a key role.

However, an increase in imports comes with the following challenges:

EU antitrust regulations prohibit the conclusion of long-term import

contracts, which would be crucial to secure prices in the long run and
thereby gain planning security. Switzerland is not the only country that
faces an uncertain energy future. Other countries, such as Germany (which
is phasing out nuclear and coal) and France (which has high dependence on
nuclear), face similar challenges, potentially increasing the risk of price
fluctuations in imports.

Switzerland faces significant regulatory uncertainty. The level of imports

necessary to meet demand will depend on access to the European
electricity market and Switzerland’s inclusion in agreements on
transmission across borders, such as those regarding maximum capacity.
There is currently no overarching electricity agreement (or
“Stromabkommen”) with the European Union that defines the integration of
the Swiss power sector into the larger European energy system, and it is
unclear whether such an agreement is even possible in the next three to
five years.

Large quantities of electricity, as opposed to resources such as oil and gas,

have a limited degree of storage. Electricity is the most fundamental
resource of a modern society, and countries that import electricity may face
increasingly fragile energy security. Reliance on other countries exposes a
 country to factors such as short-term breakdown, strategic decisions
around energy produced, and political interests.

Significant investments into the grid are needed. National transmission

system operator (TSO) Swissgrid’s Strategic Grid 2025 report shows that
CHF 3 billion to 4 billion ($3.3 billion to $4.4 billion) is needed to modernize
and upgrade the electric grid7. Two-thirds of the Swiss transmission grid is
more than 40 years old. A countrywide upgrade from 220 to 380 kilovolt
(kV) stations would help increase network efficiency and strengthen cross-
border interconnections. And the construction of high-voltage power lines,
especially if they are aboveground, will likely incur lengthy legal procedures.

Looking ahead: Energy forecasts by

2050

Based on forecasts drawn from various scenarios (see sidebar, “Four

scenarios for navigating the energy transition”), Switzerland could become a
net energy importer by 2030 and gradually increase its imports thereafter—a
significant change from the current status quo in which Switzerland is a small
net exporter. This change will be primarily driven by an increase in power
demand. Of note, both the reference case and the accelerated case are
initially more than the “zero basis” scenario of the long-term climate strategy
2050. The reference case calls for a 16 percent increase by 2035. Over the
long term, however, only the accelerated case is more than Swiss projections.
Here, the reference case calls for an increase of 46 percent by 2050, and the
close in the gap occurs around 2045 (Exhibit 1).

Exhibit 1
Exhibit 2
The growth in Swiss electricity demand is a result of increased electrification
across sectors as well as the slowly emerging share of hydrogen in the
energy mix (Exhibit 2). The largest portion of growth comes from the transport
sector8, in which a strong uptake of EVs is driven by improved economics,
favorable regulations, and technology readiness9. By 2035, 50 percent of
vehicles sales in all segments except trucks are expected to be electric. After
2035, however, the truck segment is forecasted to see a large uptake of EVs,
especially for long-haul trucks powered by hydrogen fuel cells. In addition,
electrification in buildings (such as uptake of heat pumps) will be offset by
efficiency gains, and industry will see electrification only as it relates to small-
and medium-heat processes in industries such as manufacturing (consumer
goods) and agriculture (drying or processing crops).
The largest capacity addition will likely come from solar photovoltaics (PV),
which could add approximately 14 gigawatts (GW) of additional capacity by
2050. This is due both to solar PV’s lower levelized cost of electricity (LCOE)
compared with wind and the potential offered by Switzerland’s topography
(Exhibit 3). While the current societal and political consensus presents
regulatory challenges to the large-scale construction of utility-scale solar PV
and wind turbines, there remains significant potential for rooftop solar PV.

Exhibit 3

Even with the anticipated net capacity additions, Switzerland will face a gap
between demand and supply (Exhibit 4). This gap could become apparent as
early as 2030 with the decrease of nuclear power and continue to increase as
demand rises faster than electricity generation from new power sources.
 Exhibit 4

All this said, becoming a net importer raises several questions for utilities and
power providers and operators, such as what amount of capacity is feasible,
both in terms of availability in the EU market and grid capacity. Determining
this requires an understanding of the long-term plans of neighboring
countries, as well as the EU in general. The economic implications must also
be taken into consideration, such as the direct cost of power and the
potential for job creation. There is also the question of security of supply and
the associated challenges, both in terms of political implications in the
broader EU context and the local determination across cantons (the states of
the Swiss confederation).
Finally, an increased dependency on imports will in turn cause the generation
model on a broader European level to become increasingly focused on
specific countries, resulting in higher cross-border transmission flows (Exhibit
5). Both exports and imports are increasing in magnitude for most countries
compared with 2020 as both intra- and interday fluctuations are balanced
out.

Exhibit 5

Exhibit 6
Four potential pathways for the Swiss

power sector

A core concept of Switzerland’s long-term climate strategy for 2050 is that an

increase in energy efficiency will enable the country to cope with an
increasing domestic-supply shortage, underscoring the need to determine
whether current plans and expectations are sufficient to meet the energy
demand going forward. In prior instances, when countries faced similar
situations (or even under unique circumstances, such as the one experienced
in Texas during the 2021 winter storm10) the effects were focused on the
short term, such as load shedding or a spike in power prices. However, as
industries are allocated peak demand slots, the impact can be consequential
on a country’s long-term economic stability.
With this in mind, the following four potential pathways can enable an
emission-free Swiss power supply able to meet increasing future demand:

1. Increase imports
There are two fundamental elements to this pathway: ensuring the
operational capacity of the electric grid and structuring a framework of
operation for stakeholders.

To ensure the operational capacity to the grid, it will be crucial to accelerate

the legal procedures to upgrade and renew the transmission and
distribution grid to ensure grid stability. Those may be beyond what is
currently considered in capital expansion plans and beyond that which is
considered in the European Network for Transmission System Operators
Electricity’s (ENTSO-E) ten-year network development plan. Next, to cope
with a higher import ratio, the grid must also be updated to meet new
requirements introduced by an increasing share of renewable and
decentralized power generation.

In addition to the operational expansion required, there is a need for a

structured framework for the key stakeholders to consider as they operate.
Invariably, as countries consider the long-term plans around power supply
and demand, a common solution is to become a larger importer. The
primary challenge then becomes how to orchestrate the pathway to ensure
that the solution is ultimately one that allows for increased imports.

2. Build
out domestic power supply based on
renewables
As expanding nuclear power is prohibited by Energy Strategy 2050,
increasing Switzerland’s power supply based on renewables is the only
feasible option to close the gap and stay on track for successful
decarbonization. Doing so can be achieved by adding hydropower or other
renewables such as solar, wind, and biomass—which have some limited but
tangible potential if regulation adjusts accordingly.
Even though hydropower makes up approximately 60 percent of the power
supply in Switzerland, the potential to add further capacity is limited. In
2019, the Federal Department of the Environment, Transport, Energy, and
Communications (DETEC)11 estimated an additional potential for hydro
energy of up to 1,560 gigawatt hours per annum (GWh/a) by 2050 through
further constructions (excluding 770 GWh/a from new glacial lakes).
Balancing the utilization of hydro power with the protection of waters is one
relevant factor that limits the extension of hydropower. Furthermore, this
estimate depends on the economic conditions (power price, subsidies, and
concession fees such as the “Wasserzins”) because new hydro plants must
depict a viable business opportunity. In any case, hydro expansion will not
be sufficient to close the gap.

There is also limited potential for adding other renewable energies, such as
solar PV, wind, and biomass. Overall, other than hydro, only 4 percent of
current power production stems from new renewables. In 2019, solar PV
(particularly rooftop solar) had the largest share in this category (53.0
percent) followed by power from waste (28.0 percent), biogas (9.0 percent),
wood (7.5 percent), and wind (3.5 percent).

Looking at the technical potential for wind and solar PV in Switzerland

(approximately 59 and 78 TWh, respectively), adding capacity seems like a
feasible option. However, the topology and legal and societal circumstances
reduce this potential significantly. While the midland is densely populated,
the rough terrain and shadowing through the mountains hinder
construction of wind turbines and larger photovoltaic units. There are also
strong objections against building units in mostly unaltered nature, where
tourism is the major income source—a concern that is shared among many
other EU nations. These obstacles are already reflected in today’s level of
new renewable buildout, where Switzerland is behind European peers. In
fact, wind and solar PV made up only 3 percent of power production in
 2017, while they made up an average of 18 percent in the EU-27 plus the
United Kingdom.

Last, Switzerland would also benefit from continuously scanning and

understanding opportunities that may come from technology
advancements over the next several decades. Although cost curves are well
understood, the potential of heretofore unseen technologies is not; such
technologies could lead to further opportunities to close the power gap.

3. Reduce expected energy consumption

This lever supports Swiss self-sufficiency, which the country has explicitly
stated as a political goal. But its impact is very limited as our estimates
show an increase of up to 30 percent by 2050 (without green hydrogen),
mainly due to an increase in the electrification of transport across vehicle
classes and higher industrial demand for power. While this lever is common
across a multitude of countries in the European Union, the ultimate
resolution around it will largely depend on consumer demand, centrally
driven incentives, and mandated rules and regulation. One example of such
regulations is the increasingly relevant access restrictions for internal-
combustion-engine (ICE) vehicles in cities—from 2017 to 2020, 2.5 times
more people were affected by restrictions stemming from 2030 targets.

4. Build out the grid

To accommodate these increased import and export volumes, further build-
out of grid connections to neighboring countries may be needed
(approximately 6 GW in total by 2050). Given the ENTSO-E plan postulates
a build-out of an additional 2.6 GW for connections that include Switzerland
by 2030, this seems realistic but requires continuous investment and
assessment.

There are further elements of this idea, such as interconnecting all

transmission connections, which would require a disproportional amount of
investment. Although such an approach might further support Switzerland’s
 ability to further balance power across all its neighboring countries, it would
still not resolve the fundamental power-generation issue.

***

Today, in the face of increased social and regulatory pressures, an

accelerated decarbonization agenda is all but required for both countries and
power providers. Although Switzerland will need to overcome unique
challenges in closing its impending energy-supply gap, the country will also
be presented with unique opportunities. There’s no time to waste. Making the
right moves based on the needs of the energy system is the best bet for
protecting the country’s long-term economic stability.

Tamara Grünewald is a consultant in the Zurich office, where Alexander Klei

is a partner and Marco Ziegler is a senior partner; Diego Hernandez Diaz is
an associate partner in the Geneva office; and Stefanie Stemmer is a
consultant in the Düsseldorf office.

The authors wish to thank Nikolay Avkhimovich, Cristina Blajin, Thomas

Geissman, Jesse Noffsinger, Joscha Schabram, and Philip Witte for their
contributions to this article.

1 Referred to as “Langfristige Klimastrategie 2050” outside the United States.

2 For more on the Swiss long-term climate strategy 2050, see “Langfristige Klimastrategie 2050,”

Schweizerische Eidgenossenschaft, January 27, 2021, bafu.admin.ch.

3 For more, see “Energy perspectives 2050+,” Schweizerische Eidgenossenschaft, March 30, 2021,

bfe.admin.ch.

4 Net import occurred eg, in the night of December 30, 2019. And net export occurred eg, on the

evening of August 1, 2019.

5 "Energy Strategy 2050," Schweizerische Eidgenossenschaft, November 11, 2020, bfe.admin.ch.

6 Andrea Burkhardt, "Federal Council aims for a climate-neutral Switzerland by 2050," Schweizerische

Eidgenossenschaft, August 28, 2019, admin.ch.

 7 Grid 2025, Swissgrid, April 2, 2015, swissgrid.ch.

8 Includes road, marine, aviation, and rail transport.

9 For more on EV adoption, see Thomas Gersdorf, Russell Hensley, Patrick Hertzke, and Patrick

Schaufuss, “Electric mobility after the crisis: Why an auto slowdown won’t hurt EV demand,” September

16, 2020, McKinsey.com.

10 Adam Barth, Jesse Noffsinger, and Humayun Tai, “The Texas power crisis,: Shining a light on the

generation outages,” McKinsey Power & Gas Blog, March 11, 2021, McKinsey.com.

11 “Wasserkraftpotenzial der Schweiz,” Schweizerische Eidgenossenschaft, August 2019,

pubdb.bfe.admin.ch.

The Texas power crisis: Shining a light on

the generation outages

This blog post, the first in a series of responses to the power outages in Texas,
examines what happened to the power-generation system and asks questions
about long-term mitigating actions.

  

By Adam Barth
Serves electric and gas utilities and utility-technology and -service companies on issues including
transmission and distribution-capital productivity, growth strategy, and operations

By Jesse Noffsinger
Works with organizations to understand, drive, and prepare for the global energy transition,
bringing deep insight into renewable and flexibility technologies and integrations into the energy
economy

By Humayun Tai
Leads our Electric Power & Natural Gas Practice globally, serving major utility and energy
technology clients across a variety of strategic, organizational, and operational issues

March 11, 2021 ‑ At 1:25 a.m. on Monday, February 15, 2021, the Electric
Reliability Council of Texas (ERCOT) issued a level-three Emergency Energy
Alert, meaning energy demand was very high, and conservation was critical.
By noon, more than 4.3 million homes and businesses across the state were
without power (around 34 percent of total customers) and around 26 percent
remained wholly without power or with “rolling” availability—systematic
temporary power outages—until Wednesday.1

These events occurred during a polar vortex, which brought temperatures in

Texas to lows not seen in more than 30 years and led Governor Abbott to
issue a disaster declaration in all 254 counties. The results were catastrophic.
To put the scale of the crisis into perspective, the International Energy
Agency said that the level of power outages in Texas was more than 500
times higher than the outages in California in August 2020,2 and it’s been
reported that more than 80 people have lost their lives.3

Although the implications of this event are still evolving, enough information
has emerged to start to piece together precisely what happened to the
generation system. More information is emerging every day, and we will
provide additional insights regarding implications for the transmission and
distribution system and retail market in subsequent articles.

That said, this article addresses the following key observations:

Actual peak demand and generation outages exceeded even ERCOT's

most ‘extreme’ winter peak–demand scenario. This includes both
expectations for demand and generation outages. When demand exceeded
supply (balance being the fundamental role of systems operators), ERCOT
ordered rolling blackouts to avoid broader system failure—which was
potentially just minutes away from occurring, given a drop in frequency of
around 0.5 Hz.

All power-generation sources were negatively impacted by the cold

weather, with the most significant gap coming from coal and gas
facilities. At times, there was more than 30 GW of thermal (coal, gas, and
nuclear) capacity offline (more than 40 percent of the total thermal
capacity). This was more than double ERCOT’s “extreme outage” scenario
 of 14 GW of thermal-capacity outages. As a point of comparison, 1.3 GW of
nuclear went offline (out of a total of 5.2 GW) and wind fluctuated between
0.7 and 5.4 GW (against a base plan of 7.0 GW and an “extreme” scenario of
1.8 GW).

Gas supply dropped by approximately 56 percent (and production in

Texas dropped by approximately 40 percent). This likely means that even
if all power generation facilities were weatherized and fully operational, they
would not have been able to source gas adequately without ERCOT having
to further shut down industrial demand or exports.

Questions remain regarding the best combination of actions to put in

place. Texas essentially has an independent power grid and cannot easily
transfer electricity from another balancing authority, which makes ERCOT’s
role as both an interconnection and balancing authority unique. As a result,
determining the best long-term mitigating actions to put in place is a
unique challenge. Questions must be asked about enhanced extreme-
scenario planning—as well as about communication, incentives or
mandates for weatherization and capacity, the extent of additional “tie-ins”
outside of ERCOT, the next horizon of demand response, and how to ensure
additional fuel supply during times of greatest need: winter and summer.

What follows is a fact-based account of what happened during those critical

few days, based on the currently available data and insights (at the time of
publication), as well as a series of questions that should be addressed coming
out of the crisis.

What happened: Supply and demand

forecasts versus actual outages

In November 2020, ERCOT published their Winter 2020/2021 Seasonal
Assessment and Resource Adequacy (SARA) report,4 which outlined
seasonal forecasts regarding supply and demand for the power grid.

These forecasts included a view on expected capacity (adjusted “firm”

capacity and various outage scenarios) and anticipated peak demand. And
while ERCOT’s extreme winter weather scenario peak planned up to 67 GW
of demand, actual demand during the polar vortex peaked on the evening of
February 14 at 69 GW—and could have been as high as 75 GW on February
15 if supply had been available to meet demand (Exhibit 1).

Exhibit 1
Outages were expected to be as high as 13.9 GW in an extreme-outage
scenario, leaving 68.6 GW of available capacity to meet peak demand of 67.2
GW (a reserve of 1.4 GW, or approximately 2 percent of total demand).
However, during the crisis, approximately 30 GW of thermal generation was
not available (more than two times the amount in the extreme-generation
outage scenario). This was due to a combination of factors, such as
equipment or instrumentation freezing and fuel availability—particularly gas
constrained by frozen infrastructure and gas diverted to priority heating loads
(Exhibit 2).

Exhibit 2
Wind assets were also pushed offline due to the cold. ERCOT’s extreme-low-
wind planning scenario included contributions of 1.8 GW from wind against a
base expectation of 7.1 GW. As a result, through much of the week of February
15, there was an overall gap of approximately 15 to 30 GW between expected
(“day-ahead”) power demand and generating supply.

At the same time (and signaling the depth of the challenge), ERCOT’s
wholesale market clearing price hit the administrative cap of $9,000/MWh
for 90 out of 120 hours, which is 300 to 400 times the average February
price of $21 to $27/MWh. It is worth noting that ERCOT’s market was already
experiencing very high pricing ($500 to $5,000/MWh) on February 13 and 14,
thereby indicating that supply and demand reserves were already tightening
because of the cold weather.

While all power-generation sources are being scrutinized following this

incident, the two areas receiving the most attention are wind and gas.

Wind takeaways

As of February, ERCOT had 7.1 GW of adjusted firm capacity (8.6 percent of

total adjusted firm capacity). Throughout the crisis, ERCOT’s wind output
consistently fell below the 7.1 GW firm-capacity plan (Exhibit 3). However, for
only 11 out of 120 hours (9 percent of the crisis), wind dropped below
ERCOT’s extreme-low-wind-output scenario of 1.8 GW for an average of 3.9
GW (with a difference of 3.2 GW between the base scenario and actual
supply). These outages are widely attributed to wind turbines freezing, as they
lack heating technology that other onshore wind-generation facilities have in
consistently colder climates, such as the Upper Midwest of the United States.

Exhibit 3
Gas takeaways

Thermal-generator outages due to cold weather remained at more than 30

GW for most of the crisis, significantly higher than the extreme-generator-
outage-planning level of 13.9 GW. These outages were caused by a
combination of both on-site issues and fuel availability. And while additional
data regarding the source of these outages and root cause(s) are being
collected, our analysis shows that even if all power-generation facilities were
weatherized and fully operational, they likely would not have been able to
source gas adequately without having to further curtail other vital residential
and commercial end uses.
Using February 7 as a baseline, the gas supply in Texas on February 15 fell by
approximately 56 percent—from 44.5 to 19.4 bcfd—because of freeze-offs
(when cold weather disrupts gas production) and other winter disruptions
(Exhibit 4). In fact, 40 percent of production losses occurred in Texas (6 bcfd
from the Permian Basin and 3 bcfd from others). Meanwhile, increased
demand and freeze-offs in nearby basins and pipelines disrupted imports
from other states, and frozen storage facilities stalled withdrawals at
approximately 5.0 bcfd until Thursday, February 18 when withdrawals hit
record levels of around 16.5 bcfd.

Exhibit 4
Looking at demand sources and factoring in critical end uses, we see that
gas supply would likely not have met demand even if all facilities were
operating. Furthermore, it’s likely that no other fuel sources were available to
balance out gas, as LNG feedgas reached near zero, and exports to Mexico
were cut by a third. Thus, while much of the focus has been on potential
reforms to the power-generation ecosystem, additional questions should be
asked about gas supply.

Questions to address coming out of this

crisis

In August 2011, the North American Electric Reliability Corporation (NERC)

and the Federal Energy Regulatory Commission (FERC) jointly published a
report looking at the outages that occurred in Texas earlier that winter.5
Included in the report were a number of recommendations for the electric
industry and the natural-gas system, such as incorporating more extreme
weather events into planning scenarios, anticipating the so-called next
horizon of demand response, developing stronger interconnect tie-ins, and
creating incentives or mandates to weatherize facilities.

On this last point, electric-power generators were advised to weatherize

plants to perform at the lowest recorded ambient temperature for the nearest
city. Natural-gas facilities in Texas and New Mexico were advised to
determine whether production shortages during extreme cold weather could
be effectively and economically mitigated through the adoption of minimum,
uniform standards for the winterization of natural-gas production and
processing.

Ten years have passed since the previous significant cold-weather crisis, and
weather events of this magnitude are expected to occur more frequently in
the years to come. In light of ERCOT’s unique role as an interconnection and
balancing authority, as well as the Texas Railroad Commission’s jurisdiction
over in-state gas supply, answering the following questions will be required to
help assure suppliers, power generators, grid-asset owners, and customers
that the right combination of long-term mitigating actions will be put in place
at the wholesale power level.

Next steps and covering costs

At what speed and depth will stakeholders address these most important,
occasionally interrelated questions, many of which were raised in the 2011
NERC/FERC report?

Who will pay for the changes? How much of the burden will be placed
directly on generators as opposed to being distributed through ERCOT’s
customers?

Plan for increasingly frequent and

extreme-crisis events

Given the differences between ERCOT’s extreme-weather scenarios and

actual supply and demand, how will their planning processes evolve to
account for a higher frequency and severity of climate-driven events? For
example, the winter 2020/2021 SARA report evaluated peak demand
“based on average weather conditions at the time of winter peak demand
from 2004–2018.” How can and should plans account for one-in-50 or
one-in-100-year scenarios?

In addition, how will supply and demand needs evolve as demand patterns
change (for example, as electric heating load continues to grow) and as
renewable penetration increases?
Compensation mechanisms for

weatherizing facilities

How will ERCOT compensate power generators for investing in

technologies that other operators have adopted in colder climates (for
example, heaters on wind turbines, on-site oil storage for gas facilities, or
instrumentation “hardening”)?

Will these technologies become mandatory to operate, or will they be

facilitated through more market-driven incentives?

Compensation mechanism for capacity

Will ERCOT move to some form of compensation for capacity to ensure

lower-utilization generation can remain economic—especially as fossil-fired
generation will likely decrease in utilization given the recent growth in
renewables?

How will these mechanisms interact with storage incentives to ensure the
right level of backup power?

Extent of additional tie-ins outside of

ERCOT

What additional interconnection opportunities does ERCOT have with the

Western Electricity Coordinating Council (which accounts for two Canadian
provinces, 14 western states, and northern Baja Mexico) and Eastern
Interconnection (which accounts for major land masses throughout Canada
and the United States)? How much would interconnection alleviate future
issues?
 Would ERCOT go so far as to formally join one of these FERC-regulated
markets?

Next horizon of demand response

Should ERCOT make additional investments in demand-response options

to avoid load shedding where possible? When load shedding does occur,
how can they avoid such large-scale events?

Fuel-supply availability

Given gas supply is regulated by a different body in Texas—the Railroad

Commission—what role will they have in planning changes and incentivizing
additional availability?

This blog post is the first in a series on how to respond to the recent power
outages in Texas. Entries on the electric grid and retailing will be published as
more information comes to light.

Adam Barth is a partner in McKinsey’s Houston office; Jesse Noffsinger is

an associate partner in the Seattle office; and Humayun Tai is a senior
partner in the New York office.

The authors wish to thank Jamie Brick, Evan Polymeneas and Kelsey Sawyer
for their contributions to this article.

1 Asher Price, “ERCOT officials won’t say when power in Texas will be fully restored,” Austin American-

Statesman, February 16, 2021, statesman.com.

2 Keith Everhart and Gergely Molnar, “Severe power cuts in Texas highlight energy security risks related

to extreme weather events,” International Energy Agency, February 18, 2021, iea.org.

3 As of February 25, 2021. For more, see Natalie Neysa Alund, “How did at least 86 people die in Austin
 area during Texas freeze? It remains a mystery,” Austin American-Statesman, February 25, 2021,

statesman.com.

4 Seasonal assessment of resource adequacy for the ERCOT region (SARA) winter 2020/2021, ERCOT,

November 2020, ercot.com.

5 Report on outages and curtailments during the southwest cold weather event of February 1-5, 2011:

Causes and recommendations, Federal Energy Regulatory Commission and the North American

Electric Reliability Corporation, August 2011, ferc.gov.

How to use analytics to improve water

asset management

Following a three-step approach, water utilities can harness analytics to enable

predictive maintenance of assets and significantly reduce costs.

  

By Izaro Arbide

By Diego Hernandez Diaz

Leads McKinsey’s Global Energy Perspective and advises energy and industrial companies on
strategy and digital to navigate the energy transition, drive growth, improve performance, and
build operational excellence

By Gaurang Jhunjhunwala
Supports energy companies with growth strategy and tech-enabled transformations

By Fernando Pérez López

By Jesús Rodriguez Gonzalez

Supports leading power transmission and distribution utilities with strategic and operational
challenges, and brings particular expertise in digital and advanced- analytics issues

March 1, 2021 ‑ Like many utilities, water utilities around the world are facing
increased scrutiny of their overall cost profiles. At the same time, they are up
against aging infrastructure, increasing nonrevenue losses, and a declining
ability to ensure proper supply and sanitation. There’s an urgent need to cut
costs—and a clear opportunity to streamline maintenance in operations.

Learning from the power sector , some water utilities are applying new
techniques in advanced analytics to help them better understand their assets’
history, health, and criticality. These insights are allowing them to create an
asset-management strategy built around predictive maintenance and target
the most important and most in-need assets.

Although unfamiliar given many water utilities’ engineering knowledge,

harnessing analytics is more straightforward—and beneficial—than
companies might expect. Indeed, companies can see benefits using very little
data—structural information and failure history, such as corrective work
orders, is all that is required to build predictive models for water assets. And
while many executives at utilities believe they won’t see benefits for the first
few years, a new maintenance plan will immediately result in savings in two
areas: savings from being able to focus on the highest risk and most critical
assets and savings from decreasing nonrevenue water losses. Finally, such
techniques are incredibly accurate at predicting anomalies in pumps and
pipes and typically prove to be more than 50 percent more effective than the
traditional engineering models used by most of the industry.

How can a company get started? A three-step approach can put water
utilities on the path to cost savings (exhibit).

Exhibit
1. Build a data lake

Maintenance and planning engineers can begin by capturing, cleaning, and

processing (also known as harmonizing) information about each of their
assets—such as OEM, age of installation, and last repair—to build a
harmonized data lake in the cloud. While it’s true that utilities can see
benefits with very little data, collecting it can be a challenge given that, when
data is scarce, it is often patchy, siloed, and not digitized. For example, one
water utility worked across departments (water generation, water distribution,
and waste-water collection) to compile its data, combining customer-
relationship management, geographic-information systems, and maintenance
pulls, as well as institutional engineering knowledge, to arrive at a common
understanding of its assets.

Once the data lake is established and the data is structured—formatted and
categorized consistently—and ready for use in algorithms, intelligent asset
management becomes very possible.

2. Quantify asset health and criticality

Next, data scientists should quantify the health and criticality of each asset,
using an advanced analytics model to determine assets’ risk value. To
quantify an asset’s health, scientists can use the model to combine the
established data lake with external data (such as temperature and
precipitation forecasts and geography and altitude data) to understand
overall asset health and probability of failure. Engineers and finance and
safety personnel can then work together to assess the cost of repair, safety
track record, and impact of failure—for example, water distribution next to a
densely populated center would score high—to determine how critical assets
are to the network.

3. Establish an asset-management

strategy built around predictive

maintenance

Finally, once water utilities understand the health and criticality of assets,
they can build an asset-management strategy that focuses on the most
critical and least healthy assets. Once they understand how frequently assets
are monitored and inspected, they can replace routine and scheduled
maintenance practices—such as routinely opening a pit in search of potential
 leaks or routinely replacing pipes—with targeted preventive maintenance
based on suggestions from machine-learning models. In fact, these models
will continue to learn based on asset performance, helping to predict the
condition of assets in the coming years. Thus, maintenance could include
installing a pump well ahead of the recommended timeline or replacing a pipe
given its likelihood of failure.

***

Using advanced analytics models to enable predictive maintenance allows

water utilities to see typical yearly savings of 10 to 20 percent in maintenance
operating expenditures and 20 to 30 percent in capital expenditures, making
it a gift that keeps on giving—if implemented correctly.

Izaro Arbide is a consultant in McKinsey’s Madrid office, where Fernando

Pérez López is a sr. expert and Jesús Rodríguez Gonzalez is a partner;
Diego Hernandez Diaz is an associate partner in the Geneva office, and
Gaurang Jhunjhunwala is a partner in the Dubai office.

How charging in buildings can power up

the electric-vehicle industry

More than 50 million electric vehicles could be sharing roads in the next five years.
Updating charging infrastructure will be key to scaling the industry.

  

By Zealan Hoover

By Florian Nägele

By Evan Polymeneas
 By Shivika Sahdev
Leader in the McKinsey Center for Future Mobility serving clients on navigating disruptions
relating to electric-mobility. She co-leads McKinsey’s work on EV Charging Infrastructure and
sustainability in advanced industries

January 28, 2021 ‑ E-mobility has reached a tipping point. More than 250
new models of battery electric vehicles (BEV) and plug-in hybrid electric
vehicles (PHEV) will be introduced over the next two years alone, and as
many as 130 million EVs could be sharing roads the world over by 2030.1 To
support these numbers, significantly expanded charging is required—and it
will not be cheap. In fact, an estimated $110 billion to $180 billion must be
invested from 2020 to 2030 to satisfy global demand for EV charging
stations, both in public spaces and within homes.

While EV charging stations in private residences are quite common today, on-
site commercial charging will need to become a standard building feature in
the next ten years to meet consumer demand. Across the three most
advanced EV markets—China, the EU-27 plus the United Kingdom, and the
United States—charging in residential and commercial buildings is the
dominant charging location for the foreseeable future and will remain key to
scaling the industry. Yet without upgrading buildings’ electrical infrastructure,
there simply will not be enough accessible EV chargers to satisfy demand.
Further complicating matters, EV charging at scale requires careful planning
of a building’s electrical distribution system as well as local electric-grid
infrastructure.

Over the next five years, EV sales are expected to at least quadruple in the
EU-27 plus the United Kingdom and more than double in the United States,
resulting in the introduction of more than 50 million new passenger vehicles
and more than four million new commercial vehicles in China, the EU-27 plus
the United Kingdom, and the United States combined. As EV prices decrease
and more models become available, EV ownership will reach a broader swath
of the vehicle-owning population, encompassing more than 10 percent of
sales by 2025 and between 20 and 30 percent of sales by 2030.

We estimate 22 million to 27 million combined charge-point units will be

needed in China, EU-27 plus the United Kingdom, and the United States by
2025 and upward of 55 million charge points will be needed by 2030
(exhibit).

Exhibit
Given the challenges and costs, as well as the need to integrate chargers with
existing building and grid infrastructure, installing the number of stations
needed to scale EV adoption will require the coordination and involvement of
entities that may have conflicting interests, such as building developers and
owners; urban planners and regulators; electrical consultants, engineers, and
 architects; charge-point operators; distribution operators and utility
companies; and charging-equipment providers.

Shortsighted decisions made today over electrical and civil infrastructure and
the capacity and technology of charging solutions could cause EV
infrastructure costs to compound to hundreds of billions of dollars. Added to
the already-severe costs of peak-demand charges and grid upgrades, the
impact of this additional investment could stall the progress of fleet
electrification as well as affordable, unhindered access to EV charging.

Market participants—including property owners and building operators, grid

operators or integrated utilities, and charging-solution providers and
operators—will need to adhere to a number of best practices to enable
productive collaboration.

***

EV charging infrastructure will operate at the nexus of three different sectors

with distinct but interdependent roles in the energy transition: electric power,
buildings, and transportation. There is an opportunity today to shape EV-
charging strategy to benefit each of these sectors independently, accelerate
the progress of the energy transition, and reduce costs for consumers, EV
owners, and non-owners alike.

Zealan Hoover is a consultant in McKinsey’s Washington, DC, office; Florian

Nägele is a partner in the Zurich office; Evan Polymeneas is an associate
partner in the Atlanta office; Shivika Sahdev is a partner in the New York
office.

1 Global EV outlook 2018, International Energy Agency, May 2018, iea.org.

How can utilities protect and strengthen

their culture during the COVID crisis?

Five actions for utilities to prioritize now

  

By Blair Epstein
Helps CEOs and leaders transform their organizations at scale, from strategy to execution

By Brooke Weddle
Drives lasting change at scale for global organizations through digital transformation, operating-
model redesign, enterprise agility, and leadership development

By Jonathan Taylor

By Mengwei Luo
Leads large-scale, complex operating model and culture transformations across sectors to drive
value creation and speed, with deep expertise in operating model design

July 1, 2020 ‑ Like every other industry, the utility sector is facing major
disruptions to their operations, workforce, and plans due to the coronavirus
pandemic. So far, utilities have done their job: providing power while
protecting their employee’s and customers’ safety. During times of stress,
however, other matters can get lost in the sense of urgency. Specifically, the
danger is that utilities will pay too little attention to protecting – and even
strengthening – their culture.

McKinsey views culture from the lens of organizational health —that is, how a
company aligns around a common strategy, executes against it, and renews
itself over time. Nearly two decades of research has consistently shown that
organizational health is a strong predictor of future performance, with healthy
companies showing three-times higher total return to shareholders and 2.5
times return on invested capital (ROIC). This same pattern applies to the
power sector, where companies in the top quartile of organizational health
outperform their unhealthy peers with 4.3 times higher EBITDA value and
better workforce safety . In short, organizational health is not a luxury to think
about only when times are good; it is a way to build an enduring high-
performance culture that can enable companies to survive the worst.

Here are five actions for utilities to take now to protect and strengthen
organizational health and to prepare for a future marked by uncertainty.

Let data guide you.

Daily operations in the utility sector have been upended. Engineers, office
staff, and planners are working from home. Those who cannot, such as field
crews and plant operators, are worried about contagion. Leaders are anxious
about everything, including falling demand and rising defaults; at the same
time, what they knew about their corporate culture six months ago may no
longer be true now.

As their employees’ needs evolve, how can utilities inform themselves so that
they are not flying blind? The answer is straightforward: ask them, often.
There are a range of tools that can help build this dynamic fact base: large-
scale weekly mini-surveys featuring only one or two questions; one-to-one
check-ins; townhall-style question-and-answer sessions; online discussion
forums; virtual focus groups and happy hours. Bring new digital tools to bear,
e.g., user-friendly solutions that allow employees to share free-form
comments via email or SMS and then use natural language processing to
distill themes. Organizations cannot assume they know what their people
need; get the facts, often.

Motivate with the mission.

Utilities provide an essential service that their customers—both individuals

and businesses—need as they weather the pandemic. This mission can be a
powerful source of motivation for employees; indeed, it is a source of pride for
many in the industry. As one utility leader told us, "We are at our best during a
crisis." The importance of developing these capabilities is demonstrated in
McKinsey’s Organizational Health Index database : the healthiest electric
power and natural gas (EPNG) organizations emphasize getting employees
involved and creating a shared vision and meaningful values.

To demonstrate purpose consistently, it is important to listen to what

stakeholders say they need most, and to meet those needs as much as
possible, even if it hurts—perhaps by suspending disconnections to
customers in default (as many regulators are now requiring). Utilities can also
use their strengths in unexpected ways, for example by delivering materials
from local health agencies when servicing residences. Senior executives
need to lead from the front, demonstrating their commitment to the mission
through substantive action—delivering food and care packages to on-site
workers and taking any pay cuts first. Utilities can also tell stories of how their
employees have helped their communities. The ability to connect with
purpose can build a sense of identity and meaning that could long outlast the
immediate crisis.

Communicate, care, and connect.

Communication is essential to keep the organization on the same page and
moving in the same direction. Remember that it's okay to not know all the
answers, and to say so. As one senior leader said, sometimes the best she
can do is say, "Here’s what I know, here's what I don't know (but how we're
going to figure it out), and here's what I hope for." The best
communicators nail five things:

Give people what they need when they need it.

Communicate clearly, simply, and frequently.

Be honest about where things stand.

Revitalize resilience by seeking to restore confidence

Establish a clear understanding of what is happening, and set out the path
ahead.

How companies lead through the crisis will leave a lasting mark. That
requires both paying attention to people’s needs and taking real action to
meet them. Wherever possible, leaders should work to accommodate workers
who are struggling with new challenges as they adapt to working from home
or new on-the-job safety requirements. Find new ways to balance child care
and health concerns. Connect with those who may feel isolated and
uncertain. Create moments for human connection with team members and
colleagues every day, whether virtually or in person (while respecting physical
distancing and other safety requirements). Demonstrate that you care about
employees' growth and long-term futures by helping them invest in their own
skills and career development.

According to our Organizational Health Index database, many EPNG

companies fall short on creating accountability and rewarding performance,
so use virtual learning and practical assignments to build skills in building
trust, having difficult conversations, and setting personal development goals.
If layoffs are necessary, it is important to communicate thoughtfully and to be
as generous as possible. How companies treat their people today will linger
long in institutional memory.

Finally, remember that leaders need support, too. One utility leader told us
that coping with the crisis while also projecting calm was incredibly stressful.
He valued the virtual leadership check-ins that his unit had recently instituted
as a place to let down his guard, ask questions, and empathize with his peers.

Change the way work is done.

The EPNG companies that rank best in organizational health have continuous
improvement cultures . They empower their employees to "find it and fix it";
set clear performance goals; share knowledge and ideas; and reward those
who find ways to deliver outstanding results. Use the current disruption to
hone execution. In previous research, McKinsey set out four building blocks
for leaders to bring lasting change: role modeling the desired culture;
fostering understanding and conviction; building capabilities and confidence;
and creating formal systems to reinforce the stated priorities. Along the way,
companies may find they have found new norms to preserve permanently.

What might this look like in practice? A few ideas: empower workers who
have unexpected downtime to find new and better ways to get work done: tap
into work-from-home/stand-by field crews to simplify procedures and to
"human proof" error-prone workflows. Celebrate wins to encourage others to
take smart risks. Invest in virtual capability-building in key areas like waste
identification and problem-solving. Ask leaders to help their teams identify
areas for improvement. Share "week in the life of" vignettes to show how
leaders and employees are making a difference. Protect and elevate those
who are excelling in continuous improvement.

Change the way work is done, rather than generating countless standalone
culture initiatives that could overwhelm stressed-out employees and not lead
to meaningful impact.

Stay close to customers.

 Even the healthiest EPNG organizations often lag global benchmarks in the
Organizational Health Index database on two criteria: external orientation and
customer focus. Utilities should use this moment of truth to refocus on their
customers and communities and to catalyze constructive change. Doing so is
not only critical to get through the current crisis, but to prepare themselves
for future disruption. Having strong external relationships matters enormously
during a crisis; it can also help build organization health by creating a positive
and well-understood internal culture.

Find ways to go above and beyond to care for your customers and
community. Reach out and let the community know how the organization is
committed to providing affordable and reliable power throughout the crisis. In
some cases, that can mean easing customers' financial burdens, whether by
passing on lower wholesale prices, informing them of energy saving
opportunities, or offering deferred-payment plans. Develop and deploy digital
options, such as alternative online payment methods or chatbots to help
avoid trips to in-person service centers. Make physical operations as touch-
free as possible. Help field crews and other company representatives can
explain why critical work, such as pole repair and land management, is
needed.

The coronavirus pandemic is a watershed moment. Now is the time for

utilities to improve their overall health and to live their purpose—not only to
survive the crisis, but to build strength for a next normal that will be very
different than the previous one.

Blair Epstein is an associate partner in McKinsey’s San Francisco office.

Mengwei Luo is an expert in the New York office. Jonathan Taylor is a
consultant in the San Francisco office, and Brooke Weddle is a partner in
the Washington, DC office.

How to decarbonize global power systems

  

By Jason Finkelstein

By David Frankel
Advises electric power and industrial companies on strategy and operations, with a focus on new
downstream business models and technologies

By Jesse Noffsinger
Works with organizations to understand, drive, and prepare for the global energy transition,
bringing deep insight into renewable and flexibility technologies and integrations into the energy
economy

May 29, 2020 ‑ Utilities, municipalities, states, and nations want low-cost,
reliable electricity. Many have also set goals to decarbonize1 their power
systems. How can they do both? In this article, we describe, in general terms,
how integrated power systems – across bulk-generation, transmission &
distribution, and direct customer offerings – can achieve up to 100 percent
decarbonization by 20402 and the approximate costs.3

In most markets, the costs of solar and wind power and storage have fallen so
far and so fast that they are often the lowest-cost option. Reaching 50 to 60
percent decarbonization can therefore be done with little or no investment
beyond that determined by purely rational economic behavior. Getting to 80
to 90 percent decarbonization is generally technically feasible, but will be
more expensive, more complicated,4 and require more market-specific
actions. At this level, the system would look noticeably different from how it
looks now. And getting to 100 percent is likely to be difficult, both technically
and economically. Newer technologies will need to be deployed to match
supply and demand when wind- and solar-power production are depressed.
Among them: biofuels, carbon capture, power to gas to power, and direct air
capture.
Given differences in climate, natural resources, and infrastructure, different
markets will take different pathways to decarbonize their power systems
(exhibit).

We have analyzed the possible pathways in four types of markets:

“Islanded” markets, refer to islands, such as Hawaii, as well as to places that

are unusually remote or isolated.

Thermal-heavy, mature markets typically have large populations, good

interconnections, and significant fossil-fuel assets. Their power systems are
reliable and accustomed to managing significant load. Germany and the
PJM Interconnection, the largest regional transmission organization in the
United States,5 are two examples of such markets.

Baseload clean markets are those that already have significant zero-carbon
baseload power—such as France, with its vast nuclear assets, and Brazil
and the Nordic region, with their hydroelectric resources. These markets
are likely to be able to pursue significant decarbonization at little or no cost.

Large, diversified markets refer to places like California, Mexico, and parts
of eastern Australia. They cover extensive territory and have good potential
for renewables—typically, a mix of wind, solar, and, sometimes, run-of-river
hydroelectric power. On the other hand, they often do not have much clean
baseload power.

Exhibit
 The road to deep decarbonization will be complicated, and there will be both
winners and losers along the way. If done well, however, the benefits could be
momentous. Customers will find their costs optimized, companies will create
new value from decarbonization, and society will benefit from cleaner air and
lower emissions.

Jason Finkelstein is an associate partner in McKinsey’s San Francisco office,

David Frankel is a partner in the Southern California office, and Jesse
Noffsinger is an associate partner in the Seattle office.

The authors wish to thank Amy Wagner for her contributions to this article.

1. We measure decarbonization as the reduction (in percent) in greenhouse-gas (GHG) emissions for a given power system.
Therefore, 80 percent decarbonization means 80 percent fewer GHG emissions in 2040 than in 2020; in 100 percent

decarbonization, the power sector has zero emissions.

2. The model includes the bulk-electricity generation, distributed-electricity generation, electric-transmission, and electric-
distribution systems (down to the feeder level). It also includes necessary interlinkages, including ties to the natural-gas network

for power-to-gas-to-power technologies and adoption of electric vehicles and other behind-the-meter devices to provide flexible
load, insofar as they provide support for decarbonizing the power sector. Finally, the model makes optimization tradeoffs across

the network, such as comparing the cost of a new build transmission line vs. a distributed battery storage system vs. operating an
existing bulk power asset. This analysis does not explore decarbonization outside of the power sector. For example, it does not

include decarbonizing the transportation or agriculture sectors.

3. We focus on decarbonization because the goal of most renewables-focused policies is to reduce greenhouse-gas emissions,
and most markets will require expanding the use of intermittent generation sources, such as solar and wind power, to do so.

4. Except in markets with high levels of clean-baseload generation—chiefly, hydroelectric or nuclear power.

5. The PJM Interconnection serves all or part of Delaware; Illinois; Indiana; Kentucky; Maryland; Michigan; New Jersey; North
Carolina; Ohio; Pennsylvania; Tennessee; Virginia; Washington, DC; and West Virginia.

A 2040 vision for the US power industry:

Evaluating two decarbonization scenarios

The PJM Interconnection, a 13-state market, is the country’s largest single power
system in generation, and second-largest in terms of greenhouse-gas emissions.

  

By Rory Clune

By Ksenia Kaladiouk

By Jesse Noffsinger
Works with organizations to understand, drive, and prepare for the global energy transition,
bringing deep insight into renewable and flexibility technologies and integrations into the energy
economy

By Humayun Tai
Leads our Electric Power & Natural Gas Practice globally, serving major utility and energy
technology clients across a variety of strategic, organizational, and operational issues

March 23, 2020 ‑ California and New York win the headlines in terms of state
action on climate change, but these two states account for only about 3.2
percent of CO2 emissions in the US power sector. By contrast, the PJM
Interconnection, a 13-state market,1 accounts for 21 percent;2 it is the
country’s largest single power system3 in generation (Exhibit 1), and second-
largest in terms of greenhouse-gas emissions. To put it another way, only five
countries produce and consume more power than PJM, which serves 65
million people.4

Exhibit 1
Two scenarios for PJM

A number of PJM states have announced decarbonization policies. These

could reduce PJM’s emissions by 49 percent by 2040 (relative to 2017) and
economy-wide emissions in these same markets by 26 percent. We call this
the status quo scenario. We also devised a hypothetical, “deep
decarbonization” scenario that envisions PJM markets reducing emissions by
95 percent by 2040, and economy-wide emissions by 80 percent.
The difference between the two is stark. Under the status quo scenario,
renewable power grows relatively slowly, and the overall capacity of fossil
fuel–fired power doesn’t change much, though lower-cost natural gas
displaces coal to a large degree. Under the deep-decarbonization scenario,
the grid shifts much more quickly toward renewable power, particularly the
use of onshore wind Exhibit 2). By 2040, emissions from the power sector
decline 95 percent. The transition is costly, however, requiring an estimated
additional $193 billion in investment over 20 years.

Exhibit 2

In both scenarios, power companies build new gas-fired power plants But in
deep decarbonization, much less new capacity is installed (38 gigawatts
compared with 68 gigawatts), and average utilization—the percentage of time
the power plant is actually in use—falls from roughly 50 percent to 25
percent. At such low utilization, revenues would fall, impairing the economic
 sustainability of much of the natural-gas industry. New market structures may
need to be devised to pay the industry for its role in load balancing, even as
its contribution to power generation declines.

In terms of its generation profile, connectivity, per capita emissions and the
price of delivered power, PJM is broadly similar to the rest of the United
States, and its decisions will have a profound effect on how fast and far the
country decarbonizes. If PJM charts a feasible path to power-sector
decarbonization, the rest of the United States is more likely to do so. If PJM
cannot, then the prospects diminish. In a sense, as PJM goes, so goes the
country.

Rory Clune is a partner in McKinsey’s Boston office, where Ksenia Kaladiouk

is an associate partner; Jesse Noffsinger is an associate partner in the
Seattle office, and Humayun Tai is a senior partner in the New York office.

The authors wish to thank Andrea Grass and Chad Powers for their
contributions to this article.

1. PJM serves some or all of Delaware; Illinois; Indiana; Kentucky; Maryland; Michigan; New Jersey;

North Carolina; Ohio; Pennsylvania; Tennessee; Virginia; Washington, DC; and West Virginia.

2. Although MISO and PJM are, strictly speaking, the names of the organizations that run power

markets in these regions, we use the terms to refer to the regions themselves.

3. The term “system” is used to refer to the country’s seven competitive wholesale power markets. Each

is run by an independent system operator (ISO) or a regional transmission organization (RTO). CAISO is

the California independent system operator and NYISO is the New York independent system operator.

4. International Energy Agency, energyatlas.iea.org.

Digital Dialogues

Frederic Dunon, executive committee member, Elia speaks on how the energy
transition will make grid planning and operations increasingly challenging for
transmission and distribution operators.
  

Video

Digital Dialogues
A conversation with Frederic Dunon, executive committee member, Elia.

Capital gains: How utilities can increase

their capital productivity

To improve affordability and performance, North American gas and electric utilities
need to spend more efficiently.

  

By Adam Barth
Serves electric and gas utilities and utility-technology and -service companies on issues including
transmission and distribution-capital productivity, growth strategy, and operations

By Sarah Brody

By Zak Cutler
Serves electric and gas utilities, energy companies, and infrastructure owners and investors on
issues related to capital investment and strategy

By Corey Hopper

August 21, 2019 ‑ From the early 1970s to the mid-2000s, demand for electric
power and natural gas in North America outpaced the growth in invested
capital. Regulated gas and electric utilities were therefore stable and
profitable. They earned reliable returns and were also able to keep customer
rates down, satisfying both customers and regulators. These positive
conditions, however, also meant that utilities didn’t need to be as efficient
with their capital as other capital-intensive industries, such as metals, mining
or oil and gas.

Now things are different . Since 2008, there has been no electric load growth
in North America. Thirty-three states and several Canadian provinces have
actually registered declines, thanks largely to greater efficiency and lower
industrial demand. For gas utilities, higher efficiency in home heating and
insulation has contributed to stagnating demand. Nevertheless, utilities still
need capital, to upgrade aging infrastructure and to make investments in
flexibility, resiliency, and functionality. According to Global Market
Intelligence, capital expenditures for major North American electric and gas
utilities have risen 7 percent a year over the past five years, with transmission
and distribution (T&D) accounting for about 60 percent of the total.

At the same time, regulators are pushing back against rate increases. In 2018,
they approved only 38 percent of such requests, compared with 52 percent
over the previous nine years. Regulators in North Carolina , Virginia ,
Kentucky , and Massachusetts , for example, rejected requests for rate
increases to fund utility grid modernization. There is a growing gap, then,
between the amount of money needed to maintain and upgrade North
American grids, and what regulators are allowing utilities to charge to raise
that investment.

Given these constraints, utilities need to use their capital more productively.
They do have options. Among them: aligning capital plans to strategic
priorities; focusing on the minimum technical solution; applying lean-
construction techniques; and using advanced analytics to make asset-
management decisions.

In this article, we discuss each of these options, and suggest questions

leaders can ask themselves to determine whether they are using their capital
as productively as possible.
Aligning capital plans to strategic priorities: Utilities need a rigorous
capital planning and risk-assessment process. This starts with developing a
common understanding and quantification of the most important risks. In
practice, different asset classes and planning groups often have different
views of what matters most; as a result, utilities’ capital plans often miss the
mark. Done right—that is, by focusing on the biggest risks and rethinking
where dollars are spent—we estimate that utilities can deploy their capital as
much as 20 percent more efficiently.

One gas utility achieved this level of impact after doing a thorough evaluation
of the roughly $3 billion in capital projects planned for the next three years.
The utility created a consistent record of the rationale and scope for each
project; this understanding enabled it to figure out which projects mattered
most and to spend accordingly.

The types of investments utilities need to make are changing. For example, as
more investments are made in supervisory control and data acquisition,
automation, analytics, and grid modernization, information technology (IT)
needs to support these efforts. Under typical capital-planning approaches,
however, IT investments are often left to the end, and then get squeezed for
funding. Implementing a planning process that shows regulators the trade-
offs between core power systems and supporting infrastructure is an
important first step to establish which projects utilities should pursue, in what
order.

Questions to ask:

How do you incorporate new and supporting investments into your capital-
planning process?

Are you assessing the projects in your capital plan in a consistent and
rigorous way?
 How has spending evolved over the last five years in different asset classes,
such as poles, transformers, IT, and analytics?

Do your decisions on capital spending fit your overall business strategy?

Focusing on the minimum technical solution: It is relatively easy to re-think

the business case, design, and scope of a project in the early stages. One
way is the “scrub.” This is a process in which a cross-functional group of
experts ask structured questions and scrutinize the project’s scope and
design to identify ways to develop it more cost effectively.

Project scrubs are common in unregulated, capital-intensive businesses that

are seeking the “minimum technical solution”—meaning the lowest-cost
design that meets current and likely future objectives. The context is
somewhat different for utilities, because they have a wider set of
stakeholders, including regional transmission organizations, regulators,
customers, and municipalities, with varying priorities. Finding the minimum
technical solution provides a way to assess whether project add-ons, such as
upgrading substation breaker designs or replacing equipment not yet at end
of life, are worthwhile. At one utility, a series of project scrubs before design
and construction identified 15 percent savings on $400 million of annual
spending on large, complex projects in the transmission organization. The
effort also identified more than $50 million in large projects that were no
longer needed.

Applying lean-construction techniques to capital projects can deliver planned

work for less, and additional work within the same budget. Lean-construction
techniques have a proven track record in other industries, as well as in utility
operations and maintenance (O&M), but they have not been widely deployed
in utility capital projects. One reason is that once regulators approve a project
budget, the utility has little incentive to cut costs. Another is that utilities
make greater use of outside contractors, rather than in-house crews. Lean
techniques for field execution, such as daily huddles (Exhibit 1), and tracking
and monitoring unit productivity, should be standard practices, but are not.

Exhibit 1

Exhibit 1: Huddle boards can be a useful aid for daily structured

conversations.

Lean techniques should also be applied earlier in the project planning

process. “Pull planning” is one example (Exhibit 2). In this process, a cross-
functional team starts with the commissioning date of a project and identifies
the critical dependencies, such as permitting, rights of way, and design. Then
it establishes milestones against each critical component, with clear
accountability. In one transmission organization, the pull-planning team found
in its first week of work that 40 percent of projects were either not on track or
the utility didn’t know if they were. By week four, that was down to less than
10 percent.

Exhibit 2
Exhibit 2: Display boards show job progress and readiness
Ideally, lean-construction techniques should be incorporated in parallel with
the capital-planning process. By using a combination of lean techniques, we
estimate that utilities can cut costs 10 percent to 15 percent.

Questions to ask:

Do you have a formal process to assess project plans against the minimum
technical solution?

Once a project business case has been set, how are scope additions
justified and approved?

How is project accountability assigned?

Do your crews or contractors know how productive they were on any given
day?

Of projects to be put in service in the next 10 weeks, do you know how many
are on target?

Using advanced analytics to make asset-management decisions: Making

sound maintenance, renewal, and replacement decisions conserves capital
and lowers the total cost of ownership. Better decisions start with the
collection and analysis of data, and this is easier than ever, through the use of
monitoring software, automated sensors, drones, satellites, and the improved
analytical capabilities available in the market.
One utility improved the use of its data to inform asset-management
decisions, leading to almost 10 percent savings in O&M and capital spending.
For example, the utility analyzed the maintenance records of the breakers
that were scheduled to be replaced in the following year. It found that 40
percent had never needed any attention; for these, preventive maintenance
was the right choice. On the other hand, three percent of the breakers had
incurred significant maintenance costs; for these, quick replacement was the
better option. Though the decisions were different, in both cases, the utility
optimized its spending. In general, we estimate better asset management
decisions can save about 10 percent—and more if digital tools and data
analytics are fully incorporated.

Questions to ask:

What data do you use for maintenance capital expenditure decisions?

How do you decide whether to maintain, repair, or replace an asset?

How has asset management decision-making evolved over the last two
years, taking into account developments in technology and data?

Improving capital productivity can seem daunting, particularly since many

utilities have not had to make this a priority. However, many of these options
can be implemented independently and even small changes can yield
significant improvements. With affordability pressures increasing and the
need for investment growing, utilities have to accept that using their capital
better is a matter of urgency.

Adam Barth is a partner in McKinsey’s Houston office. Sarah Brody is a

consultant in Washington, DC. Zak Cutler is a partner in Toronto. Corey
Hopper is an engagement manager in New York City.
How residential energy storage can

support the grid

  

Exhibit 1
April 16, 2019 ‑ An increasing number of US households are adding residential
power storage systems to reduce utility bills reductions and improve
reliability. The number of residential power storage systems is expected to
increase significantly in the next few years thanks decreasing technology
costs, increasing electricity rates, enhanced government and utility
incentives, and the increasing risk of power-disrupting natural disasters.

As residential storage becomes ever more widespread and neighborhood

battery density increases, communities may be able to tap into these
distributed power storage systems to reduce peak load, alleviate localized
bottlenecks, and improve the quality of supplied power. Using resources from
both the grid and residential systems could help make power grids more
cost-effective, reliable, resilient, and safe.

Utilities are beginning to explore compensation schemes that encourage

households to make the investment in residential storage systems by
defraying part of the cost of the battery. Several early examples are already in
flight: National Grid, Liberty Utilities, and the independent system operator in
New England have all started residential battery programs to help drive
adoption.

Exhibit 2
Exhibit 3
Residential energy storage is already attractive to 20 percent of US
households, and the market for these systems is expected to expand
significantly in the next few years. Growing interest and adoption are bringing
us closer to a scenario in which residential battery storage can meaningfully
decrease the burden on existing infrastructure, making the grid more stable,
cost-effective, and reliable. However, fully realizing the potential of energy
storage will require several market evolutions: increased customer
confidence that the batteries will be there when they need them, proven
 dispatch reliability by network storage aggregators to ensure the utility that
they can rely on these new resources, improved utility forecasting tools to
integrate these new resources into capital and operating plans, and
innovative rate structures to align cost and benefits.

Exhibit 4

Read our full article on how residential power storage could help support the
power grid—and the role of utilities and regulators.

Helping the industry navigate the energy

transition
  

March 18, 2019 ‑ We’re facing a dramatically different energy future than what
we might’ve anticipated just a few years ago. By 2035, global energy demand
is expected to plateau, and economic growth and global energy demand will
be decoupled for the first time in history. With that in mind, how can
organizations prepare?

Our recent Global Energy Perspective Reference Case puts forward our
perspective on how energy demand might evolve over the next few decades.
Our key findings have sweeping implications across various sectors as they
navigate the energy transition. In particular, we expect to see OECD countries
experience a decline in energy demand due to investment in greener, more
efficient sources of energy. At the same time, oil demand is projected to slow
and peak in the early 2030s, while coal use falls out of favor as renewables
become the cheaper option.

These radical changes to the global energy landscape can be challenging to

respond to and anticipate. For more on the implications, please download our
latest Global Energy Perspective .

Digital transformation for utilities

  

January 30, 2019 ‑ Digital has helped many organizations generate greater
efficiencies across their operational business units, significantly improve
customer experience, and accelerate innovation to allow them to stay ahead
of the competition in rapidly changing markets. Peter Peters, Partner
addresses how power and utility clients can bring digital transformation to the
heart of their organizations.
How utilities can speed up their digital

transformations

Three critical steps can help utilities overcome challenges that are impeding the
shift to digital.

  

By Adrian Booth
Works with clients across industries to develop and execute their digital vision with a specialty in
driving digital programs across the energy industry

By Eelco de Jong
Guides utilities and industrial companies through large-scale performance transformations,
enabled by technology and digital innovation.

By Peter Peters

December 14, 2018 ‑ By transforming its systems and ways of working

through digital technologies, a utility can cut its operating costs by up to 25
percent—savings that can translate into lower revenue requirements or
higher profits. Lured by this promise, many utilities have launched digital
initiatives , such as adopting predictive maintenance or optimizing
omnichannel customer experience. Yet, few of these efforts have resulted in
fully fledged digital transformations.

Why not? In our experience, three issues are holding utilities back: working
methods and mindsets that revolve around safeguarding major assets and
minimizing operational risk; the difficulty of attracting digital talent to what
are perceived as analogue-era organizations; and the presence of complex
legacy IT systems that slow innovation down.
 Overcoming these issues isn’t easy, but we’ve seen leading utilities succeed
by taking three critical steps. The first is adopting digital ways of working,
which will involve increasing their agility—their capacity for sensing
challenges and opportunities and quickly mobilizing their organization to
respond. This takes time, so some utilities seek shortcuts by acquiring or
partnering with digital start-ups or setting up an in-house digital factory to
produce digital applications using the latest technologies and working
methods.

The second key step is attracting and retaining digital talent—a tall order
for organizations seldom seen as innovative, cutting-edge businesses. To
boost their recruitment efforts, utilities can emphasize the intellectual
challenge and reward of the digital agenda, the social value of providing a
community with reliable energy, or the role technology can play in reducing a
utility’s environmental impact. Other helpful tactics include pursuing a diverse
talent pool and partnering with local universities to source digital talent and
ideas.

Finally, leading utilities progressively modernize their IT architecture and

environment—first by simplifying their product portfolio and business
processes, then by shifting from their old monolithic systems to a new
modular IT architecture. They use off-the-shelf software packages to meet
essential needs but develop custom applications for settings where
distinctive capabilities can confer competitive advantage, such as mobile-
enabled field operations.

While a comprehensive digital transformation can take years even for the
most advanced utility, following these three steps can certainly help
companies accelerate the process and improve their competitive position.

A new challenge: Renewables face a

promising—but riskier—future
In renewables projects, merchant risk could be a new challenge—though one that
developers and investors can manage with a strategic approach.

  

By Sven Heiligtag

By Florian Kühn
Helps clients seize opportunities in the fast-moving energy transition, drawing on deep expertise
in renewables and clean tech

By Florian Küster

By Joscha Schabram
Advises clients on energy markets and trading as well as smart grid, digital, and renewable
technologies across the value chain.

November 30, 2018 ‑ As the cost of renewables has dropped , so has

economic support for them, in the form of subsidies. Indeed, the very strength
that renewables have shown—in some instances, they are now competitive
with conventional sources of energy—could foster a new vulnerability.

Specifically, capital costs and construction delays used to be the biggest

risks in undertaking renewable projects. When there are no subsidies
involved, however—whether direct or in the form of guaranteed prices—
developers are fully exposed to wholesale prices. According to a recent
McKinsey report , this “merchant risk” can be up to four times bigger than
construction risk. This could have a profound effect on the industry if
management of merchant risk becomes decisive in winning competitive bids.

Therefore, developers and investors will need to think and act strategically in
their approach to long-term merchant risk. To start, they need to ask
themselves how willing they are to take risks (risk-averse, risk-neutral, or risk-
taking). Most are now risk-averse, because they have been protected by
 regulatory and economic support. On that basis, they can decide what kind of
capabilities to develop. For instance, be comfortable in taking on more risk
and develop sophisticated merchant risk management expertise. Right now,
few renewables entities have such capabilities and are rather risk-averse; that
could open the door to new players who do.

Traders and market makers, for example, can create value by managing risk
for renewables players and through their financial ability to absorb large
amounts of risk. To achieve this, however, they require a strong risk
framework as well as risk mitigation (hedging) strategies for the illiquid
horizon. And while investing in renewables could be riskier than in the past, it
is worth establishing just how big a deal that is. In Germany, for example , a
comparison of the volatility of merchant risk with the volatility of equities
found that that renewables projects were less volatile than the DAX-30, the
major stock index.

Merchant risk is coming to the renewables industry. That will be a challenge;

it does not have to be a problem—and it could be a great opportunity for
those who seize the moment.

Power plays: How utilities can face the

future

The utility industry is facing many disruptions at once. Here is how they can
respond.

  

By Tiziano Bruno
Focuses on the impact of energy transition along the entire value chain—looking in depth at the
implications of business model innovations, challenges, and opportunities for customer-facing
utility businesses—and drives McKinsey’s long-term perspective for the Electric Power & Natural
Gas Practice
 By David Frankel
Advises electric power and industrial companies on strategy and operations, with a focus on new
downstream business models and technologies

By Sébastien Léger

November 16, 2018 ‑ The world needs more power, and demand is growing;
electricity is growing faster than any other kind of energy, with value pools
growing a brisk 4 percent a year in the decade to 2025, or €235 billion.
Utilities make and sell power. The International Energy Agency estimates that
$7.2 trillion will be invested in the sector in the decade to 2025. Therefore,
utilities should be in good financial shape and brimming with confidence in
the future.

In fact, they are not. According to a McKinsey analysis of 50 global utilities ,

they delivered an average total cumulative return to shareholders of just 1
percent from July 2007 to July 2017. Many have lost value. What is going on
here? And what, if anything, can be done about it?

Utilities are in trouble for several reasons. There is the overcapacity and low
wholesale prices in mature markets. There is the rise of renewables, which
have introduced stability challenges on existing networks. There are
operational efficiency opportunities in transmission and distribution (T&D) ;
even in Western Europe, which has efficient players, the gap between the
best and the average performers is almost 100 percent. There is the rise of
new competition from other sectors, such as the oil and gas industry. There is
the fact that barriers to entry are lower than ever, given digitization, market
liberalization and interest from new entrants.

To convert demand growth into profitability, utilities should consider three

directions. First, go for scale, whether in geographic terms, or in specific
areas such as T&D and retail . Second, embrace new technologies, for
example the application of advanced analytics to asset management. Third,
 launch new business models, such as partnering with financial players who
can offer cheap capital.

The utility industry is facing many big disruptions all at the same time. For the
future to be different, and better than the recent past, utilities must be ready
and willing to change. If they do not act decisively, they will face big—and
maybe existential—risks.

Less carbon means more flexibility

With thoughtful, concerted action to support the electricity market, the benefits of
less carbon will flow widely.

  

By Evan Polymeneas

By Humayun Tai
Leads our Electric Power & Natural Gas Practice globally, serving major utility and energy
technology clients across a variety of strategic, organizational, and operational issues

By Amy Wagner

November 9, 2018 ‑ For the wind and solar industry, the past decade has
been something of a golden age. Costs have been falling and, not
coincidentally, capacity has been rising. Indeed, around the world,
renewables accounted for almost half of additional generation in 2017. In the
United States, renewables (including hydropower, which is a little less than
half of the total , but not growing) accounted for about 17 percent of all
electricity generation, and most new capacity ; in the European Union, it is
more than 30 percent of generation , two-thirds of it non-hydro; worldwide, it
is 25 percent , a record high. And given both economic and regulatory
momentum, these figures are not likely to represent peaks .

For the utility industry, these trends are something short of a blessing. When
wind and solar hit critical mass, problems can emerge for the grid. The issues
will vary from place to place, depending on what kind of renewables are being
used, the availability of transmission and distribution (T&D) capacity, the fleet
of nonrenewable generating stations, and the shape of electricity demand. In
California, for example, renewables are regularly dispatched at zero or even
negative variable cost, a phenomenon that can stress equipment—and that is
surely not a sustainable business model. In another example, seen in Europe,
short-term wind-forecasting errors can hamper the grid operator’s ability to
match supply and demand. These and related problems are likely to become
more acute as more wind and solar is used. Already, these sources made up
at least 20 percent of power generation in 10 US states .

At the same time, it is important to remember that wind and solar resources
need the services that utilities provide. The wind does not blow or the sun
shine on demand, and conventional sources such as gas, coal, and nuclear
ramp up to fill the slack. The greater use of renewables is already stressing
the grid in some markets. The implication, then, is that for both renewable
providers and utilities to secure a healthy future, they need to work together
more effectively than they do now—in terms of supply, demand, regulation,
and market structure.

There is no universal solution to how to integrate more renewables. Storage,

if and when it becomes economic , could be important; so could customer
programs and regulatory leadership. For utilities themselves, though, there
are universal priorities—specifically, to improve their resiliency and flexibility .
That has to start with accepting that the future will be different—and then
planning for it. The grid-planning process has to be widened, to include non-
wire alternatives; it should consider both utility-owned plants (including
storage), as well third-party aggregated distributed energy resources (DERs).
Another approach to consider is to create new services, or at least work with
others to do so. In Europe, where many utilities took a big hit as renewables
began to gain traction, “virtual power plants” help to balance the
intermittency of renewables with the flexibility of DERs, such as onsite
generation, and load resources, such as big commercial facilities .

Another is to improve T&D integration . Granted, there are big regulatory

issues, particularly when distribution assets provide wholesale-market
services. It doesn’t help that standards related to DERs often do not exist or
are in flux, when it comes to metering, telemetry, and control in wholesale
markets. In the United States, for example, electric utilities struggle to price,
measure, and manage DER services, limiting their participation in the market
—and also for operators to profit from them.

A third is to allow utilities to become platforms for grid-related products and

services, such as measurement and verification, customer acquisition, and
DER management services. By leveraging their communications and IT
infrastructure, as well as their operational expertise, utilities can create value .
In the longer term, utilities may want to redesign their systems with the
explicit goal of providing the services necessary to integrating DERs. That will
enhance the value of the grid. In the shorter term, it may make sense to work
with regulators to allow them to give incentives to move demand to hours
when renewable sources are more abundant.

From wood to coal to oil to gas—the historic trend of energy has been toward
lower-carbon sources. We believe that this is still the case. For economic,
environmental, and practical reasons, the use of lower-carbon renewables will
likely grow. As technological improvements and the new operational realities
of a renewables-based electricity mix create opportunities for new types of
resources, it is important that market designers, market participants, and
policy makers take part fully in the market’s evolution. The electricity market
will not—and should not—evolve in a vacuum. With thoughtful, concerted
action, the benefits will flow widely.