Strategies for Energy Executives
Strategies for Energy Executives
CAMPAIGN: Global Energy Seminar
The challenges facing the global energy industry are more complex than ever before. Today’s companies must navigate not only heightened environmental concerns, but also uneven globalization, regulatory restrictions, investment risks, and other issues. In this interview, Harvard Business School (HBS) professors Rawi Abdelal, Forest Reinhardt, and Richard Vietor discuss how these challenges—along with ongoing technological advancements and recent political developments in the Middle East—are shaping the future of the global energy marketplace.
What strategies should energy executives employ to analyze and minimize investment risks?
Reinhardt: There are two fundamental ways of approaching a risk problem: either try to relieve the risk by hedging with real assets or contracts, or embrace the risk and welcome the exposure. Sometimes energy managers don’t want to bear risk, but in many situations the leaders of energy firms actively seek increased risk because it brings with it an increase in expected value. Energy leaders need to determine how they can most cheaply reduce the risk exposures that they don’t want while getting compensated for the exposures they want to retain. One of the things we try to do in the Global Energy Seminar is to expose our executives to a broad range of risks and uncertainties so that they explore different perspectives on them, understand their relative magnitude, and decide the desirability of retaining each type of risk.
Vietor: In the last energy seminar I taught a case on American Electric Power, in which the company assumes a huge risk in trying to develop carbon capture and sequestration. AEP creates a demonstration plant that is the largest in the world. It’s a very large risk for the company—not only in terms of technology and the environment, but also a huge financial risk. It’s not at all clear that the company can recapture the cost in the rate base. But it decided to take on this risk because the chairman of the company is a leader who feels that the only way coal is going to be viable in the future is to move forward with carbon capture and sequestration.
Abdelal: There are energy firms that decide, as AEP did, that they can live with certain risks. They see where the regulatory environment is going and determine that a specific risk can be managed in the future.
Reinhardt: When you have a supplier and a customer who are very important to each other, they’re imposing risk on each other. They can lull themselves into thinking that those risks, because they go in both directions, have to be symmetrical. But they may not be symmetrical. It might be that the customer is in a much more vulnerable position than the supplier.
Vietor: Government policy is important in mitigating some of those risks. In the United States, the failure of the Waxman-Markey carbon legislation allowed those risks to persist for a number of the coal-related companies—even the coal-related railroads.
What is disintermediation and how does it affect existing and emerging players in the energy industry?
Abdelal: Over the past 15 to 20 years, many of the activities that traditionally had been performed in house by the western majors, in terms of projects that they ran around the world, were outsourced to service providers in various ways. This has led to the rise of great service providers such as Schlumberger and Halliburton, which have influenced the way energy markets are organized. As that has happened, some of the key value-added strategies by the majors have been moved outside those firms. That has been good in many ways in terms of specialization, but it has also created some interesting challenges for the governance of those projects. If we think about the BP oil spill, it was challenging to figure out which part of the chain of command was most responsible for what happened, because there were so many parties involved. So this trend has transformed the markets—not only in terms of how much profit there is to be made by big companies and other providers within those markets, but also in terms of how complicated the governance has become for some major projects.
Vietor: Harkening back again to the Global Energy Seminar, the Suntech case included an elaborate supply chain. Suntech had originally backward-integrated with regard to polysilicon because the number of competitors was huge, and they were all increasing their capacity. The company then integrated forward into systems where they compete with some of the same players that buy their sells. So it’s very hard in these different sectors for a company to know where in the value chain it should be, and where it can capture the largest economies of scale.
Reinhardt: The difficulty that firms have in predicting where in the value chain the rents are going to fall is what led to vertical integration. But right now the majors can’t achieve the integration that they most desire—upstream into equity oil. This is leading them into competing with their suppliers, who are traditionally willing to sell services for a fee rather than take an equity stake. And that’s putting quite a lot of pressure on them.
What will participants take away from the Global Energy Seminar?
Abdelal: One of the most important things they will experience is exposure to other industry executives. We prepare the cases and manage the discussion in a very open way, but much of the learning comes from the interaction among peers. Our audience tends to be experts in the subject matter. They teach each other—across energy sectors and across the vertical value chain, from small entrepreneurs to state-owned companies. In day-to-day business, an upstream nuclear professional doesn’t interact with a downstream wind professional. We provide opportunities like that. Overall, it’s a wonderful opportunity for them to talk with each other.
Reinhardt: We bring together people from big firms and little firms, from the oil business and the wind business and the nuclear business, from rich countries and not-so-rich countries, from producer nations and consumer nations. And we give them an opportunity to learn from one another in a relatively unstructured way. We understand that there is no shortage of opportunities for people to squint at someone’s PowerPoint in a dark room. But we’re not interested in providing that kind of seminar.
Who should attend the Global Energy Seminar?
Vietor: This program is ideal for a broad range of executives, from large companies to startups, from different functions, and from many countries around the world. These include finance executives, regulatory executives, professionals who are involved in technological innovation, and those focused on exploration.