Blockchain and the energy sector
Blockchain has become a buzzword, but leaving the hype aside, when applied to the energy sector, it has the potential to reduce business complexity and improve both profitability and customer experience.
Blockchain is basically an open ledger.
It has immediate application in energy asset management, energy trading and payment mechanisms. However, as understanding of blockchain increases, people are finding new applications.
In future, the use of blockchain, in combination with other emerging technologies such as smart contracts, intelligent sensors and the “internet of things,” could change user engagement and potentially alter market structures.
The physical movement of energy remains at the heart of these transactions.
Therefore, it is necessary to consider how blockchain applications will interface both with physical energy infrastructure and with the regulatory framework governing the sector. These industry-specific considerations must also be overlaid with other, more ubiquitous regulatory requirements, such as rules relating to data privacy, corporate governance and fraud prevention. The result is a complex regulatory matrix that varies according to energy sub-sector and jurisdiction and that will inevitably need to adapt to accommodate the opportunities that blockchain presents.
Finally, the adoption of blockchain by the energy sector also needs to be carefully considered in the light of the energy demand required for it to function; it must be sustainable. The energy usage required will depend on whether a permissionless system is needed, which may not be the case in many energy applications. Designers of new platforms must be mindful of this.
The focus of this article is existing, emerging and future applications of blockchain in two key energy industry sub-sectors: energy trading and power.
The contents are adapted from the latest chapter in our “Unlocking the Blockchain series - Chapter 4: Digitizing the energy value chain.” The full paper, as well as earlier chapters, can be found on the Norton Rose Fulbright website here.
Blockchain can act as a trusted platform for parties to record transactions and distribute information among themselves without having to share everything with a central entity. It also allows participants to transact using new technologies and data, such as internet-of-things devices, other sources of data from off the ledger (often known as oracles) and smart contracts.
Blockchain allows creation of synchronized electronic “ledgers” or records among transaction counterparties to create a single and shared version of data, commonly known as a “single version of the truth.” Thus, blockchain allows parties to avoid transacting on the basis of disparate and disconnected systems which can lead to reconciliation errors. Recordkeeping and record validation become a combined and automated activity. Transaction time scales can be reduced. Blockchain can shorten the settlement time to near real time.
It also has the potential to share costs among multiple parties and reduce them overall by streamlining numerous processes.
It may increase cybersecurity for the data recorded. For example, digital currency is not stored in a file. Instead, it is represented by transactions indicated on a cryptographic hash available for all platform users to see.
There is greater accountability. Transaction steps are recorded on the blockchain, and all participants have shared access and can spot any errors. There is an audit trail of all information and data.
Blockchain enables automation. Blockchain platforms can provide automated or partly automated products and services through use of “smart contracts.” A smart contract is a computer program that encodes conditions and outcomes and can move currency or information across the ledger.
There are possible uses for blockchain in the energy sector.
It is expected to enhance the products and services offered. For example, Grid+ is operating a platform where, using a so-called smart agent, energy will be bought and sold in exchange for cryptocurrencies such as BOLT. Separately, exchange platforms, such as WePower or SunContract, are exploring the use of tokens in energy trading.
Blockchain will let market participants more easily verify material facts relevant to the energy products being traded, such as the ownership, location or provenance of the product. Removing “unknowns” from the trading process may increase trust between the parties as well as improve compliance checks.
Blockchain is expected to play a role in emissions trading and assist with renewable energy certification because it can be used together with intelligent sensors and smart meters to provide more accurate data. For example, IDEO Co Lab, with Nasdaq’s and Filament’s support, reportedly designed a prototype of a blockchain-connected solar panel that monitors its energy and autonomously creates the renewable energy certificates. Separately, Poseidon is understood to be developing a blockchain-enabled system that will allow emissions allowance to be traded transparently, enabling greater regulatory compliance. Regulators might adopt a similar system for reporting renewable energy certificates used in fuel mix disclosure and renewable portfolio standards.
Big data are being used to inform increasingly precise and segmented trading decisions, including pricing and risk assessment.
Blockchain may provide potential new data sources for analyzing big data in almost real time that can then be used to inform trading strategies and pricing decisions. Access to near real-time information might enable better monitoring of open positions, mark-to-market exposure and customer credit standing.
Blockchain could be used to store data on counterparties, subject to customer agreement. For example, once a counterparty is validated by another trusted market participant, the counterparty could be accepted by reference to its existing records in the ledger. This may ultimately require regulatory approval as a regulated entity does not typically discharge its regulatory know-your-customer obligations by relying on checks undertaken by another entity.
Blockchain may reduce the number of administrative processes involved in deal execution. With the use of smart contracts and systems of electronic payments, it may, for instance, be possible for blockchain to execute dispatch of commodities automatically once the trade is booked.
By reducing the involvement of intermediaries, blockchain will decrease the time and costs involved in executing transactions. For example, when ING and Société Générale concluded the first oil trade using a prototype blockchain platform, Easy Trading Connect, ING estimated that blockchain helped reduce its involvement in the transaction from three hours to 25 minutes, resulting in 30% cost savings per transaction.
Blockchain can also automate much of the regulatory reporting process. It lets trade data be posted directly to regulators’ systems.
Altered market structures
The power value chain has been divided traditionally into generation, transmission and distribution, supply and consumption.
Blockchain and other innovations are likely fundamentally to blur the distinction among these roles, potentially altering market structures.
For example, blockchain has already changed the fundraising methods used by some energy start-ups. “Initial coin offerings,” often described as the evolution of crowdfunding, have been particularly prominent. Power Ledger reportedly raised more than $24 million in an initial coin offering by selling POWR tokens using an Ethereum-based technology.
Such offerings also have the potential to raise funds for constructing power plants, as an alternative to traditional debt or equity capital, by allowing developers to sell tokens representing kWh units of future energy.
These tokenized rights to the power produced are sold at a discounted rate to the market price, much like a forward power purchase agreement. This approach was pioneered by WePower, a green energy trading platform and independent energy supplier. Customers holding tokens acquire rights to discounted electricity generation or can trade these rights.
Blockchain will also make small grids more commercially viable, allowing “prosumers” — that is a person who both produces and consumes a product such as electricity — to sell excess energy to other households. An example is the Brooklyn, New York micro-grid project designed by LO3 Energy that lets households trade excess solar power directly.
Blockchain can help manage over- or under-supply of energy at peak times. It can record and regulate metering systems, networks, generation facilities and demand-side response. Reporting of positions to system operators by balancing market participants could be fully automated, and smart contracts could be used to execute efficient transactions needed to balance supply and demand.
For instance, in November 2016, TenneT announced that in Germany it was running the first European blockchain-controlled power stabilization scheme, in a partnership with battery supplier Sonnen, using IBM’s blockchain software. To balance the system, instead of dispatching power plants, TenneT draws the required electricity from Sonnen’s customer home storage systems. Blockchain can support this technical solution by tracking the movement of excess energy and helping to manage bottlenecks.
In areas with less developed electricity networks, blockchain and smart contracts can facilitate access to electricity by making it easier for micro-grids to function and by coordinating trading and operations among small generators, diesel back-up, battery storage units and smart appliances in order to provide security of supply.
Blockchain can make metering more accurate and facilitate switching among energy suppliers. For instance, Electron is working on a proof-of-concept platform populated with simulated data from 53 million metering points and 60 energy suppliers to represent the UK market. Scale-out tests have shown it capable of executing switches over 30 times faster than is possible currently.
It may also reduce the operational hurdles to collecting and analyzing corporate energy usage data across multiple facilities in different countries. This will help identify potential savings.
Blockchain can also create real-time payment systems. For example, in South Africa, Bankymoon has launched an application for pre-payment meter top-up using Bitcoin.
Legal and regulatory issues
The energy industry is highly regulated. Regulation will have to evolve to deal with the many uses of blockchain. Issues crop up in the following areas.
In the United States, although many entities still provide bundled services, federal regulations restrict the ability of internal business units engaged in energy delivery, on the one hand, and in production and supply, on the other hand, from sharing non-public, operational information. This is a matter of competition law.
A license is required to supply retail customers in many jurisdictions, which makes peer-to-peer supply difficult.
Gas and electricity must be physically delivered. Transmission and distribution network returns are generally regulated, permitting recovery of capital infrastructure costs from customers over the asset life via rate structures. Where customers choose to go “off-grid” and to use independent energy supply regimes such as micro-grids, the network owner faces a shrinking rate base, meaning higher costs per remaining connected customer.
Collaboration with regulators will be important for those developing blockchain platforms.
Another issue will be how legal relations between participants will be recorded and managed. One approach may be to put in place a participation agreement to be entered into on behalf of each participant. The participation agreement would act as a governance framework for the platform setting out, for example, the agreement as to access and administration of the platform, allocation of validation permissions, how regulatory compliance is assured and how liability is apportioned among participants.
Consumer protection will also loom large in transactions with the general public. The current energy regulatory framework is based on a clear delineation of roles within the system (for example, supplier, customer, transmission owner). However, in the medium to long term, this framework will have to be adjusted to accommodate changes to generation and consumption brought about by the convergence of distributed energy, energy storage, electric vehicles, smart appliances and distributed transaction models. The market will require a policy framework that is flexible enough to support innovation while providing consumer protection.
Where blockchain is used in a regulated activity, then it is possible that entities using it could require authorization to do so. Financial regulatory authorities are taking a close interest in blockchain and crypto-currencies; in particular there is likely to be increased scrutiny of the initial coin offering market.
Privacy-related issues must be also considered. The sharing of information passed through the blockchain will need to comply with local data-protection rules.
There are a number of intellectual property rights associated with blockchain. Blockchain has an “open source” core upon which a bespoke application may be built. It also contains data in the form of a database of “messages” or transactions. Businesses developing the technology will want to take steps to entrench value via the protection of intellectual property rights in it and to ensure that what they are developing does not infringe another’s intellectual property rights. Similarly, businesses that license the technology will need to undertake due diligence to ensure that they have the rights they need and protection for their use if it infringes another’s intellectual property rights.
Information can be included in a distributed ledger that is false, whether through mechanical error, human manipulation or through cyber intrusion. Due to the immutability of blockchain (as it stands at the moment), such errors can become locked into the chain. A methodology for error adjustment will have to be incorporated into the framework.
Crypto-currencies, like bitcoin, require high levels of processing power for mining. The International Energy Agency estimated in 2017 that the electricity usage by bitcoin data miners may currently be on the order of 0.25% of global electricity use.
Blockchain uses a consensus protocol, agreed among the participants and provided for by the rules of the relevant distributed ledger to facilitate agreement on data among the relevant parties. The consensus protocol may take the form of a “proof-of-work” mechanism, a “proof-of-stake” mechanism, an administrator or a determined sub-group, depending on how a distributed ledger is designed and its proposed functionality.
Bitcoin and many other crypto-currencies use a proof-of-work consensus, which creates high electricity demand by requiring computing power to solve mathematical problems to prove the integrity of the information contained on the ledger.
By contrast, permissioned or closed systems, where transactions are taking place between parties with existing legal relationships, may adopt consensus protocols requiring lower energy usage.
The energy usage associated with blockchain is an important consideration to be factored into the design and implementation in any sector.