The energy sector has always lived with a degree of uncertainty. Every stage of the supply chain, from drilling to distribution, is sensitive to the price of oil, which is in turn dictated by factors as unpredictable as international politics and consumer trends. Also, the past few decades have seen countries including the UK open up previously nationalised infrastructure to competition, with unpredictable effects.
But the industry’s future is arguably less certain today than it ever has been. Prompted by environmental and geopolitical concerns, the whole world is rethinking the way it produces and consumes electricity, and governments are experimenting with measures to reduce energy consumption and encourage the use of renewable sources.
The industry is also at the brink of a technological revolution, with so-called Smart Grid systems promising producers greater control over their distribution networks, and consumers greater insight into their usage patterns.
Thirdly, the political structure of the Middle East, so pivotal to the global oil and gas economy, is in evident upheaval.
And fourthly, the growing economic influence of China places another question mark over the sector’s future. “It is hard to overstate the growing importance of China in global energy,” said Nobuo Tanaka, executive director of the International Energy Agency, at an event in London in November 2010. “How the country responds to the threats to global energy security and climate posed by rising fossil fuel use will have far-reaching consequences for the rest of the world.
“The energy world is facing unprecedented uncertainty,” Tanaka said.
This uncertainty has been reflected in a number of IT outsourcing megadeals signed by energy companies in the past few months. Many of these deals have included measures to protect the buyer from uncertainty by building in a degree of flexibility, thereby reducing the risk that they invest in more IT than they eventually need.
In November 2010, European energy giant E.ON announced two large IT outsourcing deals, together worth e3.2 billion. It handed network infrastructure management to T-Systems, and desktop and data centre management to Hewlett-Packard. E.ON remarked that the decision to outsource had been prompted by a need for more “agile” IT systems to maintain leadership in the “ever-more dynamic energy market”.
Soon after, HP also won a $400 million contract from existing customer BP, which includes provision of flexible, ‘cloud-based’ hosting services.
Centrica, the parent company of British Gas, signed a similar deal with HP in February 2011 (HP seems to have been the main beneficiary of recent outsourcing activity in the sector). Under the seven-year, £250 million contract, HP will provide Centrica with utility computing services, ostensibly allowing it to scale usage and up and down according to demand.
In March, French energy giant EDF appointed compatriot suppier Capgemini to provide IT services and desktop support to its 15,000 users. The £100 million contract is for three years, with an option to extend it for a further two years.
And in April 2011, HP (again) won a seven-year contract with National Grid, which operates the entire electricity and gas infrastructure in the UK and is expanding overseas, to provide IT service management. As explained below, that deal is the first step by National Grid towards an entirely new operating model for IT, in which flexibility is one of the primary concerns.
This seems like a burst of outsourcing activity. However, the energy sector, alongside financial services and manufacturing, has long been one of the most voracious consumers of outsourced services. Outsourcing advisory firm TPI says the combined value of deals by energy companies has been stable for the past three years, and despite these high-profile deals it does not expect to see a marked uptick in the first quarter of 2011.
Nevertheless, the details of these recent deals reveal an industry that is attempting to plan for the unknown. With the future post-recession economy remaining uncertain, that is a discipline that businesses in all sectors would do well to perfect.
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According to John Keppel, a partner at TPI, flexibility is one of the primary drivers of outsourcing contracts across all sectors these days. “Outsourcing is famous as a tool for cost savings, but the majority of the work that we do is focused just as much on variability and flexibility as it is on cost,” he says.
For companies facing uncertain demand, Keppel explains, the priority is to reduce the risk of making investments in IT that go to waste if it is not used. “They don’t want large pockets of trapped investment,” he says. “They want to be able to use their investments across the business, and change the direction of IT capacity if necessary.
“With a lot of in-house IT operations, that is extremely difficult to do,” he explains.
Keppel argues that the best way to achieve this is to appoint a variety of outsourcing suppliers, and to make sure that the contracts contain mechanisms to scale service volumes up and down according to demand.
“When you can start to look at your IT operating model a little bit more holistically, and get different service partners for specific things, with contracting vehicles that allow to ramp up and down very quickly, that is when you get good cost variation,” he explains. “That is what allows you to make swift business decisions.”
The deal between HP and E.ON, in which TPI was involved, is a good example of this transformational outsourcing in action, Keppel says. “E.ON is moving into a much more balanced, multi-sourced supply environment, where they have a number of different parties providing services.”
To a degree, Keppel says, virtualisation and cloud computing make it easier for providers to offer that variability of service volumes when it comes to hosting or data centre services. “Now, it’s much more possible for organisations to really get the on-demand notions that, although they were marketed for a number of years, were difficult to get contractually.”
That said, IT services providers are still often reluctant to offer the ability to reduce the volume of services, Keppel explains, as obviously it means they get less revenue.
“Is it easy to convince [suppliers] to have scalability on the downside, the same way they have scalability on the upside? No, it’s not,” he says. “But it is expected, and the vendors understand that that is the role they play. Because they service multiple clients, they are better able to balance the investment risk.”
The volume of a service that a company receives (e.g. the number of desktops supported) is not the only factor that can be scaled up and down: they might also want to vary the level of that service (e.g. how many hours a day desktop support is available). According to Paul Dyson, an energy expert at management consultancy PA Consulting, making sure service levels can be flexed up and down is another effective way to reduce the risk of over-investment.
“I have seen deals that have the scope for four or five different levels of service, where the customer can drop down tiers of service if they need to save money” he explains. “There are limits, but that allows you to control how much service you are actually buying and you’re not stuck with a single service level for the life of the contract.”
Dyson believes that cloud-based hosting engagements, like HP’s deals with Centrica and HP, have the potential to achieve the efficiencies that previous data centre outsourcing were supposed to deliver, but often did not.
“Four or five years ago, everyone was talking about outsourcing data centre operations,” he says. “But when you look back now and ask whether those kinds of deals achieved what they set out to, the answer is probably not. In a lot of cases, the customers ended up hiring extra staff to do a lot of internal data centre management.”
However, the IT services industry’s ability to live up to that potential, and the buy-side’s ability to evolve their systems to a point where cloud-based hosting is appropriate, are still both unproven, he adds.
“For the energy companies, it’s not just a case of lift and shift – there’s a huge amount of change that needs to be done around standardisation, and understanding exactly what it is they want their providers to deliver,” he says. “Meanwhile, the vendors have some great marketing material but they’ve got very little track record delivering [cloud-based services]. So there’s a huge amount of potential, and with the right focus it could work, but it’s not without risk.”
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When National Grid Plc signed its seven-year IT service management outsourcing deal with HP in April 2011, it was the first step in a far-reaching reinvention of the company’s entire IT operating model.
The company was created in 1990, when the UK’s national electricity distribution infrastructure was privatised. In 2000, the company began to diversify, acquiring the country’s privatised gas distribution operator and a number of energy companies in the north-east of the US.
In 2003, it outsourced much of its UK-based IT operations to CSC, but the US divisions continued to operate their own in-house IT departments. These various divisions often use their own systems, and today the company uses around 17,000 different applications.
Now that the original CSC contract has expired, National Grid is moving to a single, global outsourced IT operating platform. This will consist of a number of component services, each sourced individually, most of which have yet to be awarded to any supplier. They include data centre services, network management, application development and management, email and collaboration, cloud hosting and more.
Under the seven-year deal announced in April, HP will provide IT service management functions, including help desk support, incident resolution and supplier management, from its offshore facility in the Philippines (with some extra resources in Tulsa, Oregon, to meet data protection requirements in the US).
According to Martin White, National Grid’s account manager at HP, the service management contract was awarded first because it will be the point of integration for all the other services. “They’ve always said they need the service management supplier to be able to manage onboarding and offboarding the other service providers,” he explains. That also explains why the contract is for seven years – longer than any of the contracts are expected to be, he says.
The service management layer, White explains, sits across all the other services, providing a bird’s eye of view of how much IT is being consumed and where. One driver for this is regulatory compliance, he says: parts of the company are still regulated, and others operate in competitive markets. It therefore has to prove that IT services procured by the regulated components are not being used to support the competitive divisions, giving them unfair advantage. “They have to be able to say how much each line of business is being charged for each IT service.”
The other key driver for the new IT operating model is flexibility, says White. Even the IT service management layer itself scales according to demand, he says.
For one thing, the company hopes to explore new geographical markets. “They want to expand into new parts of the world, but they also want to be able to move out of those areas if need be too,” White explains. “Their business depends heavily on the regulatory environment, and if the environment changes in a market they don’t want to be stuck there.” This underlines the need to be able to scale down IT operations at will.
The other reason National Grid in particular needs flexible IT provision is that it is at the sharp end of the Smart Grid revolution. Its customers – energy producers, distributors and retailers – may soon require detailed, real-time data about the performance of its gas and electricity grids, which would require an altogether more complex IT infrastructure than it operates today.
White says that the implications of Smart Grid were not explicitly discussed as the HP deal was being negotiated, but he nevertheless says it is something that the National Grid is giving serious thought to. “They have a big programme around Smart Grid, but I believe that they are as uncertain as anybody as to what it really means to them as a company,” he says.
The magnitude of that approaching challenge is another reason why energy companies are keen to outsource conventional IT, White argues. “I think energy companies are going to have so much on their plates managing Smart Grid that they just want to get rid of all the normal IT stuff they’ve done in the past.”
