Blockchain technology receives a lot of media attention these days with promises made that it will revolutionise many sectors. Blockchain is the backbone of cryptocurrencies such as Bitcoin or Ethereum.
As blockchain was developed as an offshoot from the financial sector, it makes sense to compare the possible applications in the energy sector to those developed from the financial sector.
The use of blockchain could remove the need for banks as middle men. Accounts would be based on the distributed ledger, and the transaction would be securely recorded. This would reduce costs and increase transparency.
The energy sector however has a different concept of “middle men”. In many transactions, a physical delivery of gas or electricity is made. As you can see the system is highly complex:
It involves various market participants between buyer and seller, including transmission system operators (TSOs), exchanges, central counterparts, and clearing houses. These may be involved in:
– operating critical transportation / transmission infrastructure; or
– reducing the risk of counterparty default.
Regarding infrastructure, this would be required even under a blockchain and smart contract regime. Assuming that TSOs are “middle men”, in order to be removed either buyer or seller would need to own the linking infrastructure.
Regarding default, such “middle men” are designed to reduce transaction risk. As blockchain seeks to remove third parties to reduce transaction risk, it could be argued that no significant benefit is to be gained through replacing such third parties by using blockchain.
In light of these factors, two questions are key to considering the value of implementing blockchain in the energy sector:
– Who do you want to remove from the transaction? e.g. facilitator, transporter, exchange operator, clearing house
– Why? e.g. reduction of cost, risk, other?
The answers to these should be considered in that the success of blockchain lies in its specific ability to:
– reliably and securely record transactions; and
– automatically execute transaction-specific clauses.
Considerations in implementing blockchain
Certain energy transactions lend themselves well to justify the use of blockchain, such as the trade of Renewable Energy Certificates or Guarantees of Origin, whereby:
– the administrative infrastructure is currently designed to ensure a reliable register of transactions and the prevention of double counting; and
– transactions are separate to the trade of actual electricity, so that there is no (direct) physical delivery component, i.e. the transaction is entirely virtual.
Other transactions are however more complex, such as those requiring the physical delivery of energy. These may currently rely on administrative infrastructure designed to reduce risk, negating any significant benefit which blockchain could offer.
Furthermore, these require physical input from the contracting parties or third parties, potentially undermining the benefit of automatic execution and/or the security of the system.
• As demonstrated by some of the pilot projects, wholesale electricity and gas trading may lend itself to a shift towards blockchain technology.
• Unlike many other physical goods, gas and electricity transport is to a great extent already controlled remotely. Smart contracts could enable the automatic execution of a gas delivery from one party to another.
• Payment could be made automatically by transferring a fiat currency held in escrow or a cryptocurrency. This would significantly reduce the risk of buyer default, and only upon full payment would the title to the gas be transferred.
• Using a framework agreement, blockchain could reduce transaction times, costs and the risk of payment default, and reduce the need for insurance and credit guarantees. Transaction data could be automatically reported, facilitating regulatory compliance and offering market price tranparency.
• This system could be coupled with the automatic matching of gas supply and demand across various timeframes, allowing for highly efficient and low cost electricity gas markets.
• The adoption of blockchain and smart contracts by various sectors appears to be gaining momentum. This is likely to continue.
• Blockchain is a technology still in its infancy and there are no clear trends or limits as to how it could be used in the energy sector. There are many pilot projects which are currently exploring various uses.
• The initial use for blockchain in the energy sector will likely be process optimisation, involving the automation of simple and standard internal processes.
• There are however several takeaways from a legal review of the benefit of blockchain in its current form, in particular smart contracts
– smart contracts are self executing, however cannot replace paper contracts and require a conventional legal framework to have legal effect;
– smart contracts appear to work best when a contract is entirely virtual, rather than requiring physical inputs or deliveries; and
– consideration must be given whether removing the third party from a transaction is of actual benefit in terms of increasing efficiency and reducing costs and risk.
• In testing and implementing a blockchain system, one needs to consider the type (public, consortium or closed), as well as whether one should develop the blockchain internally or outsource it to a blockchain service provider.
• Even where large companies could absorb the risk associated with internally- performed smart contracts, it would need to consider matters such as:
– whether blockchain would be implemented for a core (high risk) or non-core (low risk) business area;
– the degree of control it has over the blockchain;
– data privacy issues the balance between encryption and transparency;
– IP rights over the data (held by the company or the service provider);
– performance assurances from and liability of the service provider;
– the appropriate jurisdiction;
– regulatory compliance obligations; and
– an exit strategy(e.g.data migration assistance).
Source: Andreas Gunst and Kenneth Wallace-Mueller from from DLA Piper