This document discusses Saudi Arabia's transition to more sustainable energy sources from its current reliance on oil. It notes that Saudi Arabia has faced challenges related to sustainability, competitiveness and energy security that will drive a "third energy revolution" focused on sustainable resources like solar power. The document analyzes how path dependence and lock-in to oil as the dominant energy technology have made this transition difficult but also discusses how entrepreneurship and policy support can help drive innovation and the commercialization of new technologies to enable Saudi Arabia's transition to a more diversified energy system.
Venture Capital and Cleantech: The Wrong Model for Energy Innovation
Entrepreneurship in the Middle East energy sector
1. Entrepreneurship and Path Creation in
the Saudi Arabian Energy Transition
By Tatjana de Kerros
Posted on April 9, 2012 on The Entrepreneurialist
A nation’s transition from
one technological path to another is the underlying feature to understanding the
transformation to an innovation-led system. The process of change and factors that
favour the adoption of certain types of technologies over others enables to examine the
role of different innovation mechanisms and actors that drive an economic and
industrial transformation.
Within the last two years, three combined challenges have emerged in the Kingdom of
Saudi Arabia; sustainability, competitiveness and energy security. These challenges are
coupled with other pressing macro-economic issues such as job creation, workforce
nationalization and diversification of the economic structure. In the coming years, these
factors will be drivers of the third energy revolution in Saudi Arabia.
The first energy revolution started in 1938, with the discovery of oil fields in Al
Hasa and the formation of the most powerful oil company in the world, Saudi Aramco.
The second energy revolution in 1973, led by the OPEC crisis and the oil embargo, saw
the price of the barrel double and led to one of the fastest economic and infrastructural
transformations ever seen globally. Saudi Arabia transformed from oil exporter to one
of the most powerful and affluent nations in the world, having a widespread effect on its
organizational and industrial evolution, whose impact remains visible to this day. The
third energy revolution is shaping, its backbone remaining Saudi Arabia’s vast natural
2. resource wealth, but this time, sustainable resources are the central feature of this
transition.
In 2011, Saudi Arabia saw a US$ 40.3 billion loss in oil revenues due to domestic
electricity consumption, which is encountering a 5% growth annually, and has risen by
27% in the last four years alone. Oil revenue losses are expected to rise to US$ 54.9
billion by 2015, equivalent to one third of Saudi Arabia’s 2012 national budget and 18
times the expected government surplus. According to the Electricity and Co-Generation
Regulatory Authority (ECRA), the number of new electricity consumers rose by 57.4%
from the period 2000-2009, 52% of which is compromised by residential growth
alone[1]. By 2016, the number of customers connected to the power grid is expected to
grow by 116%, and the impetus given by the Saudi government to increase private
sector actors has seen an increase of 93.7% in sold energy by the SEC to the
commercial sector[2].
However, Saudi Arabia is far from blind from these issues. Rather, the unfolding of its
domestic energy security has given rise to the opportunity to invest in new technological
paths that will transform an energy crisis into an energy revolution. Approximately US$
100 billion has been set aside to invest in alternative energy sources, which will see the
large-scale deployment of nuclear and solar power, aimed to compromise up to 15% of
the total energy mix by 2020[3]. The return on investment of alternative energies is also
significant- a US$ 1 billion investment in solar energy could lead to a revenue potential
of $2 billion by 2013, equivalent to a 72% return[4].
This leads us to explore who will be the drivers and actors of this new technological
path, which could lead Saudi Arabia to become the global hub for alternative energy
production and exports. How will Saudi Arabia be able to balance the integration
of alternative energy to its energy mix without disrupting other sources of
competiveness? The Kingdom is engaging into a process of economic
irreversibility which will lay the foundations for all future resource allocation; not just
by government institutions, but by the set of actors that are incremental to achieving
these goals and form part of the current system of equilibrium. Intentions can only be
transformed into a reality if Saudi Arabia manages to break its technological ‘lock-in’ to
enable the launch and adaptation of a renewable energy path away from oil dependence.
And at the very heart of the creation of a new technological trajectory, lays
entrepreneurship.
Oil dependency, technological ‘lock-in’ and path dependence in Saudi Arabia
To understand how entrepreneurship can reconfigure Saudi Arabia’s energy system,
understanding the mechanisms that has led to the dominance of a particular
technology- in this case hydrocarbons- over a sustainable energy source, such as solar
energy, is crucial. To this effect, evolutionary economics and path dependence plays a
huge part in explaining why the transition to alternative energy is only being pursued
now, rather than in the late 1970’s, as would initially have been possible. This also
enables to project the role of entrepreneurship in the development of new energy
systems, and subsequently, develop inducing regulations for all actors involved.
Path dependence implies that the evolution of an industry is governed by the
consequence of past events and decisions that create self-reinforcing mechanisms and
3. positive feedback loops enabling a predictable outcome for prices and market shares.
From an economic standpoint, it has been argued that technological path dependence
stems from a minor or inconsequential event that provides the impetus for a technology,
product or standard to lead, having irreversible influences on the market allocation of
resources[5]. In its most negative connotation, it means a system, once having adopted a
dominant path, finds itself unable to ‘shake free’ of this technology on the premise that
it will destabilize the whole of the system’s equilibrium.
Path dependence is a concept that also easily applies to regional disparities in economic
development, as economic landscapes inherit the legacies of pat developments which
can influence its future development. Regions become ‘locked in’ to particular
economic specialization, becoming over reliant on a particular technological resource,
leading to rigid and inflexible structures and restricting its ability to adapt to
competitive forces. Regions that suffer from path dependence become more vulnerable
to external shocks, which in turn, can bring about the decline of an industry as whole[6].
We can argue that at one stage, a state of multiple equilibrium existed in Saudi Arabia,
where both oil and solar power had the opportunity to compete successfully, but
investing resources in oil was favoured beyond investing in the stock of alternative
energy. A mechanism of selection took place where actors ‘branched out’ and decided
to extend the chosen path.
Oil already detained a selectional advantage as it was more technologically advanced,
detained wide-spread user experience, and brought about ‘increasing returns’ for actors
involved. This meant that although oil-based energy industries had an inferior long-run
potential, the actors involved in the industry had gained an early lead, gained experience
on how to increase production and reduced costs, directly raising the benefits for the
wider market. Added to this were the large fixed and sunk costs associated with oil
extraction and production, as compared to the cost of non-modular technologies, whose
costs tend to decrease at much slower rate that wind or photovoltaic modules[7].
Among other investment assets that cannot be ignored include the reputation
of individuals, firms and organizations, as well as heavy investments into the creation
of knowledge assets through education and training. At the time, the credibility,
feasibility and commitment to enabling policy was not substantial enough for these
actors to engage in competitive behaviour. This was aggravated by the government’s
tendency to detain large stakes in energy actors, and to partake in the practice of
selecting ‘winners and losers’, hence creating an artificial competitive environment.
From research in the field of path dependence, it has emerged that there exist various
degrees of this type of system behaviour. Path dependence at its most engrained is based
on decisions to use a particular system (or technology) that may have a controlling
influence for decades, and by which the long-term effects are fully appreciated by
decision-makers. All other actors become ‘locked-in’ to this technology despite its
inferiority due to its profit-making abilities, or in the case of Saudi Arabia, revenue
which contributes to 47.6% of GDP[8].
From an organizational perspective however, decisions to prolong the usage of oil rather
than develop alternative energy technologies resides primarily in asymmetric or
imperfect information. Without a clear market outlook and the ability to project the
return potential and demand, the associated risks are deemed too excessive by
4. incumbent firms and investors. In addition, the failure to deploy past alternative energy
projects such as SOLERAS resulted in the widespread belief that the initial conditions
and selection of an alternative path didn’t lead to the anticipated outcome. ‘Failure to
launch’ tends to include what is coined as ‘technologies of unknown merit’. Economic
momentum is lost as either the market place for such technologies do not yet exist,
affected parties are not yet born and actors cannot successfully coordinate or pool their
resources. Past events demonstrate that these factors heavily influenced the slow uptake
of alternative energy in Saudi Arabia, with key energy incumbents preferring to balance
between meeting external pressures whilst conforming to their undeniable competitive
advantage in hydrocarbons and sunk costs in infrastructure.
Above any other technological field, path dependence in energy systems is concerned
not only with technology, but the ideas and practices that are imbedded within the
organizational behaviour of actors, and consumer demand and behaviour by end-users.
Ideas and practices in the energy field subsequently shape innovation capabilities,
government policy, the environment and competition- all of whom are interlinked
within the reigning energy paradigm. Experience acquired with the usage of
hydrocarbons as the primary energy source generates knowledge derived from
experience. As technological knowledge is gained, this creates coordination effects;
whereas the benefits derived by one user increases when others use it. This creates a
domino effect, simultaneously increasing the positive expectations of its benefits by all
actors within the system, and generating increasing returns in the form of profit,
sustaining the ‘technological lock-in’ and influencing macro-level inputs and micro-
level behaviour.
The end of industry, innovation and creative destruction
When examining the impacts of path dependence,
policy-makers and practitioners often neglect how closely related it is to industry
lifecycles, therefore how easily it can be disrupted. As path dependence is linked to the
evolution of an industry, it will follow the same industrial lifecycle of formation,
development, maturity and eventually, discontinuity.
At the formative stage, a breakthrough discovery will enable firms to enter a new
industry, with those that are successful able to expand their production and generate
economies of scale, leading to the exit of firms that are not able to compete. As the
industry develops, firms compete with alternative products, technologies and designs,
whereas by the rules of the industry, one technology will have dominance above all
others. This creates ‘lock-in’ as new products become uncompetitive and innovation
5. occurs only in processes, aggravating barriers to entry. When industry maturity has been
reached, new entrants are unable to compete with incumbents, and can only operate
within niche markets which do not allow for economies of scope.
However, incumbents cannot dominate niche markets, making it the ideal ecosystem for
new entrants to gain resilience and sustainability. Niche environments such as
specialized clusters, preferential policy or even incubators create a ‘protected’ space
whereas collaboration, rather than competition with incumbents is favoured, and
enables new entrants to differentiate their products from the dominant path. These
spaces allow for innovative activity, experimentation and growth, building on the
existing resource base and competencies of large firms. In this niche, technologies can
develop and mature whilst remaining sheltered from market forces.
However, a dominant energy system cannot be rendered discontinuous without the
technologies developed in niche markets being commercialized and diffused. This
requires the mobilization of skills and resources, as well as the transfer of knowledge.
Schumpeter clearly distinguishes the difference between an invention and an
innovation; an invention being a product or process conceived for the first time, as
opposed to an innovation which is the commercialization of that invention, involving a
transition from what is technologically possible to what is economically viable[9]. Only
once a critical mass of innovations have occurred within a protected niche it is then
possible to commercialize them via new investors, entrepreneurs, policy-makers,
incumbents and ultimately, the end-users.
To achieve this process, supporting new ventures and entrepreneurial activity is critical.
It is a well-known fact that entrepreneurial firms are more likely to adopt disruptive
innovation. Entrepreneurs seek solutions to problems that cannot be solved by old
technologies, and without radical innovation within the energy space, the dominant
market for fossil fuels cannot be destabilized.
Entrepreneurs have two strategic options: create new ventures based on incremental
innovation- thus prolonging the dominant path, or pursuing innovations that aims to
break the mould and create a new technological path. This differs from incumbents who
are more likely to invest in R&D based on technologies that balance between emerging
external pressures but retain their competitive advantage. However, these types of R&D
investments only contribute to creating discontinuous improvements in the dominant
technology. If an alternative technology manages to break the mould, the old system on
which the firms are dependent becomes obsolete, as will eventually be the incumbent.
Other forces such as organizational inertia, hierarchical rigidity and risk aversion are
additional features which destabilize incumbent firms and create a loss of vitality and
power to develop.
Nowhere is the battle between old and new more pronounced than in the energy field, as
it is the means of production that changes, not the end-product. A new system will not
emerge on the side-lines, but amidst the old structure. It will build on the existing
competency base and recombine existing resources with new players. To this effect, it is
important to realize that no single energy technology will be the ‘be-end and end-all’,
but that several technologies shall have to compete in parallel. During this stage of
discontinuity, one or more firms may have a competitive advantage or superior position,
but this will only be temporary. It will take a mass scale of innovations within the sector
6. and inducing policy to generate the momentum to transition from one technology to
another.
Goodbye the ‘Heroic Entrepreneur’
As was argued above, new entrants are incremental to the process of creative
destruction that garners change and unproductive economic growth. As has been the
case in many economies which today have radically shifted their energy systems to
alternative energy, entrepreneurship was one of the root enablers to this transition.
Entrepreneurs are known as ‘path creators’. They set in motion the process that shape
emerging social practices and technologies, and deviate from existing structures.
Entrepreneurs understand the factors that have create path dependency, and choose to
deviate from its structure. This means entrepreneurs do not conceive new technologies
as neutral, but mindfully know they are socially embedded. They understand that to
generate increasing returns and profit, they must not only create new solutions to
existing problems but new contexts in which the solutions can survive[10].
However, the concept that a single entrepreneur can change a technological path is
incoherent. To deviate from the existing path necessitates collective action, momentum
and a combination of inputs that harnesses the gradual involvement of all actors who
form part of the old system. It requires the ability to mobilize resources, networks and
know-how. The technology has to eliminate boundaries among actors so that it makes
economic sense and generates positive expectations that reduce uncertainty and
eliminate information asymmetries attributed to ‘technologies of unknown merit’.
The central challenge found in all entrepreneurial pursuits’ remains access to resources,
legitimacy and knowledge asymmetries. Whilst new entrants may be the proponents of
disruptive innovation, and are incremental at the early stages of market formation, new
contexts for these innovations cannot be created without the support of incumbents
firms, policy and finally, consumers. The role of networks and institutions cannot be set
aside when seeking to create emerging social practices, as entrepreneurs are least likely
to influence policy processes. In the case the change is actively sought due to the
inedibility of the future exhaustion of raw materials, the role of the state becomes
emphasized as market mechanisms are less effective to support energy
entrepreneurship. Upon this realization, the actions of large incumbent firms and actions
taken by the state represents change that is managed, centralized and coordinated.
Whilst centralized government and quasi-monopolistic market structures are usually
associated with a reduction of entrepreneurial activity, such is not the case in the
creation of new energy systems. Rather, this type of structure can facilitate new market
entrants by having the advantage of being able to pool and manages resources and
decision-making structures. They can clarify the nature of the value chain, and reduce
uncertainties on whether entrepreneurs can ‘fill the gap’ by combining their efforts with
large incumbents. In addition, many of the skills required within alternative
technologies are closely aligned with those existing in oil & gas, enabling the
knowledge-transfer required and increasing experience with a new technology. To this
extent, entrepreneurship is not a “random act of genius, but a disciplined effort of
many[11]”. Technological developments and the adoption of new energy systems may
7. be initiated by a limited number of actors, but needs to be backed by a social movement
to garner the required momentum.
Policy-induced energy innovation
Energy entrepreneurship finds itself at the intersection of science, technology and
innovation. Increasing the scope of innovative activity within energy systems and
creating an enabling environment demands a careful balance between supply-push and
demand-pull mechanisms. In the past and as many international examples have
demonstrated, technology-push policies in the form of public R&D, tax levies and
support to basic science have been the preferred regulatory instruments to induce
innovation within new energy technologies. However, it has been well documented a
balance between demand-pull regulations is the most favourable option. In turn, policies
that affect that the system distribution of new entrants and incumbents will impact not
only the energy system, but the innovation ecosystem as a whole, as this remains
embedded in a variety of socio-economic contexts.
Institutional players are critical in generating and steering various types of learning.
Their role should focus on steering the technological development process and
developing the complimentary assets necessary to create new paths. Energy systems are
unique in the sense that they require institutional intervention for a new path to emerge,
and cannot rely upon market forces alone to transition. A ‘level playing field’ has to be
created, which from its on-start must include the creation of niche environments, as well
as shared spaces among players. This can only be achieved through the implementation
of multiple policy instruments that encourages the participation of new entrants and
creates favourable market conditions. Institutional players must realize that new energy
technologies cannot compete on equal terms with the dominant energy path, and this
must be translated into policy.
Learning and coordination effects have been identified as prime elements of path
dependence- policies that focus on these features can steer new paths. This includes
supporting the creation of inter-industry alliances and creating shared industry
standards. In addition, policies that foster the availability of financing and generates
networks within education, institutions and associations induces the social movements
necessary to garner technological momentum.
Rather than banking on steering policies to induce breakthrough innovations, at the
stage of market formation and development, institutional players should favour
bricolage. Bricolage is an approach that harnesses the co-evolution of an industry sector
through a series of inputs from all actors, aiming to make smaller but steady gains with
a particular technology- hence mutually shaping a new technological trajectory. It is at
the opposite scale of actors attempting to achieve quick and dramatic changes within the
system, running into the risk of reducing learning and coordination effects. Most
importantly, if the attempt to achieve a dramatic technological transition fails, it
becomes much more difficult for firms to recover or correct deficiencies[12].
Bricolage induces experimentation, particularly among new entrants, and enables to
build the competency structures, networks and knowledge-sharing which are critical to
entrepreneurs and spillovers.
8. Factors that enable the rapid creation of new energy paths among institutional players
include a long-term alternative energy adoption plan, and broad political consensus.
Signalling years in advance the future requirements and objectives provides an incentive
for private sector participation, as well as the creation of a future market-space. If
incumbents and new entrants believe that a market will exist for their products, they are
more likely to invest resources, enhance their competencies and experiment in
innovative activity. Understanding how the future market will be shaped enables
entrepreneurs to secure key assets and assess how collaboration with incumbents will
affect them.
Institutional players must realize that policy-induced mechanisms for path creation
typically favour large incumbents rather than new entrants. Large firms detain the
legitimacy, know-how, resources and competencies to influence the shaping, or failure
of a market. Strong incentives have to be developed to garner their commitment,
investment and collaboration with new entrants in order to transfer resources and
knowledge. Critically, during the transition from one technological path to another, the
objective is to ensure the survival of large incumbents alongside new entrants.
Lastly, the role of civil society cannot be ignored when shaping the transition. It is
lead users and active consumers who create the new market for companies, and
influence the political climate. As the end-product will remain the same, consumers will
be influenced by price rather than by product. Therefore policies which enable
competitive pricing alongside fossil fuels are indispensable. To harness learning effects,
a large-scale demonstration provides experience to the user, having a domino effect that
will lead to the belief that the use of the technology will increase with every new user
and augment its benefits. Again, building networks, education, incentives and providing
regulatory plans well in advance increases the build-up of momentum which enables
widespread adoption.
Whilst new entrants set in motion the processes of change and new path creation, the
possibility of failure remains very much inherent. Rather than compete, entrepreneurial
firms should seek to collaborate with incumbents to secure legitimacy, increase
capacity, access complimentary assets and facilitate the selective development of new
markets. The ability to orchestrate efforts with all players within the system enables to
overcome the challenges that are associated to current path dependence. There needs to
be a concerted effort for entrepreneurs to understand the current and future market in
which they are born, and not limit themselves solely on their growth and technology. To
this end, an understanding of the nature and structure of the value-chain, their intended
positioning and stakeholder networks are key.
As being possessors of knowledge that can deviate from the dominating path,
entrepreneurs are required to be able to translate their ideas into an interaction. The
manner in which the entrepreneurial venture is communicated and presented enables to
test the preferences of actors within the system, and co-mutually shape them through
experimentation. This creates the positive feedback loops that set a path in motion.
Through practice, new entrants can re-combine existing and under-utilized resources to
their advantage, and partake in the creation of a context for their innovation.
The deviation from an existing energy system to a new path involves a multiplicity
of players and their careful orchestration. First and foremost, recognizing the
10. [9] (Carpenter, Simmie, Conti, Povinelli, & Kishagen, 2011, p. 8)
[10] (Lovio, Mickwitz, & Heiskanen, 2011, pp. 274,279)
[11] (Garud & Karnoe, Path Creation as a Process of Mindful Deviation, 2011, p. 26)
[12] (Garud & Karnoe, Bricolage versus breakthrough: distributed and embedded
agency in technology entrepreneurship, 2003, p. 296)
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