Things of life make me circle around the core of my present work, namely around that business plan for the EneFinproject. Last Monday, a friend of mine, with whom I am doing a lot of work on FinTech things, asked me a general question: ‘If you had like to explain your students what is a financial innovation and how it is being done, what would you tell them?’. The question fits my current interests, so I will try to kill two birds with one stone. I will try to develop an intellectually satisfactory answer to that general question, and, in the same time, I will try to move one step forward in the writing of my business plan.
‘Financial’ means something about money. It is about money moving in transactions, or about money staying calmly and nicely in one place, in some cosy balance sheet. Innovating about money means figuring out some new ways of paying with money, or some new manner of piling money up. The essential job that money does for people is to assure liquidity, i.e. money makes it possible to move economic utilities in space and over time, with a minimum of transaction costs. If you have to move a mountain, like in one go, from spot A to spot B, you need either a small particle of really solid faith or a really big piece of civil engineering. Still, if you can move the mountain in question piece by piece, e.g. bucket by bucket, things become easier. You can move those buckets around with a lot less of civil engineering, and your faith is being put to significantly lesser a strain, as well. This is what ‘financial’ means in the first place: transforming a mountain of economic utility into a set of small buckets of financial equivalence, and moving those buckets around smoothly and efficiently.
Any movement happens with a given velocity, along a given vector, and our control over that movement is observable as the capacity to modify both the vector and the velocity. Inventing something new about money and its use, thus making a financial innovation, is equivalent to finding out how to give more velocity in and/or more control over the movement of money. This little elaboration in the lines of Newtonian physics serves me to introduce a secondary effect to the primary financial function. When you create financial instruments, i.e. standardized legal deeds representing small parcels of economic utility, those instruments, although being technically something derivative from something else, start having an economic life of their own. Having an economic life means being tradable, and actually traded, and thus having a market price.
Sounds nice, so far. I am trying to apply those fancy generalities to my EneFinconcept. The mountain of economic utility comes, logically, in the first place. I can distinguish three big masses in the geography around me: the capital immobilised in power generation (power installations), accompanied by the capital immobilised in power grids (systems of distribution), and finally the population of users. They all move, and so, logically, they are not mountains, but rather the tectonic plates that mountains rest on. The mountains per se are made of long-term contracts between power plants and power grids, for one, as well as contracts between power grids (distributors) and their end-users. Ah, there are, in some places, the contracts between power plants (those rather small, local ones, like solar farms) and the end users, directly.
Now, it looks weird. I have mountains rising sort of at the junction of tectonic plates they are supposed to stand on. These are intercontinental mountains. See? I was sure I can invent something unparalleled. That’s the thing with metaphors: you push too far and they become meaningless. Anyway, I have those big masses of long-term contracts, moving very slowly, or hardly at all. Those long-term contracts have economic utility in them. Anything financial one could possibly do about them would consist in creating a complex set of financial instruments, i.e. tradable legal deeds equipped with intrinsic value expressed in the units of currency. I have come up with a few ideas as for those financial instruments, and I am listing them below.
Idea #1are standardized coupons for purchasing electricity, like for 1 kWh each, tradable either like coupons strictly spoken, or, in a technologically fancier manner, as tokens of a cryptocurrency. Those coupons are financialized commitments from the long-term contracts between the consumers of electricity and their direct suppliers, this the distributors who operate power grids. In such a contract, the consumer commits to purchase electricity from a distributor, like for 2 years in a row, and said distributor commits to supply electricity, in a given amount. This type of tradable, standardized deeds for purchasing electricity have been used for decades in the wholesale market of electricity, i.e. between power plants and distributors. I am thinking about developing the same concept in the retail market. It would allow the distributors to cash today their future expected deliveries of power to consumers, and consumers could have a more diversified portfolio of suppliers.
As I think about it now, that type of financial instrument, as conceptualized in my Idea #1, would be workable mostly for new suppliers in the market, for example for new solar farms or new, local hydraulic turbines of moderate size. They could sell to the neighbouring consumers their future output of electricity, in the form of those coupons, instead of signing long-term contracts. Lower and more liquid a commitment from the part of consumers could convince the latter to try and buy that new, fancy power from the new solar farm, sort of.
The more I think about that Idea #1, the more I am convinced that it would require to operate power grids similarly to railways. In the railway business, at least in Europe, you frequently have a separation between the operator of the physical, actual railway (infrastructure), and the operators of trains, on the other hand.
Idea #2is based on the same contracts, and consists in making the consumers’ financial commitments into tradable deeds, like into bills of exchange. In a long-term contract I sign with a supplier of electricity, I am supposed to pay standardized amounts of money every month, and those monthly instalments are based on a smoothed prediction of my future consumption of power. Idea #2 sums up to singling each such future, promised instalment out of the long term contract and trading it as a security, or, once again, as a token of value in a cryptocurrency. As a financial utility, it gives, once again, more liquidity to the distributors. Of course, those financial claims on consumers would be conditional on supplying them a given amount of electricity. As I look at it now, it would essentially amount to have something like options or future contracts, i.e. financial instruments that guarantee a fixed future price of 1 kWh.
As for Ideas #1 and #2, you can look up Les marchés possibles à développer à partir d’une facture d’électricité, A first approach on the financial sideor Une plantation des clients qui portent fruit.
Idea #3is an app coupled with the network of electric sockets, in a smart city. You use the app to pay for electricity as you actually use it, sort of smoothly. Initially, I developed that idea for a network of publicly available electric sockets, made for sort of causal charging of smartphones (see Je recalcule ça en épisodes de chargement des smartphones), but, as I think of it, the idea could extend to all the usage of electricity in a smart city. I could, for example, use the app to drive the usage of electricity in my apartment to a strict minimum when I leave for the weekend, and I would pay just for that minimum. On the other hand, when I use a lot of electric tools in my garage, e.g. when I build a DIY intercontinental ballistic missile, I would pay on the spot for that extra juice.
In legal and financial terms, Idea #3 would amount, once again, to turn the long-term financial commitments on the part of consumers into short-term, spot payments. As I think of it, it wouldn’t even require much change in the distribution system. Large populations, and in the case of a typical, European project of smart city, we are talking like 1,5 million people or more, have a predictable consumption of energy. I managed to provide some scientific proof of that in my article: Settlement by energy. The amount, and, I dare say, the structure of final consumption in energy, remain fairly predictable in such a large human settlement. What is being financialized, i.e. made more liquid, is just the payment for energy.
Good, I have listed my so-far ideas. Now, I keep inventing. We are in a smart city, and there are many local projects of setting local power sources from renewable energies. They are competing for accessing the market of energy in that smart city. They are selling futures contracts on their future, expected output of power. Normally, when you sell your future expected output in the form of futures contracts, you need to give a substantial discount on the present price. If you buy futures on coffee, for example, and you agree to pay today for the coffee beans from the next harvest, like in 6 months, you can negotiate even 40% lower a price, as compared to the coffee beans actually available in the warehouse. Here, the same, future expected power, sold today, is bound to be noticeably cheaper than the presently available juice. Still, we can add to the fun. I imagine a financial instrument which embodies a compound contract: a futures contract on future expected supply of electricity paired with a participation in the equity of the supplier.
That would be my Idea #4, in the framework of the EneFinproject, and here comes a little calculation. In my home country, Poland, 1 kilowatt hour, in the retail market, costs like €0,15. In the semi-retail market, i.e. power for institutional consumers, costs about €0,09 per kWh. I want to start a local station of hydraulic turbines. Nothing big, let’s say two turbines of 1 megawatt each, thus 2 MW in total. That makes an annual output of 2000 kW times 8760 hours in a year, and equals 17 520 000 kWh in a year. In standard retail prices it would make a revenue of 17 520 000 * €0,15 = €2 628 000 a year. I am offering futures on my output, paired with shares in my equity. The buyer pays €0,09 per 1 kWh of future power supply, and €0,06 of small participation in the equity of my power plant, so €0,15 in total, which is just the same as the price of presently available, retailed power. That makes, from the point of view of the supplier, an annual revenue of 17 520 000 * €0,09 = €1 576 800, plus 17 520 000 * €0,06 = €1 051 200 in equity.
As business structures come, what comes out of my Idea $4 is an actual cooperative structure. Even if I make it into the legal vehicle of a company, the basic concept is cooperative: the buyers of my output become my shareholders. We can go even further down this path and create a FinTech platform for any market, where barriers to entry, in terms of physical investment, are relatively low, and there is a big fork between retail prices, and the wholesale ones. I think about transportation services, food supply, maybe construction services as well. A start-up sells futures on its future expected output, paired with small shares in its equity. This could make an excellent financial tool for building local cooperative structures.
I used to belong to a few cooperatives in the past. They were housing cooperatives. The thing about those structures is that they are functional as long as membership remains limited to a small number of people. A classical cooperative with 15 members is just fine, with 150 it becomes really clumsy as for decision making, and with 1500 it turns into a feral bureaucracy. My idea – for the moment I name it Coop EneFin– offers all the advantages of the cooperative scheme, whilst giving the whole thing the smooth liquidity of a corporate structure. If I do it the FinTech way, with some smart app facilitating the buying and selling, as well as reselling, of those cooperative futures contracts, it looks the way a good financial innovation should look: lean and adaptable.
There are two levels of testing that business concept. Firstly, the financial soundness: the transactional FinTech platform for trading those cooperative contracts should generate profits sufficient to give a good return on the equity invested in its creation. As a wannabe mad scientist (I don’t have any old castle in the mountains, so I have to wait a bit before graduating into a full mad scientist), I can use the same cooperative scheme to raise money for that technological platform. Anyway, the FinTech utility needs to earn its living somehow. There are three essential ways (look up Plus ou moins les facteurs associés). At the most basic level, Coop EneFin can be just a transactional platform, collecting a commission on each transaction in those ‘futures + equity’ contracts. Secondly, it can be a closed club, with an entry lump fee to pay for the corresponding software package, and then a monthly membership. Thirdly, and finally, the Coop EneFinproject can specialize just in the development of the technology, which, in turn, allows the creation of local cooperative networks around local suppliers of energy.
The realistically appraised cost of technological development, regarding that FinTech utility, comes as the key factor in the business planning. I already had that intuition after browsing the financials of Square Inc., one of the big players in the FinTech business (look up The smaller more and more in FinTech). I can intuitively, and provisionally, nail down the cost of product development at some 15% of revenues in the maturity phase of the business. Liaising with the preliminary calculations I presented a few paragraphs ago, that would make like €236 520 for maintaining and developing the FinTech technology for supporting the Coop Enefin scheme for one local power plant of 2 megawatts. The trick is to minimize the cost of current upgrading in that technology, or, in other words, to minimize its pace of moral obsolescence.
I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund (and you can access the French versionas well). You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon pageand become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?