The blockchain boom—driving efficiency in the energy sector

Energy analysis: As part of a series exploring the ‘blockchain boom’, Adam Brown, managing practice development lawyer in the energy, transport and infrastructure practice at Dentons, considers the potential for blockchain technology in the energy sector.

What opportunities can blockchain technology promise the energy sector? What are some issues in the market right now that will benefit from such technology?

At a high level, blockchain offers the energy sector what it offers many other sectors:

  • a means of improving the efficiency of existing systems and processes
  • a tool for developing new markets

In the financial sector, there is a great deal of interest around the potential for blockchain to be used to reduce processing costs in securities transactions. Similarly, in the energy sector, a number of banks, oil and gas companies and trading houses are working on platforms that could be used to trade cargoes of oil products or liquefied natural gas (LNG) and carry out the post-transaction processing of trades in a rapid, secure and paperless way.

This is because blockchain can maintain an immutable record of transactions and other information that is visible to all relevant parties, and so solve some of the problems inherent in current commodity trading, which is often based on bills of lading. These paper instruments exist in multiple copies that can easily be lost or falsified, and the need for them to be transmitted physically from one party to another creates a drag on commercial activity.

At the other end of the scale, in terms of individual transaction values, blockchain and the associated technology of smart contracts are perceived as key enablers of ‘peer-to-peer’ electricity trading networks. In theory, households with renewable energy generation or electricity storage facilities could become ‘prosumers’, taking advantage of movements in electricity prices to sell surplus power to chosen buyers (rather than just spilling it onto the grid or automatically selling it all to one utility). In practice, most people will not want to be constantly monitoring spot prices or the weather. They are only likely to be attracted to prosumerism if they can set a series of default parameters within which their ‘trading’ decisions will be made automatically on their behalf, with a full audit trail and some assurance that the costs of being ‘green’ in this way will not outweigh the benefits without their approval. Blockchain and smart contracts can provide that audit trail and assurance.

What future applications are being envisaged across the energy sector?

In addition to the two areas of work mentioned above, other areas where companies or consortia with blockchain-based business models are active include:

  • managing supply chains in the oil and gas industry—eg where there is scope to integrate these with production data streams
  • tracing the provenance of materials through the value chain and evidencing their compliance with environmental or other standards
  • facilitating the charging of electric vehicles and their participation in electricity markets (using their batteries to provide grid services while they are connected)
  • allowing power grid operators to transact with increasingly small and dispersed demand-side or generation assets that can provide flexibility in power systems that include a high proportion of intermittent renewable power sources, and speeding up settlement times in electricity balancing markets from weeks to seconds
  • creating a platform for registering huge numbers of distributed flexibility assets and allowing them to be rewarded for the flexibility they provide simultaneously by a range of different market players
  • facilitating new techniques for funding renewable generation capacity, for example by providing investors with a digitally encoded right to sell or use a fixed amount of the power it generates, or conferring fractional ownership rights over the equipment itself (eg individual cells on a solar panel, which are then ‘rented’ to the operator
  • creating international, private sector equivalents of the certificate programs that many national or state governments have used to incentivise the purchase of renewable electricity or the reduction of carbon emissions

Are there any examples of blockchain technology already being used in the sector? What has the impact been?

There is a considerable amount of work going on in all the areas mentioned above—see the many examples mentioned in the ‘further reading’ below. In a number of cases, proof of concept has been achieved. However, our overall impression is that so far everything that is happening is happening on a fairly small scale. Interest is intense, but we are not yet seeing full-scale commercial deployment of the technology taking over sectors of any market.

What are some key challenges to the adoption of blockchain technology in the energy market?

Some potential beneficiaries of the technology, in energy as in other markets, are put off by its association with cryptocurrencies—which are linked in the popular imagination (and sometimes, in fact) with risk, volatility and criminal behaviour. It is true that Blockchain (with a capital ‘B’) was set up as a vehicle for Bitcoin, the first cryptocurrency, and many blockchain start-ups use cryptocurrencies as part of their business model. However, it is entirely possible to run a business based on blockchain using only ordinary ‘fiat’ currencies like the Pound Sterling, US Dollar or Euro as payment.

Another set of concerns that inhibits more widespread acceptance of blockchain is around some of its technical features. For example, there are concerns around:

  • the amount of energy consumed by some of the computing activities associated with it
  • the extent to which it is scalable and suited to the very rapid processing of very large numbers of transactions
  • the ability of different blockchain networks established to perform similar functions to talk to each other

There probably are or will fairly soon be technical answers to many of these perceived problems. In the meantime, they add to the uncertainty felt by many energy sector companies as to when to ‘take the plunge’ with blockchain, rather than just testing the water with their toes.

Turning to the legal aspect of things, there is a range of further complexities that need to be unravelled. Existing legal and regulatory systems can constitute obstacles in a number of ways. In the case of bulk trading of oil and LNG cargoes by blockchain, it is not clear that the paper bill of lading can yet be eliminated without undermining existing commodity financing techniques that rely on the law of pledge. Many of the current experiments with peer-to-peer electricity trading are taking place either in ‘sandbox’ environments—where some of the existing sectoral regulation has been ‘switched off’ to promote innovation—or between participants who are not linked by regulated public grid infrastructure. The fundraising techniques used by some blockchain-based businesses are designed to confer rights on investors that are not the same as either conventional debt or equity but do not always sit happily with existing securities regulations.

Perhaps more fundamentally, from a legal point of view, there is the question of the relationship between the computer-coded world of blockchain and smart contracts and the more familiar legal world of ordinary contract law. Smart contracts are a good way of automating straightforward ‘if X, then Y’ instructions, but may not be so well equipped to cope with provisions whose operation turns on the making of a judgment or evaluation by one party, for example. We seem to be some considerable distance from the stage when complex commercial arrangements can be entirely reduced to code, meaning that there is still likely to be a conventional contractual underpinning for a blockchain business model. Tying contract and code together and choosing how much of the process to try to automate is not simple. It can also be difficult to ensure that the interface between the digital, internally self-consistent world of blockchain and reality does not become a place where fraud can contaminate blockchain’s otherwise secure and unfalsifiable ecosystem.

How can it be regulated and what should energy lawyers be aware of?

What we see at the moment is:

  • regulators and businesses trying to work out how to apply existing legal regimes—such as the rules governing the issuing of securities, data protection legislation, or competition/antitrust rules—to blockchain businesses, so as to protect investors or customers from the same kinds of mischief that those rules were established to prevent in the pre-blockchain world
  • a sense that in some areas (such as retail electricity markets), some existing rules will need to be changed or removed in order to facilitate the full deployment of blockchain technology

It is not clear that blockchain requires any specific form of regulation as a technology in and of itself. However, in considering any proposal to use blockchain, it is usually appropriate to be sceptical of any overblown claims about its immediate potential (other than in some cases as a fundraising tool) and to pay careful attention to the internal governance arrangements for any blockchain transaction system.

Further reading

Descriptions of how blockchain and smart contracts work can be found in Denton’s recent publication on blockchain in the energy sector and in the even more comprehensive academic survey recently published by researchers at Heriot Watt University.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
Filed Under: Energy

Relevant Articles
Area of Interest