Germany has been one of the most aggressive supporters of renewable power in the world and, accordingly, provides an appropriate case study of the law of unintended consequences.

by Jeffrey Altman, Senior Advisor to Finadvice

Although German developments in electricity markets are, by no means, unique in Europe, they do provide a cautionary tale of the negative consequences that short-sighted energy policies and over-subsidized resources have on electric systems. The country’s very generous policies have led to a massive build out of “green energy,” wind and rooftop solar in particular. However, these resources are increasingly proving to be economically unsustainable as costs keep climbing and rapid penetration threatens the reliability of the electric grid.

Concerns about Germany’s green policies are such that the country’s Federal Minister of Finance, Wolfgang Schäuble, warned in late January that the German economy is being harmed by increasing energy costs. “Therefore, we have to rebalance,” he said.1

Rising Electricity Bills

Germany’s new energy policy roadmap, the Energiewende, calls for a reduction of carbon dioxide (CO2) emissions by 90% from 1990 levels and for the country to provide 80% of its electricity generation with renewables by 2050. In addition, the government wants to phase out nuclear power by 2022. Yet, the German government needs to also face the legacy of past policies.

A 2013 cover story in Der Spiegel magazine titled, “Luxury Electricity: Why energy is becoming more expensive and what politicians must do about it,” showed gold-plated and diamond-encrusted power cables, which succinctly summarized the mood of the German public toward high energy prices. Since the feed-in tariff (FIT) program supporting renewables started in the early 2000s, electricity prices have more than doubled, from 18 cents per kilowatt-hour in 2000 to more than 37 cents in 2013. By comparison, the average electricity price in the United States is 10 cents per kilowatt-hour. The reality is that unless the current system is corrected, electricity prices are expected to increase in Germany by 35% for consumers and some 30% for industrials by 2020.

Not surprisingly, Energiewende is now being challenged by power companies, industries, consumers, and government officials. Part of the explanation for the increase in electricity prices can be found in the generous government support for renewable energy technologies. The FIT subsidy program, the main mechanism used by Germany to promote the adoption of renewable energy, has cost more than $468 billion, and some estimate that program costs could exceed $1.3 trillion by the time it expires in 2015.

German consumers and companies finance clean-energy subsidies by paying a surcharge on their monthly power bills. The levy jumped 18% on January 1, 2014, and has surged more than fivefold since 2009, according to a recent Bloomberg report. In October 2012, this surcharge amounted to 14.6% of the electricity price paid by consumers according to the Web site, www.stromvergleich.de. Germany’s new Economy and Energy Minister Sigmar Gabriel indicated that the cost of renewables paid for by consumers is around $32.5 billion per year.

Decreasing Wholesale Prices and Thermal Generators

While retail prices of electricity are rising for consumers, wholesale prices are artificially going down, threatening the reliability and the stability of the electric system. Due to massively
subsidized renewable energy through FITs in Germany, producers of other sources of electricity have seen the prices paid to them fall, as renewables, with much lower short-term marginal production costs than traditional thermal plants, get dispatched first. Still, because of the variability of wind and solar, thermal generators are still producing a majority of the load in Germany, as illustrated in Figure 1.

Depending on the region, the growth in renewables is creating load and margin destruction to conventional power plants. As more renewable energy is used to meet electricity demand, there is less need for the electricity produced by conventional sources. In addition to this loss of revenue due to reduced production, there also is a reduction of the wholesale price per unit paid to conventional generators, since least-cost, subsidized renewable resources displace more costly sources of generation. In Germany, last year’s estimated market price for power was 48 euros per megawatt (MW). In mid-November 2013, the market price for power stood at 37 euros per MW—a reduction of 23%.

The variability of wind and solar resources requires thermal plants to provide backup and balancing services. The need for these plants increases as penetration of renewables rises, and the amount of time these plants must intervene in power markets to produce electricity to quickly make up for the lack of output generated by variable renewable resources is growing. (See Figure 2.)

However, wholesale prices are not sufficient to keep many of these thermal plants economically viable under the current market regime and, as a result, many thermal plants are now being closed, including cleaner natural gas-fired plants. Because of higher natural gas prices and lower CO2 emissions costs, new coal power plants are being built in Germany, which is obviously having an impact on the country’s greenhouse gas emissions.

In Germany, natural gas prices hovered around $10.00 per million British thermal units last summer, and coal delivered to power plants fell to a record low last fall. In these conditions, many of the highly efficient natural gas-fired power plants are being put off-line in favor of coal since the price of gas in Europe is so high.

Increased Distribution Investments and Capital Costs

It is not only the power plants that are being stressed but also the German electric grid. As the need for other system resources grows to restore balance to the grid so will the necessity to invest in smart grid technology in order to account for unreliable renewable resources.

Moreover, grids will need to be refurbished to handle additional loads, as well as built out to go to those locations where renewable resources are more prevalent. Germany, for example, is going through a massive build out of its grids to facilitate new onshore and offshore wind farms as well as solar farms. It is estimated that this investment will range from 21–27 billion euros over the next decade.

The impact to European utilities has been materially significant as well, as has the impact to their credit ratings. This helps to explain why the cost of capital is going up for the major utilities there. (See Figure 3.)

The Coming Wave of New Regulation

All of the factors mentioned previously have been exemplified by what has occurred in Germany, but have not been unique to it. They have made various European governments review their policies toward renewables. Some governments have instituted retroactive taxes or changes in existing regulatory policies where they had inappropriately structured various tariff regimes that had been gamed by various market players or made obsolete by unforeseen technical or market conditions. Spain, for example, went through five regulatory interventions over the last several years that impacted more than 6 billion euros of investors’ equity and debt.

There are many lessons for U.S. regulators and policymakers to learn from these developments in Germany and in other European countries. With the realization that they can no longer afford to massively subsidize uneconomic renewable power and introduce further instability to the entire electric system, these countries are now considering the appropriate regulatory frameworks that will allow these new technologies to generate clean electricity, while also ensuring that the system is safe, reliable, and affordable.

Jeffrey Altman has more than 20 years of infrastructure and energy experience, and is a Senior Advisor to Finadvice (FAA Financial Advisory AG), one of Europe’s largest boutique energy advisory practices, and other institutions.

Jeffrey worked within several utilities (electricity, gas and telecoms) and advised on infrastructure-related assets in Europe and the United States. Most recently, Jeffrey was Director of Investment Management at First State Investments’ European Diversified Infrastructure Fund and was a member of the holding company board of Electricity North West, the electric distribution company for the City of Manchester, UK. He also served 10 years in the U.S. and Europe with Southern Company/Mirant Corporation. During this time, he spent five years successfully privatizing and restructuring Bewag AG and GASAG AG (Berlin’s electric and gas utilities). Jeffrey has a Masters of Business Administration from the University of Southern California and a Bachelor of Science in the School of Foreign Service from Georgetown University. He is the Editor of the book titled Best Practice in Infrastructure Asset Management and has authored several articles.

1 “Schäuble warns green policies are harming German economy,” by Peter Spiegel, The Financial Times, January 28, 2014.