26 Aug 2015
| Jakob Schlandt

The power market and the energy transition

The country of the Energiewende strengthens competition and flexibility

The Energiewende involves tough choices for politicians: How will Germany organise the market around the ever-increasing share of renewable energy? What happens if the sun does not shine and there is no wind? A decision by the German government to put their trust in the free market will have long-lasting implications. Most experts agree there will be little or no investment in fossil power plants in the future, but disagree if this really matters.

Content

Competing flexibility options – the market will pick the winners

Power station operators: the EOM won’t trigger enough investment

Will the state really never mingle with the power market?

The majority of organisations welcome the EOM

What about the perspective from abroad?


Germany’s green energy production is going from strength to strength. Renewable energies, driven by increases in wind and solar, contributed one third of electricity consumed in the first half of 2015. Yet the “Energiewende” is not just about producing an endless supply of green electricity, as Germans have discovered in recent years. The power grid as a whole is challenged by fluctuating production from these sources. How then will Germany keep the lights on at all times? Where will the power come from when the wind subsides and the skies are overcast on a winter day with high consumption? And, finally, what will happen to the many coal- and lignite-fired power plants that are still in service?

The German government is trying to solve these problems with a complete overhaul of the energy market design, which was outlined in a white paper in early July 2015, and has opted for a market- based rather than a state-sponsored approach. Foreigners are surprised. For Gerard Reid, Co-Founder of London-based consultancy Alexa Capital, “it is a big decision by the government to assume that the market will solve all the problems – and not one that is very typical of the German stereotype in the Anglo-Saxon world.” 

Rainer Baake, the Green State Secretary of the German Ministry for Economic Affairs and Energy, presented the market design at a press conference where he talked about a power market driven by prices rather than state intervention and built around the expanding share of green but fluctuating renewable energy in Germany. The theme was repeated in the white paper his government published the same day. Baake claims that his government made a fundamental decision that will influence the German market for perhaps decades. In essence, Germany’s way forward is that fossil power plants will not receive systematic support for providing security of supply – even though the remaining eight nuclear power plants will shut down, one after the next, by 2022. Germany is taking a different approach than, most notably, the UK and France, who recently introduced so-called capacity market schemes. Instead, the free electricity market, where power is traded by the megawatt hour (MWh), will be updated and the focus will be on letting prices reign freely. The name of the project: Energy-Only-Market (EOM) 2.0.

Competing flexibility options – the market will pick the winners

The basic idea of the new power market design is that all options for flexibility in the system will compete to provide the cheapest solution to this problem – be it storage providers, gas power plants or demand-side management. The market will pick the winners. At the same time, electricity retailers will be bound by stricter rules to fulfil their obligations to deliver power to their customers. The state, at the same time, will guarantee that it will not mingle with prices, to ensure flexibility for investors of power plants. Baake likened this to a “constitution” for the power market. An overview of the white paper and its detailed policy proposals can be found here. However, should the EOM fail, there will be a safety net in place. A capacity reserve of approximately four gigawatts (GW) will pick up the slack according to the plan. Importantly, these power plants will only spring into action should the free market fail completely and not be allowed to compete under normal conditions – different to a general capacity market like in the UK and France. The German government calls this “suspenders in addition to a belt.”

A number of laws and regulations will have to be amended in the coming months – most importantly, the Energy Industry Act (Energiewirtschaftsgesetz, EnWG), the central law of the energy market other than the Renewable Energy Act (EEG). The changes are scheduled to be approved by the cabinet in the fourth quarter, according to the timetable attached to the white paper – after talks with experts and stakeholders and a consultation have been concluded.

In early 2016, the new EnWG should be adopted by parliament. Even though it is a law that needs to be approved just by the federal parliament, the Bundestag, and not by the federal assembly of representatives of Germany’s states, there might be some resistance by state governments over details of the law. But overall, Baake’s claim that there is mostly agreement on the objectives of the reform is justified. Angela Merkel’s coalition of Conservatives and Social Democrats has a solid majority in the Bundestag. So far, parliamentarians have not openly criticised the proposal. Even the political opposition in parliament voiced only muted disapproval. Oliver Krischer, parliamentary energy expert of the Green Party, said in a statement that the white paper lacked details. For example, projects like a reform of the grid tariffs and the regulation of smart meters had been announced a long time ago, but even the white paper could not offer detailed proposals.

Power station operators: the EOM won’t trigger enough investment

Owners of fossil fuel power plants lobbied hard for the introduction of a capacity market, even though the odds were never in their favour after the German government had commissioned studies, which argued in favour of the EOM and published a green paper on the issue last year. Now, their largest lobby organisation, the German Association of Energy and Water Industries (BDEW), is less than thrilled with the results. “We don’t believe that there will be incentives for investors to build new, flexible power plants that will be needed in Germany to accompany the expansion of renewable energy,” says Frank Brachvogel, BDEW spokesman. BDEW reckons that even though almost ten gigawatts (GW) of fossil capacity will be added to the German grid over the next ten years, because of investment decisions taken when power prices were much higher, total capacity, which can operate independent of weather conditions, will fall by five GW by 2020 and drop fast thereafter. Market prices, however, do not reflect a shortage at the moment. On the EEX, the German energy exchange, a megawatt hour of electricity trades at around 33 euros for 2020, just slightly above the market price of today. In the view of the BDEW, it would nevertheless be only a matter of time until peak consumption of 80 GW could no longer be met and prices could spike.

The reform proposal includes some benefits for fossil power plant operators. For example, 2.7 gigawatts (GW) of lignite power plants, approximately the size of three very large power stations, will be kept on the above-mentioned emergency reserve for four years, and paid for by German consumers. Additionally, mothballed power stations in the south of Germany that cannot close down because regional generation capacity is not sufficient will receive higher compensation, including investment costs. Some economists, however, think that capacity markets are ultimately necessary. Felix Matthes, an energy expert at the Öko-Institut Berlin, an ecological think tank, proposed an alternative capacity market design, which would have given preferential treatment to greener power plants. He said: “There is absolutely no question about the basic problem that Germany faces a power-generation shortage in the mid- to long-term.” Matthes also doubts that investors will trust the political promises in the energy-only-market and calls the plans a “gigantic market experiment in Germany with potentially high volatility.” Prices, according to research commissioned by the energy ministry, could go as high as several thousand euros per megawatt hour – and if necessary, this is welcomed in order to encourage investment.

The Arrhenius Institute for Energy and Climate Policy argues in a research paper that revenues from the electricity markets are not high enough to finance the fixed cost of building and maintaining a new power plant, because prices are based on the variable cost of power stations, mostly for fuel and carbon emission certificates.

André Wolf, an economist from Hamburgisches WeltWirtschaftsInstitut (HWWI), one of the leading economic research institutes in Germany, sees clear disadvantages in support schemes for fossil power plants. “A capacity market puts a lid on energy prices and ensures security of supply at a very high level, but it is potentially very costly.” Nevertheless, there would be a substantial risk in sticking to an energy-only market. “Market failure can happen for a lot of reasons, such as collusion of utilities or the inability of the market to foresee capacity tightening.”

Will the state really never mingle with the power market?

Germany’s largest utility, E.ON, which will be split into two companies early next year – a conventional power in one and renewables, power grids and energy services in the other – had always argued for a capacity mechanism. Nina Scholz, who oversees regulatory affairs for the Dusseldorf based company, says that the new market design “falls well short of what we expected and think is necessary to ensure security of supply”. In her view, the German government declined the introduction of a capacity market by referring to regulatory risks and government intervention. But for Scholz, the problem of government intervention could not only occur by introducing a poorly designed capacity market, but also in an energy-only market by supporting or discriminating specific technologies or types of capacity:  “A gas power plant is a flexibility option for the system. But so is, for example, battery storage. Any government support scheme for battery storage would influence the margins of new gas power plants.” Additionally, the question is if the German government can really stick to its promise not to mingle with the power market in the future – which would deter investors further. Ines Zenke, energy market expert at law firm Becker Büttner Held says that “from a formal point of view, it is not possible for the German government – or any other democracy – to guarantee investors that there will be no changes to the regulation of the new power market design.” Future legislation could change the power market design. Nevertheless, the German government could raise the credibility of their intentions by granting investors the protection of their legitimate expectations.“ In her opinion Germany should do that to entice investments. Although relying on the concept of legitimate expectation could be tricky, this would at least attach a higher political price for future changes because investors could argue, in the political discourse as well as the courts that they had good faith in the German state as a whole not to interfere with high power prices.

Based on worries about the long-term legal stability of the design, BDEW questions new market design as a whole. “We are not convinced that the German government will stick to this approach, and eventually will change their policies when the pressure rises. There is a reason why the UK and France have opted for capacity payments,” he adds.

The majority of organisations welcome the EOM

Despite some pinching criticism, the decision by the government is broadly welcomed in Germany. Overall only 25 of 142 organisations that participated in the public consultation of the market design proposals, according to the economics ministry, argued in favour of the introduction of capacity payments.

Take Robert Busch for example, CEO of Germany's energy association BNE, which lobbies for the interests of challengers to the incumbent utilities. Busch said in a statement that for companies of the new and digital energy economy, the white paper would be “an important signal that shows once more that the energy transition cannot be successful with the ideas of yesterday.”

Neither can the renewable energy lobby be unhappy about the result. The green energy industry feared for a while that Energy Minister Sigmar Gabriel, a Social Democrat who has spoken in support of the employees of power stations, might be inclined to make sure fossil fuel power plants receive long-term subsidies. Carsten Pfeiffer, the chief political lobbyist of the German Renewable Energy Federation (BEE), fretted last year that the “patient is obese, but somehow it gets diagnosed with anorexia and is force-fed public money.” Now, he says that new flexibility options will render any support of fossil power plants superfluous. “There will be no shortage of capacity in Germany in either the short or in the long run, because new flexibility options will flood the market,” he says.

As an example, he cites that large capacities of emergency power systems run by companies could jump in if electricity shortages occur. Pfeiffer adds that in order to harness the full potential of available and future flexibility in Germany, the legislative details that will be negotiated during the coming months could be crucial. “For example, the grid operators in Germany want to stick to their old ways and are not welcome to opening the market for balancing power. But I am convinced that this is mostly a temporary problem,” he says.

Holger Krawinkel, who develops and implements end-consumer business models at MVV Energie, one of the largest German municipal energy companies, is clearly convinced of the reform, too. “The EOM 2.0 is the right solution,” he says. “It will help unleash most flexibility options that are existent in the current system.” In the medium term, he thinks, there will be no shortage of flexibility. On the contrary: “Prices will go down, because options like home batteries or demand-side management of industries will compete with gas power stations. For fossil fuel power plant operators, this poses a problem, but not for security of supply.”

However, Krawinkel thinks that the white paper and the ensuing reforms will only constitute an intermediate step. In the long run, the centrally controlled electricity system as we know it would cease to exist. Millions of producers and consumers could participate in the market, enabled by modern IT solutions, in combination with distributed production, mostly from photovoltaics, and storage. “In my view, politicians, the central government and most lobby groups have not yet realised what this will entail: A consumer-driven, fragmented market cannot be under tight state control and has very different political dynamics. Perhaps the current reform is the last reform that will see politicians in central government being in the driving seat.”

What about the perspective from abroad?

Germany’s neighbours support the market reform via an agreement that they would not interfere with power prices. And, according to state secretary Baake, the European Commission, too, is in favour of the new market design. “I am glad that the Commission's communication places a clear focus on the market and advocates for the flexibilisation of supply and demand and the use of price signals,” he said recently in a statement. Germany, which for years mostly ignored the effects of the Energiewende abroad, is now much more keen to act in accord with Brussels and its neighbour states.

Gerard Reid from Alexa Capital sees the reform as a defeat for the incumbent fossil energy industry. In the UK, he argues, big utilities lobbied hard and eventually successfully for a capacity market – “which is nothing else than a bailout.” He agrees with most commentators that no one will invest in new fossil generation capacity, but just like the renewable industry, this will not matter if other flexibility options are fully utilised. “What the EOM really needs in order to function well is even deeper markets than proposed by the German government,” he says. To free all flexibility options, he proposes that electricity, like stocks, should be traded not in 15-minute intervals, but rather by the minute, or even the second. “This would encourage all possible flexibility options to enter the market. “At the moment, long intervals in trading and balancing power favour big conventional power stations, which are slow to react.”

 

Jakob Schlandt is a freelance contributor to the Clean Energy Wire. He also writes for Europolitics and BIZZ energy today and his own blog http://phasenpruefer.info/.

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