31 Oct 2014 | Jakob Schlandt

Government paper lays out options for German power market overhaul

The German government plans a complete overhaul of energy sector legislation. But one key question is as yet unanswered: Do fossil power plants need subsidies if Germany is to avoid power shortages? A green paper on energy market reform addresses this issue.

The German Energiewende – which aims to phase out nuclear power by 2022, and boost the share of renewable energy to 40 - 45 per cent by 2020 – will completely transform the energy market. And it poses an increasingly urgent problem: Fossil fuel power plants are being pushed out of the market and operate at a loss. Some have already closed. A controversial law barring owners from shutting down stations that are in the red and giving the grid regulator, the Bundesnetzagentur, the power to lease power stations in Germany and abroad for the winter, is now the only backstop to ensure there is always sufficient capacity to meet peak demand.

In short, the German energy market is facing serious challenges and the coalition government of Social Democrats and the Chancellor Angela Merkel’s conservative CDU-CSU see major reform as inevitable. The key question is: Should fossil power plants be eligible for subsidies to keep them in the market? If the answer is yes, it would amount to biggest reform in the German fossil-fuelled electricity industry since the market liberalisation of 1998.

On 31 October a green paper headlined “An electricity market ready for the Energiewende”, was published by the Energy Ministry in Berlin. It can be downloaded here (in German). So, what are the main points of the paper?

Firstly, the document outlines a string of reforms that the government sees as “no-regret” measures aimed at making the energy market more efficient. Greater responsibility will be placed on energy traders to buy sufficient electricity to meet consumer demand – with hefty penalty charges likely if they don’t. Grid operators will be allowed to shut down green power producers to stabilise the grid on a regular basis. Grid extension is to be a priority. And the European integration of the German energy grid will be pushed further, both physically and by creating smoother markets.

However, at the heart of the paper, in part three, two main options are weighed for further and much deeper reform: “The main point of the discussion is if an optimised electricity market can ensure enough capacities are available for security of supply or if an additional capacity market is necessary” (p. 39).

The paper, as well as a number of studies commissioned by the Energy Ministry and published in July this year, set out extensive arguments in favour of the so-called energy-only market 2.0 (EOM 2.0) that relies solely on market forces to determine the price power plant operators get for every megawatt hour they sell on the market.

This would allow power plant operators to hike up their prices in times of electricity scarcity to whatever power consumers faced with the lights going out are willing to pay – and far beyond the current production costs of even the most expensive power plants.

The green paper proposes that the “legislator should make it clear that there is no intervention in the form of price ceilings” (p.43). The paper also notes that this would give large producers substantial market power, requiring some oversight. But politicians would ultimately have to accept massively increased prices at certain hours of the year.

In addition, the EOM 2.0 reforms would introduce a capacity reserve, consisting of power plants that do not compete on the market, as a last resort in case the market fails.

The second main option that the paper discusses is the introduction of a capacity market. "If society and politics are not prepared to evolve the electricity market towards scarcity prices, we need a capacity market," the green paper argues (p. 40). This would mean operators of fossil power plants are compensated just for providing generation capacity all year round.

Numerous capacity market options are introduced and discussed in the reform proposal. A fully-fledged capacity market receives some criticism, with the authors arguing that inflexible and high-emission power plants would also receive payments, which would be counterproductive to the aim of an increasingly flexible energy supply and national climate policy goals (p.43).  

However, such a market could be decentralised. This would mean utilities must acquire certificates from power plant operators according to the electricity they plan to sell, putting the onus on the utilities to determine the capacity needed. The green paper is more positive on this proposal, saying that “Regulatory risks are lowest with this option” (p.43).

Lastly, the green paper weighs the merits of centralised capacity markets where the state is responsible for determining how much overall capacity is needed. An additional option would be to introduce “focused” capacity markets “that could favour flexible and low emission capacities” (p.43).

Overall, the paper leans slightly towards abstaining from capacity markets. The analysts’ argument that capacity markets are a “risky” option, while optimisation of the current power market would be sufficient, is given substantial space in the paper.

Still, the decision will not be made by economists and experts but by politicians, and it remains to be seen if the German government is willing to leave decisions on key infrastructure to a volatile market. The argument in favour of this is that it minimizes costs to consumers, which have been rising sharply due to subsidies for green power generation. On the other hand, the government may introduce a potentially costly capacity mechanism in the interests of stability.

Energy Minister Sigmar Gabriel (Social Democrats) is keen to stress that no decision has yet been made: “The green book is not a decision, but it is supposed to provide the basis for the decision that will be taken in 2015,” he said. Stakeholders are invited to comment on the green paper over the coming weeks.

Before the Energy Ministry publishes its white paper on the issue slated for spring 2015, the decision – a yes or a no for capacity markets in Germany – will be made. Proposals on legislation are promised by the end of 2015 and the new law is to come into effect in 2016, the ministry said.

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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