Can a country slash its CO2 emissions and avoid electricity price spikes at the same time?

By Eric Marx | 01/30/2015 08:17 AM EST

BERLIN — The goal is ambitious: Can Germany successfully adapt its electricity market to a future where the predominant power is renewable energy?

The country is trying to pull together its current plan to get there at a difficult moment, when all across Europe, countries are suffering from market conditions that favor a fuel switch from natural gas to low-cost coal. This has yielded record export levels and rising emissions that threaten to undo Germany’s reputation as a champion of climate change action.

At the same time, plummeting power prices have rendered many conventional plants unprofitable, sparking fears of power shortages and even blackouts after Germany’s last nuclear power station is turned off in 2022.

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Analysts say the country must have a coherent strategy to transform its electricity sector, with one of two basic options now on the table: Either tweak the free-market approach by allowing for price spikes in periods of low supply or move toward a capacity market, one in which utilities are paid to continue operating in times of scarcity.

Each approach has its perils, and after months of speculation, it fell to Sigmar Gabriel, Germany’s economics minister, to try to put an end to the debate. In an interview with the Handelsblatt newspaper this past week, Gabriel ruled out subsidy payments, saying it was time to take "a clear, unbiased look at the energy market" to ensure "we get signals where there are real scarcities."

"That’s not a sensible energy policy," added Gabriel in describing a capacity mechanism that he said would "preserve existing overcapacity at the cost of German power consumers."

Gabriel, who is a likely Social Democratic Party candidate for chancellor in 2017, in effect told utility operators to expect no relief from the government. For the four biggest energy providers, E.ON, RWE, Vattenfall and EnBW, which own most of the fossil fuel plants in Germany, the announcement was like a punch to the gut.

"Mr. Gabriel cannot claim papal infallibility," shot back Johannes Teyssen, the boss of E.ON, Germany’s largest utility. "The capacity market will come … this discussion has only just begun."

Search for a strategy

Teyssen may ultimately be right. The search is for legislation or some kind of deal with industry that could yield subsidy payments for conventional baseload operators, just as long as they don’t include coal plants that were otherwise at risk of closure. The recent £1 billion capacity market auction in the United Kingdom is thought to have done just that, say German commentators.

Turbine parts
More power from the Baltic: Parts for an 80-turbine wind farm stack up in Sassnitz, Germany. | Photo by Stefan Sauer, courtesy of AP Images.

Still, some kind of control mechanism may very well be needed. Energy market researchers cite investments in combined heat and power (CHP) generation as one example of a technology that could benefit from a flexible capacity mechanism.

An expensive technology, these dual-mode heat systems link the power and heat sectors by producing heat either with fossil fuels or with electricity. Official government targets forecast an increase in electricity generation from CHP plants to 25 percent by 2020.

These plants will soon constitute the majority of controllable power generation in Germany and are expected to play a pivotal role, given their ability to balance consumer demand with fluctuating electricity production from wind and solar plants.

"There is a lot of elasticity in our system," said Patrick Graichen, executive director of the Agora Initiative, a Berlin-based think tank whose work focuses on the electricity sector. "The issue, however, remains how these flexibility options could be brought to the market."

Renewables surge to the top — for now

Renewable energy increased by 2 percentage points in 2014, to account for 27.3 percent of all German electricity production, ousting lignite coal from the top spot and reversing an ominous trend that had seen greenhouse gas emissions rise three of the last four years.

For the first time, renewables were the most important source of electrical energy in the power mix in Germany, with more expected in coming months as offshore wind connects to the system for the first time in a significant way.

By 2020, renewables will account for 35 percent of the energy mix. In the short term, at least, the issue is overcapacity, says Craig Morris, an author of the website "Energy Transition: The German Energiewende," which is funded by the Heinrich Böll Stiftung, a foundation associated with the German Green Party.

"The coal debate that we had last year played into this, where we had people calling for certain coal plants to be taken down so prices would go up on the market again," said Morris.

With only current policies in place — including further development of renewables and combined heat and power generation, reforms to the E.U. Emissions Trading System, and a boost in energy efficiency savings — Germany would still fall short of its 40 percent reduction goals by at least 7 percentage points, or 87 million tons of carbon, according to estimates by the Environment Ministry.

"The real problem is so many plants on the grid and building so many renewables faster than other stuff can be taken down," said Morris.

Price rises halted

Reforms to the renewable energy law entered into force last August could very well begin to rectify this imbalance.

This controversial step — cutting the costs for energy paid by consumers by capping the amount of green power qualifying for state-guaranteed income — may prevent further cost increases. Future wholesale prices have already dropped below current levels now that the energy reallocation charge has stopped rising, and in light of anticipated legislative action still to come. This may, in turn, relieve pressure on the downward wholesale price paid to conventional power plants.

Yet nearly all experts say more is needed. Minister Gabriel acknowledged as much in addressing the further build-out of cross-border power lines linking Germany to Italy and other neighbors, thereby enabling a more affordable sharing of the countries’ varying peak load.

"You can only benefit from this if the exchange of electricity between the two countries works smoothly," said Gabriel. "That isn’t the case at the moment, and we have to change that."

What doesn’t seem to be in the cards is a quick phaseout of coal.

"The German response will be to let the power sector try to figure this out and maybe nibble away at the edges," predicted Morris. "They will address the needs of a particular plant to stay on by formulating a special payment, but they won’t call it a capacity charge."

Lobbyists and sources close to the energy ministry now say the preference is for improving the current market system in combination with some kind of small capacity reserve. In such a system, dubbed the "Energy Only Market 2.0," investors would need to be assured that the very high power prices to be expected in times of high demand would be politically accepted.

This could lead to a great deal of volatility, but proponents of this approach say that markets and investors — given the right framework — will be able to predict power shortages and head them off.

A government white paper with firmer recommendations will provide more details in the spring, and in late 2015, Gabriel plans to draft a reform bill to come into effect in 2016. That puts Germany just 18 months away from what could be the deepest reform of its energy market since its liberalization in 1998.

At stake is the ambition to carry out the biggest clean-energy push of any industrialized nation to date. Yet at least for now, German government officials believe they’re sufficiently back on a course that may get them there.

"A functioning energy market also means having real scarcity prices that send a signal to investors," said Gabriel. "My advice is ‘Trust the market.’"

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