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Development and integration of renewable energy: Lessons learned from Germany  

Author:  | Economics

EXECUTIVE SUMMARY

Over the last decade, well-intentioned policymakers in Germany and other European countries created renewable energy policies with generous subsidies that have slowly revealed themselves to be unsustainable, resulting in profound, unintended consequences for all industry stakeholders. While these policies have created an impressive roll-out of renewable energy resources, they have also clearly generated disequilibrium in the power markets, resulting in significant increases in energy prices to most users, as well as value destruction for all stakeholders: consumers, renewable companies, electric utilities, financial institutions, and investors.

Accordingly, the United States and other countries should carefully assess the lessons learned in Germany, with respect to generous subsidy programs and relatively rapid, large-scale deployment and integration of renewable energy into the power system. This white paper is meant to provide further insight into the German market, present an objective analysis of its renewable policies, and identify lessons learned from Germany, and to a lesser degree, other European countries.

The rapid growth of renewable energy in Germany and other European countries during the 2000’s was due to proactive European and national policies aimed at directly increasing the share of renewable production in their energy mixes through a variety of generous subsidy programs. Two main types of subsidy programs for renewable power developed in Europe include feed-in tariffs (FITs), which very quickly became the policy of choice for Germany and many other European countries, and quota obligation systems.

FITs are incentives to increase production of renewable energy. This type of subsidy guarantees long-term (usually for 20 years) fixed tariffs per unit of renewable power produced. These fixed tariffs normally are independent of market prices and are usually set by the government, but can be structured to be reduced periodically to account for technology cost decreases. The level of the tariffs normally depends on the technology used and the size of the production facility. Because of their generosity, FITs proved capable of quickly increasing the share of renewable power, but since the FITs are set administratively, it is difficult to meet renewable energy goals in the most cost-effective way possible.

The quota system is the European equivalent to the Renewable Portfolio Standard used in the United States. Whereas FIT programs set the price for the resources and let the market achieve whatever level it can at that price, the quota system is a market based system that sets the desired amount of renewable resources and lets the market determine its price. Under the quota system, compliance is proven through renewable certificates that can usually be traded.

Germany used FITs to help finance its energy policy, “Energiewende” (the energy transformation), that calls for a nuclear-free and carbon-reduced economy through a vast deployment of renewable technologies.

Because FITs levels were administratively driven and slow to adapt to the evolution of the solar market, the incentive became excessively generous, which initiated an uncontrolled development of renewables, which, in turn, created unsustainable growth with a myriad of unintended consequences and lessons learned. Accordingly, this analysis will focus on Germany, whose FIT policies allowed it to realize the highest production of non-hydro renewable electricity (wind and solar) in Europe.

The most important lessons learned include:

  1. Policymakers underestimated the cost of renewable subsidies and the strain they would have on national economies. As an example, Germany’s FIT program has cost more than $412 billion to date (including granted and guaranteed, but not yet paid FIT). Former German Minister of the Environment Peter Altmaier recently estimated that the program costs would reach $884 billion (€680 billion) by 2022. He added that this figure could increase further if the market price of electricity fell, or if the rules and subsidy levels were not changed. Moreover, it is estimated that Germany will pay $31.1 billion in subsidies for 2014 alone. A recent analysis found that from 2008 to 2013, Germany incurred $67.6 billion (€52 billion) in net export losses because of its high energy costs, compared to its five leading trade partners. Losses in energy intensive industries accounted for 60 percent of the total losses. This was further highlighted by a recent International Energy Agency report, which stated that the European Union (EU) is expected to lose one-third of its global market share of energy intensive exports over the next two decades due to high energy prices, expensive energy imports of gas and oil, as well as costly domestic subsidies for renewable energy.
  2. Retail prices to many electricity consumers have increased significantly, as subsidies in Germany and the rest of Europe are generally paid by the end users through a cost- sharing procedure. Household electricity prices in Germany have more than doubled, increasing from €0.14/kilowatt hour (kWh) ($0.18) in 2000 to more than €0.29/kWh ($0.38) in 2013. In Spain, prices also doubled from €0.09/kWh in 2004 to €0.18/kWh in 2013 ($0.12 to $0.23) while Greece’s prices climbed from €0.06/kWh in 2004 to €0.12/kWh in 2013 ($0.08 to $0.16). Comparatively, household electricity prices in the United States average $0.13/kWh, and have remained relatively stable over the last decade.
  3. The rapid growth of renewable energy has reduced wholesale prices in Germany, with adverse consequences on markets and companies. Large subsidies and guaranteed interconnection to the grid for renewable energy led to unexpected growth over the last 10 years in Germany and elsewhere. The merit order in Germany’s wholesale markets switched as renewables, with a zero variable cost of production, take precedence over thermal plants. As a result, wholesale prices in Germany for base load have fallen dramatically from €90-95/megawatt hour (MWh) in 2008 to €37/MWh in 2013. This has created a large amount of load and margin destruction for utilities that built and financed thermal plants. Many new gas-fired power plants have been rendered uneconomical, leaving owners to shore up their balance sheets by undertaking large divestitures of some of their holdings, as well as by reducing their operational costs. The impact to utilities’ shareholder value has been dramatic and has come on top of the impact of the global financial crises, and, in the case of Germany, the decommissioning of nuclear power. The German utilities have seen their stock plunge by nearly 45 percent since 2010. Some power plant operators in Germany and other countries, like the United Kingdom, are now calling for capacity payments to ensure that reliability is maintained and not threatened by the shutdown of various thermal power stations.
  4. The wholesale pricing model has changed as a result of the large renewable energy penetration. In the past, wholesale prices followed the demand curve, but in Europe they now react to the weather; going down when the sun shines and the wind blows, and up when—at times of high demand—the sun does not shine and the wind does not blow. Price forecasts and power trading require more skill sets and different know-how, including weather forecasting.
  5. Fossil and nuclear plants are now facing stresses to their operational systems as these plants are now operating under less stable conditions and are required to cycle more often to help balance renewables’ variability. Investments in retrofits will be required for these plants in order to allow them to run to these new operational requirements. Moreover, renewable resources are dramatically changing thermal plants’ resource planning and margins. As a result, many of these plants are now being retired or are required to receive capacity payments in order to economically be kept online.
  6. Large scale deployment of renewable capacity does not translate into a substantial displacement of thermal capacity. Because of the variability of wind and solar, there are many hours in the year during which most generation comes from thermal power plants, which are required to provide almost complete redundant capacity to ensure the reliability of the system. In turn, grid interventions have increased significantly as operators have to intervene and switch off or start plants that are not programmed to run following market- based dispatching. For instance, one German transmission operator saw interventions grow from two in 2002 to 1,213 in 2013. It is higher amounts of renewables with low full load hours relative to the total portfolio of power production that creates greater variability and strains on the grid. In the case of Germany, it is the large-scale deployment of both wind and solar that has impacted the entire system.
  7. Large-scale investments in the grid are being required to expand transmission grids so they can connect offshore and onshore wind projects in the north of Germany to consumers in the south of the country. The total investment cost for the build-out of German onshore and offshore transmission systems is estimated to be around $52 billion (€40 billion) over the next 10 years. Moreover, the grids are now being challenged to meet the dynamic flows of variable renewables and require significant additional investment to accommodate increased penetration of renewables. All of these costs will ultimately be passed on to electricity consumers. This has not gone unnoticed in Germany or in the EU. A report was released in late February 2014 by an independent expert commission mandated by the German government, which concluded that Germany’s current program of incenting renewables is an uneconomic and inefficient means to reduce emissions and therefore should be stopped. Moreover, the European Commission released new guidelines on April 9, 2014, with effect starting in 2017 that will correct market distortions. It will essentially ban all FIT subsidies and introduce technology agnostic auctions as the only incentives for renewables.
  8. Overgenerous and unsustainable subsidy programs resulted in numerous redesigns of the renewable support schemes, which increased regulatory uncertainty and financial risk for all stakeholders in the renewable energy industry. As the lessons above show, some European renewable energy regulatory regimes were inappropriately structured, gamed by market players, or made obsolete by market conditions. As a result, governments and regulators corrected unsustainable regulatory regimes by reducing the level of subsidies, sometimes retroactively, and modifying the rules of the programs. These changes often resulted in significant value destruction to various renewable players and their respective investors. This continued regulatory uncertainty across Europe is increasing the cost of capital to European renewable companies, which the rating agency Fitch just recently highlighted as the most likely sector in the European energy market to receive a downgrade in 2014.

These lessons learned are important and provide factual analyses to assist other countries’ electric industry stakeholders’ in creating more technically-efficient, cost-effective and sustainable ways to integrate renewable energy.

U.S. stakeholders should take into consideration the lessons learned from Germany and Europe:

Utilities should incorporate those lessons into their strategic planning, load forecasting, financial planning, trading, and regulatory affairs organizations. Decisions about current and future investments should then be made with this new analysis in mind.

Renewable companies should calculate appropriately the true costs of grid enhancements, capacity, and other important measures when submitting their plans to commissioners, investors, and other stakeholders.

Legislators and regulators should use the lessons learned from large scale integration of renewables in Germany and elsewhere in Europe to ensure a stable transition of renewables as part of the overall power portfolio while ensuring high reliability of power, stability of pricing to all users, as well as minimal value destruction to both utilities and renewable companies.

Finally, consumers must be made aware of the tradeoffs to a large portfolio of renewables and the necessary requirement for a smooth transition as part of the overall power portfolio.

In conclusion, the lessons learned in Europe prove that the large-scale integration of renewable power does not provide net savings to consumers, but rather a net increase in costs to consumers and other stakeholders. Moreover, when not properly assessed in advance, the rapid, large scale integration of renewables into the power system will ultimately lead to disequilibrium in power markets, as well as value destruction to renewable companies, utilities, and their respective investors. The U.S. has the opportunity to incorporate these lessons learned to ensure the sustainable growth of renewable energy over the long-term, for the benefit of all customers.

July 2014

Hans Poser
Jeffrey Altman
Felix ab Egg
Andreas Granata
Ross Board

FAA Financial Advisory (Finadvice), Adliswil, Switzerland

Download original document: “Development and integration of renewable energy: Lessons learned from Germany

This article is the work of the author(s) indicated. Any opinions expressed in it are not necessarily those of National Wind Watch.

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