What impact could the ‘German dawn’ have on Czechia?
A few days ago, oEnergetice published an article by Michal Šnobr considering the possibility that, in order to achieve an economic replacement of coal with gas, Germany is now aiming for a dramatic increase in the price of emissions allowances. Let us consider what impact this could have on Czech energy.
In a recent article on oEnergetice, Michal Šnobr, a well-known and highly successful energy investor, developed the hypothesis that Germany’s current support for European Union policies leading to high allowance prices, and its considerable pressure to build the Nord Stream 2 gas pipeline, are not coincidental. It could be planned, with the aim of using expensive emissions allowances to push coal-fired generation out of the market through gas. Current allowance prices, which result in electricity prices from coal-fired units of around 50 EUR/MWh, would not be sufficient for this and would have to rise several-fold. However, this would have truly dramatic effects not only on electricity prices in Germany, but across Europe.
The extensive subsequent discussion showed that I am not the only one who believes this is more likely an attempt by German politicians to manoeuvre their way through the consequences of their irrational energy decisions and promises. I assume Germany will continue trying to ensure that the rise in emissions allowance prices is not overly dramatic. But what if Michal Šnobr is right and I am wrong? His investment speculation has been very successful and profitable in the past. By contrast, I am neither an economist nor, certainly, a successful investor.
It is therefore very useful to examine what impact his hypothesis of Germany using market mechanisms to replace nuclear power and push out coal-fired generation with gas would have on the Czech Republic. In my view, the effects could be very dramatic. This is also why I am glad that Michal Šnobr set out his opinion in writing and that it sparked a broad discussion. I believe it is important to analyse and discuss this possibility and its impacts. Michal Šnobr examined it from an investor’s perspective. I will try to show other aspects and discuss the risks such a development would bring. As mentioned, I am not an economist, so some of my considerations may not be accurate. Please regard the following text only as a stimulus for thought and discussion.
What is the ‘German dawn’?
According to Michal Šnobr’s theory, German energy is undergoing a turnaround that should help Germany rationally reverse a whole series of previous irrational and contradictory decisions, while preserving its image as one of the leaders in fighting climate change through CO2 emissions reductions. It should also restore the trust of at least some partners in the EU or the Energy Union, who are losing patience with developments in German energy. Germany is now very close to shutting down all its nuclear units, which still supply a significant 70 TWh. This is happening at a time when CO2 emissions are to be reduced and lignite-fired power plants in particular are to be shut down. At the same time, the German transmission system is becoming unable to cope with the pressure of connecting new and intermittent renewable energy sources, whose annual additions the German government has had to begin sharply limiting.
For the reasons outlined above, Michal Šnobr’s ‘German dawn’ theory holds that Germany changed its strategy and allowed European institutions to adopt a reform of the EU ETS emissions allowance market and strict rules for coal-fired power plants that are to operate in the next decade. The adoption process ran throughout 2017 and was completed in the first quarter of 2018. The price of emissions allowances rose sharply over one year from 6 EUR/t to today’s 21 EUR/t, i.e. by 250%. However, that is not enough for Germany; it needs allowance prices to rise further. Only then will it have a market-based solution enabling it to quickly reduce coal capacity and secure stable and flexible capacity through gas-fired units. A several-fold higher allowance price will ensure that electricity from gas is cheaper than from coal, while the high electricity price will make gas-fired units profitable and attractive to investors. The market and investors will then ensure the replacement of coal and nuclear power with gas. At the same time, an electricity price significantly exceeding 60 EUR/MWh would enable a market-based approach for some wind power plants. However, because Germany sets electricity prices in the region, implementing this vision would also mean very high electricity prices and other impacts for Czechia.
Evidence for the ‘German dawn’ theory
Michal Šnobr sees evidence for his theory not only in the aforementioned change in Germany’s approach to emissions allowances, but also in two other facts. One is the very strong support from German representatives for the construction of the Nord Stream 2 gas pipeline despite opposition from some EU states. Germany would thus secure direct access to abundant and cheap gas supplies. The other is that RWE in particular bought large quantities of then-cheap allowances and had already sold electricity from its coal-fired units forward for the following years, 2019 and 2020. German companies are now beginning to address this situation for further years as well.
In my view, Germany’s actions are not driven by the described new plan, but rather by considerable helplessness. It is true that Germany did not take the opportunity to join countries such as Poland, Czechia and other Central and Eastern European countries in securing a blocking minority in negotiations on allowances and higher green targets. However, this was more because it sacrificed its interests to preserving its reputation as a progressive green country that would not stoop to the level of backward barbarians in the East. Even now, albeit covertly, Germany will seek to keep allowance prices rather lower.
Impacts of the ‘German dawn’
I base my view on the fact that, in my opinion, a ‘German dawn’ would have very dramatic consequences for Germany. The fundamental problem is that rising emissions allowance prices increase not only the price of electricity from coal, but also from gas. The increase is smaller because emissions from gas are half those of coal, but it is still significant. It will therefore take longer for gas to catch up with coal, and their prices will meet at a higher level. This naturally also depends on the price of the fuel itself, which has recently risen for both commodities. The convergence of their electricity prices could become even more difficult as gas demand rises and coal use declines during the ‘German dawn’.
There is thus a considerable risk that the transition to gas would mean truly very high allowance and wholesale electricity prices. This could be very unpleasant for German consumers and industry. So far, rising charges for renewable energy subsidies and network services have been partly offset by low wholesale electricity prices. Even so, Germany has the highest electricity price for consumers, and the price for industry, where some renewable subsidy costs are passed on to consumers, is also high. At the same time, an increase in the wholesale electricity price need not mean a noticeable reduction in the scale of renewable subsidies. During periods of ideal wind conditions, there will still be such a surplus of wind power that it will lead to low or even negative wholesale energy prices on the exchange. Prices will be high when output from wind and solar sources is limited.
In the event of a German dawn, electricity prices would rise enough that wind generation in suitable conditions could certainly be installed without subsidies and on market principles. The problem for Germany and its neighbours, however, is that this applies only where the share of wind and solar generation is limited. In Germany, the situation has already reached a point where installed capacity, especially wind capacity, is such that under ideal conditions it can supply more than is needed. Newly built turbines therefore will not improve the situation when there is no wind, and under ideal conditions they cannibalise existing turbines and reduce the market price at that time. This is discussed in more detail in a recent article. Germany’s situation is further worsened by the construction of new wind capacity in neighbouring countries, which reduces the potential for German exports. Only completion of north-south interconnections and a massive increase in storage capacity could help. However, this cannot be expected within years, or even decades.
Michal Šnobr assumes that a stable high price will encourage investors to rapidly bring gas-fired capacity back online and build new plants. And that this is precisely what the ‘German dawn’ envisages. However, I am not at all sure this can happen. It is true that Germany has mothballed gas-fired units built at the beginning of this decade. Some of them, however, have already been dismantled and sent abroad. I do not know to what extent potential investors will believe such a situation can endure longer term. I clearly remember the period at the beginning of this decade when I debated economic experts who, based on developments in the US and environmental attitudes in Europe, expected gas to become cheaper and allowance prices to rise. In their view, only subsidised renewables and gas-fired generation had a bright future here and in Germany. We now know how investors who followed their forecasts fared. The same economic experts predicted a few years ago an endless period of low electricity prices or even their continuing decline. Relying on the stability of an emissions allowance price that can be changed almost immediately by political decision may therefore not be particularly rational.
German energy is full of radical reversals that have cost investors dearly. In 2010, the red-green coalition decided to phase out nuclear power and ordered the shutdown even of modern nuclear units before much of their potential operating life had been used. This decision created a need to build the most modern and efficient fossil-fuelled units possible, using gas and imported hard coal, to replace nuclear plants. It soon became clear that the time and, above all, financial demands of implementing a larger share of renewables were far higher; therefore, in 2010, the German government and plant operators concluded an agreement to extend the operation of nuclear units, which in return would contribute additional funds to subsidise renewable sources. This agreement was cancelled after the Fukushima events, bringing a return to the original Energiewende plan, without cancelling the additional payments from operating nuclear units. As mentioned several times, the political emphasis on emissions reductions at the time led to expectations of rising allowance prices and support for gas-fired generation. We know how that turned out.
If a ‘German dawn’ really occurred, the first sources to be economically threatened would be hard-coal-fired plants. This would include those recently built to address the loss of nuclear units. These are the most modern, highly efficient and therefore costly plants. In my view, that would be another blow to investor confidence. For that reason too, I believe investors will not rush to build new large gas-fired units. The shortage of firm capacity would then further increase electricity prices.
Overall, electricity prices for consumers and industry could rise very dramatically. It is true that German wages and industrial efficiency are among Europe’s highest, but I simply cannot imagine that they would accept such a dramatic increase. Especially when, in terms of CO2 emissions, Germany would still be the dirtiest country in Europe.
Even if all coal-fired power generation were switched to gas, its CO2 output would remain high. A gas-fired power plant reduces emissions only by half compared with coal. In addition, gas-fired power plants would have to be built to replace the shut-down nuclear units. In their case, this is purely an increase in emissions. The question is how successfully emissions can be reduced in other sectors. Especially as a transition to electrification would rely on Germany’s still highly emissions-intensive electricity sector. Germany would therefore truly be unable to present itself as an environmentally green leader, which has so far made it easier to accept the consequences of the high costs of the Energiewende.
Who would benefit and profit from the German dawn?
In my view, Germany would pay the price for the German dawn through another extreme increase in Energiewende costs. But who would benefit? Primarily hydro and nuclear power plants, and countries whose energy sectors are based on them or on a combination of them with other renewable sources. Existing nuclear units would become golden geese. The same would apply to hydropower plants, especially as their output can be regulated effectively. Among countries, France and its energy company EDF, with their dominant share of nuclear generation, are clear beneficiaries, as is Norway, where hydropower dominates. Sweden, Switzerland and Slovakia would also be winners; after completion of Mochovce, Slovakia too will have an energy sector based mainly on nuclear and hydro power. If Hungary and Finland manage to complete their planned nuclear units on time and without significant cost increases, they too would benefit. In the event of long-term, very high electricity prices of the kind required by the ‘German dawn’, Olkiluoto 3, Flamanville 3 and Mochovce 3 and 4 would ultimately become financially very successful projects despite all their failures, complications, delays and cost overruns.
In this case, attitudes towards building new nuclear reactors would also very likely change significantly. The main economic objection to their construction, namely the low wholesale electricity price, would disappear.
Impacts on neighbours, including Czechia
For successfully surviving the ‘German dawn’, the most important factor would be the lowest possible share of fossil fuels, not only in electricity generation. Where fossil fuels cannot be avoided, the key would be the most direct possible access to the cheapest possible gas. It is therefore clear that such a scenario for European energy development would be most disastrous for Poland. Its electricity sector is dominated by coal and, for strategic and political reasons, it seeks to be as little dependent as possible on Russian gas. Poland can therefore never hope to obtain cheaper gas than Germany. If market prices are set by German gas-fired power plants, any Polish gas-fired units would struggle to remain profitable. Moreover, Poland’s rapid transition from coal to something else would have such drastic impacts, including on employment, that it is difficult to imagine how it could be implemented. As I wrote, in the case of a German dawn, the impact on the price of electricity from coal would be so great that, in my opinion, German consumers would find it difficult to endure. For Polish consumers, it is clear that the social impacts would be so catastrophic that Poland would most likely have to leave the EU emissions trading system in time, whatever the political consequences.
In Czechia, a little over 40% of electricity is generated by low-emission sources and over 50% by fossil sources, mainly coal. Generation from, and potential exports of, nuclear power would bring very high profits in the event of a ‘German dawn’; coal-fired units, by contrast, would find themselves in an entirely different position due to high emissions allowance prices, even with high electricity prices. Plants that had been environmentally upgraded at relatively high cost would suddenly be pushed out of the market by rising allowance prices. We do have some prepared but so far unused gas-fired power plants, but they are minimal in relation to the need to replace coal. Electricity prices for consumers would still be lower here than in Germany, but high enough to have fairly dramatic social consequences.
Possible impacts on district heating and the environment
In the Czech case, the ‘German dawn’ could also have a considerable impact on district heating. Centralised heat sources above a certain size must also purchase emissions allowances. A significant increase in their price could dramatically affect their profitability. This could even lead to the demise of coal-based centralised heat sources, while those operating on gas would also be threatened. High electricity prices and reduced availability and a higher price of gas would also affect the availability and profitability of a number of local heat sources, including heat pumps. Local coal-fired heat sources, on the other hand, would become cheaper as supplies were freed up and prices would probably fall. Small sources do not have to meet emissions limits or purchase emissions allowances. A shift away from centralised heat sources, gas and electricity back to household coal boilers could therefore also have substantial environmental impacts.
Conclusion
Over the past year, the price of emissions allowances has been rising and it can be assumed that it will continue to rise for at least some time. Their current price is around 20 EUR/t CO2. This results in wholesale electricity prices above 50 EUR/MWh. Such prices existed at the beginning of this decade, before allowance prices fell and surplus capacity was built, mainly in Germany, leading to low wholesale electricity prices. If this or a similar situation stabilised, it could contribute to a relatively smooth and bearable transformation of European energy towards a low-emission model. However, if allowance prices rise over the next few years to 40–50 EUR/t CO2, as some experts predict, or even to the prices required by a possible ‘German dawn’, it would mean dramatic impacts for Czech energy and society as well.
A few days ago, our book, ‘Czech energy at a crossroads’, was published, in which we seek to examine possible scenarios and risks facing Czech energy. We identify the beginning of the 2020s as the first turning point, when all nuclear reactors in Germany will close and a number of coal-fired units will close in Germany, Czechia and elsewhere among our neighbours. If emissions allowance prices remain at a reasonable level, total electricity generation in Czechia will roughly match our needs. Covering daily, weekly and seasonal load profiles will be more challenging, but with reasonable effort and preparation in the coming years, it should be possible.
However, if the ‘German dawn’ were implemented, an entirely different situation would arise. The tendency for coal capacity to be lost would be far more dramatic. In this case, even coverage of our total electricity consumption might no longer be assured. Prices formed here by the German market would also become socially unacceptable. This would be precisely the situation that justifies and requires establishing procedures in advance to ensure that cheaply generated electricity, for example at Temelín or Dukovany, is used to meet Czech needs and not to bring only a modest price reduction on the German market. Even though profits for ČEZ from sales to and exports to Germany would be very high. These risks, and ways to address them, are also discussed in the book.
As I wrote, I am rather sceptical about the validity of Michal Šnobr’s ‘German dawn’ theory. However, the risk to our society if it were implemented is enormous. It is therefore necessary to discuss this possibility and consider potential ways of addressing it. This is why I am very glad that Michal Šnobr raised this issue and examined it from the perspective of an investor and economist. I believe that, in addition to the investor perspective—particularly as it is the view of a speculative investor targeting high profits over a relatively short period—the question has a number of other, longer-term social, strategic and security aspects that also need to be discussed. I have therefore taken the liberty of raising some of them. I am aware that, in my view too, the risk of the more catastrophic outcomes occurring should be low, and that I may also be wrong on a number of points. Nevertheless, as serious problems could occur, I would welcome the most serious possible discussion of the potential scenarios and risks. That is also why I wrote this article.
Written for oEnergetice and Osel.
