Germany's dawn

I have had a theory for some time now. I call it “Germany's dawn”. Its essence is another turnaround in the German power sector. Another in a series of surprising U-turns by Chancellor Merkel's governments over the past ten years. It is a solution in the search for a way for Germany, a thoroughly rational and highly economically efficient country, to get out of the difficulties caused in its power sector by the more or less political-ideological decisions of recent years. How Germans will manage to rationally reverse a whole series of previous irrational and contradictory decisions while retaining the face of one of the leaders in the fight against climate change through CO2 emissions reductions. And also restore the confidence of at least some partners in the EU or the Energy Union, who are losing patience with developments in Germany's energy sector.

It is enough to recall that it is already clear that Germany will not even come close to meeting its own climate protection targets for 2020, which Chancellor Angela Merkel, newly re-elected after the autumn 2017 elections, nevertheless championed and had no doubts about fulfilling. Worse still, assuming that all nuclear power plants cease operation by the end of 2022, doubts are already emerging over whether the new targets set for 2030 can be met. The feverish political support for a new direct gas transmission link between Russia and Germany via the Nord Stream 2 pipeline is also controversial, and not only in Europe.

My entire theory has a simple basis. While just a few years ago Germans, including the government and government politicians (one must not forget the steps taken by Economy Minister Rösler between 2011 and 2013), fought very actively but inconspicuously against reforming the CO2 emissions market and were fully content with the dysfunctional EU ETS market with its very low allowance price (at 3 to 5 EUR/t), they have now evidently made a complete U-turn. At the time of the deliberate degradation of the EU ETS, propaganda for massive and very costly support for renewable energy sources (wind, solar, biomass) was based on renewables themselves cannibalising the emissions market.

Logically, Germany did not then want to allow costly renewables support to fall exclusively on the shoulders of small consumers and households while also making them pay for expensive “carbon” in the wholesale electricity price. German consumers were reassured that the renewables support they paid for directly and at great cost would be offset by low wholesale electricity prices. And it worked. Massive, even ideologically fanatical support for renewables, enabled by German consumers and combined with the very short investment horizon of renewables, delivered a rapid result. Germany literally changed “overnight” from an electricity importer into a major European exporter. This reality affected conditions in the electricity market not only in Germany but also across the wider region, including Czechia.

The main cause of the drastic fall in wholesale electricity prices was not only the aforementioned low price of emission allowances and the related rapidly growing surplus of electricity generation, but also the market-disrupting, non-market support for renewables. Everything was further accentuated by the commodity crisis of 2015 and 2016. Electricity thus fell from 55 EUR in 2012 to an almost unbelievable 20 EUR/MWh by spring 2016. At the same time, during this short period Germany began exporting up to 50 TWh of electricity a year, despite the fact that German consumers paid dearly for this increase through renewables support and that the electricity was subsequently exported at a fraction of its real price.

Later, however, Germans too understood that this was not a viable long-term path. Not only did the entire European energy sector become completely disoriented, investment activity fell sharply across the sector, and dissatisfaction among European partners and major energy companies began to emerge. They, along with the expert community, warned that the energy sector had entered territory that was economically entirely outside a reasonable natural reproduction/investment framework. It also gradually became apparent that the Energiewende behind the renewables boom had never been a German tool in the fight against climate change, but primarily a means of shutting down nuclear power plants, which paradoxically are also zero-emission. Electricity generation from lignite has in fact remained unchanged since 1990 and has shown almost no change over the past ten years either.

The entire costly built-up surplus of electricity production (exports) thus became merely a temporary “bulge” in Germany's energy sector to enable the final closure of nuclear power plants by 2022. Germany completely deceived Europe in this respect and made a mockery of itself. Its own emissions reduction targets for 2020 remained a sad theory after the immensely costly efforts of the entire past decade. Germans also gradually understood that, from an energy perspective, we are already much closer than it ever seemed to 2021 and 2022, when under their own timetable they must shut down all their nuclear power plants. Yet nuclear power plants with annual generation of 70 TWh still remain a firm part of Germany's energy mix, and replacing them will be very difficult. Especially in a situation where CO2 emissions are to be reduced, meaning primarily lignite-fired power plants are to be shut down, while the German transmission system is slowly but surely ceasing to cope with the strain of connecting new and unstable renewables, whose annual additions the German government has had to begin sharply restricting.

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For the above reasons, Germans changed their strategy and allowed European institutions to adopt EU ETS market reform and strict emissions rules for coal-fired power plants that are to operate in the next decade. In many respects, even stricter rules were adopted than Germans themselves had envisaged. This process was highly active throughout 2017 and culminated in an agreement among EU member states, as well as the European Parliament and the European Commission, in the first quarter of 2018. Since then, however, the price of CO2 allowances has risen gradually but very sharply, moving in one year from 6 EUR to today's 21 EUR/t, i.e. by 250 %. And this is apparently far from the end for the coming years.

My theory of “Germany's dawn” rests on the assumption that this price solves nothing for Germany. Germans now need the price to be much higher still! Germans are seeking a way to reduce coal-fired electricity generation relatively quickly while retaining stable and flexible capacity. A German government expert commission has even been grappling with this for several months. But it will hardly have tangible results if the market itself does not deliver them. Germans therefore need the CO2 allowance price to be somewhere between 35 and 45 EUR/t. Such a price level could contribute to a natural shift in generation from coal-fired to gas-fired power plants, whose emissions are less than half those of coal. Such an allowance price would restore profitability to gas plants, energy mammoths that have been dying out in recent years. It would breathe new life into them, and that is precisely what Germany needs.

The resulting electricity price of around 60 EUR/MWh, or perhaps even higher, would also at least partly put the output of newly built renewables, particularly wind power plants, on a market footing, something that has been called for over the past ten years. Thanks to the shift from coal to gas, Germans would thus manage not only to reduce CO2 emissions but also to justify newly built renewables at market level. Achieving the vision of shutting down such unwanted nuclear power would be an enormous cherry on the cake. But it will be a very expensive cake, albeit one literally prayed for in disciplined Germany. Consumers will have to pay more again, but I have no doubt that the story of a temporary increase in prices and the “final” victory of the renewables strategy will continue to live on within Germany's energy sector. Germany does not ask, and never has asked, what the rest of Europe, including economically weaker countries that will be affected, thinks about it.

In short, Germany has surprised Europe again. It appears to have inconspicuously shifted its strategy from a complete rejection of the EU ETS market to its full functionality, including fulfilment of the market's original idea, which was primarily meant to help fundamentally change the structure of European power generation from dirty sources to cleaner and ideally renewable ones. EU member states supported the EU ETS market with this idea more than ten years ago. But neither Europe, nor above all Germans and their ideology based on opposition to nuclear energy and the rapid renewables boom, were apparently prepared at the time for the real consequences.

Just as the emissions market rose rapidly at the end of the previous decade, it fell flat on its face just as quickly. It must be acknowledged that Germany played a significant but quiet role in giving it a bloody nose. Today, however, the original scenario of high emissions prices is back on the table. Indeed, all of Europe supported it again as part of EU ETS reform. But most importantly, Germany is this time truly carrying the EU ETS battle flag.

In the context of these changes, the scenes and backdrop of this European energy story fall into place like dominoes. It is impossible not to see the unmistakable interest of Chancellor Merkel and Russian President Putin in completing Nord Stream 2, another direct link between Germany and the Russian gas producer without unnecessary territorial complications, which today may include both Ukraine and other Eastern European countries. It is also impossible not to notice recently published comments by RWE, Germany's largest owner of coal-fired power plants. The company sold its electricity generation for 2019 and beyond long ago and secured cheap CO2 allowances for it in the preceding period. Now, however, RWE, and evidently other similar major “polluters”, are addressing their strategy after 2021. RWE has even admitted this.

It therefore cannot be ruled out at all that this very fact lies behind the very rapid rise in CO2 allowance prices in 2018. One can speculate that they are already active in the market because they know that, over a longer horizon, even today's CO2 allowance price may be quite “cheap”. The activity of the first bold buyers may then have swept along the others as well.