Concern rife that German CCGT rescue plan remains insufficient

Germany has opted not to develop an electricity capacity mechanism, despite recognising the need for gas-fired power plants to back up variable renewabels. But will its free market ever be capable of supporting gas-fired plants again without intervention?

As utilities across Europe struggle with structural change in the power mix , ICIS asks, how should the continent’s most developed power market ensure that vital, gas-fired generation remains economically viable?

Germany’s plans to shift its hard coal- and lignite-fired power plants into an electricity capacity reserve will support the poor prospects of the gas-fired power sector, figures provided by Norbert Schwieters, global power and utilities leader for accountancy PWC, suggest.

But this alone will be nowhere near enough to make the industry profitable, ICIS figures show.

PWC expects a reduction in baseload capacity, when Germany shifts 2.7GW of coal-fired plant into a strategic reserve, to increase power prices by €1.00–1.50/MWh.

If the maximum €1.50/MWh increase was added to the German Calendar Year 2017 Baseload product at Friday’s ICIS closing assessment, it would have been valued at €31.125/MWh.

This would have fed into a Year 2017 dirty spark spread – a measure of profitability for combined-cycle gas turbines (CCGTs) that does not include the cost of carbon – of negative €9.07/MWh.

Growth in electricity supply from renewables has eaten into profit margins for CCGTs by forcing down the price of electricity to historic lows.

And while the price of natural gas has fallen, it has not kept pace over the long term relative to the reduction in power prices.

The German power sector draws heavily on coal, particularly lignite, a soft, highly polluting coal the country can cheaply produce. And with cheap coal on the global market, coal-fired power plants run as baseload generation, further pressuring electricity prices relative to gas.

Since the 2.7GW reserve plan became public around early July, the economic outlook for CCGTs, while still deeply negative, has at least become less negative (see graph).

The German dirty spark spread for Q4 ‘15 was calculated at negative €7.82/MWh on Friday. Despite being firmly in negative territory, this marks a significant improvement from when ICIS started calculating this product in October 2014 when it was valued at negative €15.51/MWh.

Nuclear

By 2020 Germany plans to phase out its nuclear power capacity, which will provide an opportunity for the gas sector in the south of German, the primary location of nuclear plants, according to Florian Haslauer, partner at management consultant AT Kearney.

Transmission lines are planned to allow power to flow from the north to the south of the country as the nuclear capacity comes offline.

However, there is concern these will not be functional in time to fill the growing supply gap left by the nuclear exit, which would provide an opportunity for the gas sector to meet the deficit, said Florian Haslauer, partner at management consultant AT Kearney.

From October 2014 to March 2015 the total required winter reserve was 3.1GW. Since then it has escalated to at least 6.6GW and 7.00GW for winters 2016/17 and 2017/18, respectively, according to a spokesman for regulator BNetzA. Much of this will have to be filled by gas-fired plants.

The German government also plans to reform its combined heat and power (CHP) plant legislation by subsiding gas-fired CHPs in favour of coal-powered equivalents.

Lignite reduction

By 2020, the German government wants to reduce its use of lignite in power production by 19% as it moves from coal and nuclear to a power generation mix more reliant on renewables.

But a planned 32% growth in renewables by the end of the decade will leave the country’s power mix vulnerable to fluctuations in renewable production. So the government has had to look at ways to ensure there will always be sufficient power available in the system.

However Germany has opted not to set up a capacity market in which generators bid for the right to supply energy when it is required – to be constantly on stand-by – in return for regular payment. Instead, Berlin has proposed the establishment of the capacity reserve system.

After four years the 2.7GW of lignite-fired plants will be shut down, to be replaced by flexible energy sources such as existing gas-fired plants or biomass.

Concerns

However, analysts even doubt whether these developments combined will be sufficient to return gas-fired power plants to profitability.

Ernst & Young power and utilities director Helmut Edelmann said he expected “a small, but not a significant price effect from the planned reserve”. The new reserve will total 4GW, including the 2.7GW of coal plant, which is 5% of Germany’s total installed capacity, according to the federal energy ministry.

Elsewhere, concern for the prospects of gas run deeper still. Rather than German power prices increasing, as forecast by PWC, Oliver Schuh, director at Fitch Ratings, said the reverse could occur.

“Given that economic activity in China is slowing, hard coal as a commodity input may go down further in price and electricity prices could reduce further,” he said.

As the result of a decrease in the price of coal, Edelmann does not predict an improvement in economic prospects for CCGTs until beyond 2020.

Other avenues

There are other options that the German government can pursue to encourage a more profitable gas sector once the reserve is in place.

One of the “most important” would be to raise price limits in place on energy exchanges, while operating a non-interventionist policy towards high energy prices, said PWC’s Norbert Schwieters.

If gas-fired power plants can step in during periods of very high energy prices for a “few hours per year” they can again be profitable, he said.

Edelmann advocated a stricter CO2 emissions trading scheme across the EU to make the burning of coal more expensive and increase the profitability of natural gas plants relative to coal.

Germany could also implement a carbon tax to add to the cost of burning lignite, Schuh said. “A carbon tax would have been the better policy choice [than a capacity reserve] as it would have had an impact with rising carbon costs on the merit order,” said Schuh. “The 2.7GW capacity reserve for lignite plant was a compromise that ultimately does not achieve the outcome the government wants.”

The idea of a carbon tax could be more politically viable after the elections of October 2017, Schuh said. jon.stibbs@icis.com