ICIS View: German coal power exit deadline already looks dated

Author: Roy Manuell

2020/07/20

LONDON (ICIS)--German coal phase-out legislation that came into effect in July, stipulating the complete closure of the country’s 40GW fleet by 2038, already looks dated given the currently-weak outlook for coal-fired generation in Europe, incentives for early plant closures and political pressure building for a faster phase out.

Germany has set out staged closures for coal and lignite assets over almost two decades in legislation finalised around 18 months after the government-appointed commission published its initial recommendations in January 2019.

A lot has changed since then. Gas markets have fallen to record lows, carbon prices reached decade highs and European countries have either pledged to faster coal phase-outs, as in the case of Portugal as recently as this week, or have seen coal generation fall to zero for significant periods, as seen in the UK.

In Germany itself, economics has not favoured hard coal assets in 2020. Output has fallen to its lowest total on record over the first half of the year while gas production has risen to a decade high .

Looking at clean dark spreads, which calculate future profitability given carbon and coal prices, for the rest of the year and in 2021, the margins for coal generators are unlikely to improve. Gas-fired generation is set to remain significantly more profitable.

Given that Germany has an abundance of underutilised gas plants in its thermal fleet, the level of fuel switching is limited to the heights to which carbon prices can reach and the depths to which gas prices can fall.

ICIS analysis that considered an extreme bearish gas scenario demonstrated that there is much room for further fuel switching in Germany and other countries. We also expect bullish carbon prices over at least the first half of the decade will mean that coal operators will struggle to turn a profit.

The current gas and carbon price context casts a fresh light over the German coal phase-out law which in terms of deadlines for capacity closures, is largely unchanged from the initial commission proposals in January 2019.

While coal and lignite operators hedge their power in advance to insulate against commodity price movements and the impact of a huge carbon upswing as a result, the incentives provided by the German government to close assets ahead of schedule, coupled with a substantially weaker profit outlook for the 2020s than expected only a few years ago, means that the incentive to close assets ahead of schedule is strong. Initial compensation in retirement auctions that start this year for hard coal plants begins at €165,000/MW.

Security of supply is likely to become an increasing issue in Germany with the country phasing out nuclear capacity by the end of 2022. Nuclear production accounted for 13% of power generation in 2019. Sluggish onshore wind expansion also means that renewable growth is slowing relative to the last decade. Supply may become tight, pushing up German power prices, raising the possibility of potential reliance on imports of French nuclear, and offering a lifeline to coal operators.

However, the political pressure is building to close coal earlier than 2038. Germany’s paradox lies in the fact that it is both one of the world’s largest renewable power generators but also among the dirtiest polluters.

With EU policy firmly set on clean energy be it in the overarching Green Deal policy, the focus on green hydrogen in a recent strategy document, or climate targets in 2030 and 2050, Germany, which recently assumed the council presidency, will face increasing pressure from member states to close its coal plants earlier than 2038. The current market dynamics mean that shutting coal plants has never been easier.