One of the most successful travel guides of the last decade has been the Australian authored Molvania: A Land Untouched by Modern Dentistry.1
While being hilariously funny and utterly absurd, Molvania is an utter figment of the imagination.
This contrasts with real life Germany, where the Government has embarked on a journey towards greener energies – a venture which has nevertheless more in common with the imaginary country of Absurdistan than one may think, given that Germany is not well known for its sense of humour.
A tsunami of subsidies
Following the March 2011 tsunami and consequent nuclear disaster at the Fukushima nuclear power station in Japan, the German Government decided to turn away from nuclear energies.
By 2022, all electricity production from nuclear power plants is to be replaced with electricity from renewable energies.
Moreover, the Government has legislated that 50% of Germany’s electricity consumption should be produced from renewable energy sources by 2035 and 80% by 2050, largely replacing all fossil energies in the electricity sector.
However, as electricity from renewable energies is not competitive on its own, the four transmission-line companies that operate within Germany are required by law to purchase all electricity from renewable energies at rates (so-called ‘feed-in tariffs’) set by Parliament and to on-sell this electricity on the wholesale electricity market (line companies may not directly sell to consumers).
The difference between the costs of the feed-in tariffs and the wholesale revenues is passed on to consumers in the form of a renewable energy levy, which is currently 5.3 eurocents per kWh.
The underlying philosophy is one of cost-based regulation: producers should be entitled to have their cost reimbursed, including an appropriate rate of return.
As a consequence, there are now around 4000 different feed-in tariffs, depending on the technology used (solar, wind, geothermal, hydro and so on), the size of the plant, its year of construction, and location (for example on-shore versus offshore wind, solar panels on roofs versus solar panels in fields).
Bring me sunshine
A major problem with the feed-in tariff system has arisen from the fact that input costs have been falling faster than politicians had expected.
Moreover, feed-in tariff levels have become an election issue, because the solar industry (and other industries) have been quite active in the sponsoring of political parties.
As a consequence, the feed-in tariffs for solar energy have not only been the highest by far but have also included the most generous rate of return: as of 2013, the average subsidy for solar power is 246 euro/MWh; for on-shore wind it is 49 euro/MWh.2
As a consequence, solar power has, at least since 2005, attracted most of the investment in Germany.
Today more than 40% of the worldwide solar capacity is installed in Germany, a country not well known for its sunshine.
From a wider European or even world perspective this is a gigantic misallocation.
The same panels could generate between two and three times as much electricity had they, for example, been installed in Spain. Because solar power (the most costly form of green electricity production) was blessed with an increasing rate of return,3 the average subsidy that German consumers have to pay per kWh of green electricity has increased from 8.5 eurocents per kWh in 2000 to 18.4 eurocents per kWh in 2011 – that is, the subsidy per unit has more than doubled.
The main reason for this is the falling price for solar panels, which led to an increase in the rate of return on solar energy and changed the technology mix more and more from wind towards solar.
Hence, thanks to the German Parliament, German consumers have been ‘suffering’ from falling input prices that made the most expensive form of green technology also the most attractive.
Paying for one’s own Christmas present
A side effect of the feed-in tariff system with its requirement on lines companies to purchase all green electricity is that wholesale prices in the German electricity exchange are more and more frequently turning negative.
In the early hours of Christmas Day 2012, for example, one MWh of electricity commanded a price of -473 euro/MWh.
In other words, consumers were paid 473 euro for every one MWh of electricity they were willing to consume.
The reason for the negative price was that the wind was blowing heavily on Christmas Day, creating a good supply of electricity, but demand was low because there is little industrial production on public holidays. Still, lines companies were required to purchase the green electricity and inevitably they tried to get rid of it, so that the price reached a negative 473 euro. The difference is borne by consumers as part of their green electricity levy; the green electricity producers can simply enjoy the profits of their fixed feed-in tariff.
Naturally, the producers have developed a ‘produce-and-forget’ mentality as they do not need to be concerned whether the electricity they produce is needed or not.
In addition to carrying the direct costs of green electricity production (plus subsidising the decent profit enjoyed by green electricity producers), consumers also have to bear the massive indirect costs resulting from the required network investment.
Most wind capacity is located in the northern and eastern parts of Germany, but electricity consumers are mainly located in the southern and western parts. Consequently, substantial investments into both transmission and distribution networks are necessary.
In contrast to New Zealand, Germany does not operate a nodal pricing system nor do producers face a so-called G-component. Therefore there are no price signals to guide decisions on the location of green electricity production.
As a result, consumers have to pay for all network extensions.
In addition, the costs for redispatching electricity (as a result of network bottlenecks) have also risen significantly.
The exercise has become unnecessarily expensive. And now a new policy debate has just begun on whether gas-fired power plants also need to be subsidised through so-called ‘capacity mechanisms’, because these plants are needed as back-up facilities to wind and solar power (which are inherently unstable) but are no longer profitable (having been squeezed out by green electricity production).
All of that may be seen as forgivable if the green electricity boom had at least a positive impact for climate change. However, as the expansion of green electricity production is not connected at all to the European emissions trading system (EU-ETS), the German ‘energy turnaround’ does not even help to reduce emission levels, which are fixed under the EUETS.
The (tradable) emissions rights that are not used for electricity production in Germany are on-sold either to electricity generators elsewhere in Europe or to firms in other industries.
Hence, German consumers are currently forced to spend about 20 billion euro per year on fostering green electricity without changing emission levels in Europe at all.
Travelling the ‘green route’: from Absurdistan to Scandinavia
Economists have made several suggestions how to replace this rather absurd system. The first-best solution would be to rely completely on the emissions trading system, which could be complemented with aid for research and development.
However, given the massive lobbying power of green energy producers, this proposal is currently not politically viable.
A quota-based system, such as those successfully implemented in Sweden and Norway, has been suggested as a second-best solution. In these systems, electricity retailers are required to purchase a certain quota of green electricity (or, alternatively, the relevant green certificates) but can make their own decision on how to contract for green electricity and what kind of green electricity they wish to purchase.
Hence, competition between various forms of green electricity emerges and more-efficient forms of technology, size and location (rather than the most expensive ones) are rewarded.
While the second-best option would still not have any effects on climate change, it would at least be less costly to foster green electricity.4
Unfortunately, though, distributional concerns dominate the current debate. This is because the existing arrangements induce transfers between the states in the German federal system (with Bavaria being the major winner) as well as towards farmers (who operate large-scale wind and solar farms).
To end on a positive note: at least other countries can learn how they should not ruin their electricity markets, which Germany is currently about to do.
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1 S Cilauro, T Gleisner & R Sitch (2003) Molvania: A Land Untouched by Modern Dentistry. Hardie Grant Books. South Yarra.
2 BDEW (2013) Erneuerbare Energien und das EEG, Zahlen, Fakten, Grafiken p55. BDEW (Bundesverband der Energie- und Wasserwirtschaft) is the German Federal Association of Energy and Water Industries.
3 This is because cost decreases of solar panels, which are decisive for the adjustment of feed-in tariffs, turned out not to be aligned to the election cycles of Germany’s federal states.
4 M Frondel, C Schmidt & C Vance (2012) ‘Germany’s Solar Cell Promotion: An Unfolding Disaster’ Ruhr Economic Paper No. 353 (at: http://papers.ssrn.com/sol3/papers. cfm?abstract_id=2122527).
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Justus Haucap is Professor of Competition Theory and Policy at the University of Dusseldorf, Director of the Dusseldorf Institute for Competition Economics (DICE) and a member of the German Monopolies Commission. He visited ISCR in January 2013.
3 Comments
I quite like the look of wind turbines.
I have a friend who has a phd in electrical engineering and has worked for electricity regulators for almost 20 years. He is quite positive about the contribution wind makes to NZ electricity supply.
He also says NZ is in no danger of running out of energy as we have huge amount of geothermal energy that we can harvest.
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