Energy Economist: tough times for European utilities may have a lesson for the US

Europe has taken renewable energy generation further and faster than any other region of the world in terms of system penetration, and now appears to be heading into a maelstrom. Where Europe falls, others will follow. Perversely, the impacts of the successful build out of low carbon generation could put at risk the consensus behind climate change mitigation policies. US utilities should take note: never before has the need for international comparison been so pressing. Ross McCracken discusses this issue in a story that appears in this month’s edition of Platts Energy Economist

There has been talk in the United States of the utility “death spiral,” a process in which environmentally-targeted subsidy support enables consumers to disengage, partially if not wholly, from the electricity grid through demand-side management and distributed generation. Utilities, required to invest to incorporate renewables into a centralized system, are left in an unsustainable situation of higher embedded costs and fewer customers.

This talk may not, in fact, be overblown. Europe is way ahead on renewables and evidence suggests its utilities may be travelling further and faster down their own tunnel of doom — a more developed and advanced version of the death spiral. Although different in as many aspects as they are similar, the European experience is highly relevant to what the US has in store.

One example is negative electricity prices, resulting from a buildout of wind. Denmark, the earliest developer of mass wind generation got there first, but Ercot West in Texas wasn’t far behind.

In June, negative pricing took a new twist as it struck across EU borders. Wind and solar in Germany combined with cross-border market coupling to transfer the power surge into France, Belgium and Austria. In a significant but still pale imitation, the same month saw prices at the Mid-C hub in the US plummet toward zero, owing to a combination of strong hydro output and wind generation. The Old World can still do some things on a grander scale than the New.

Negative pricing is just the visible tip of the iceberg. No region in the US has the same solar PV concentration as Germany, where over 30 GW of capacity has been installed, but when they do, they too are likely to see traditional pricing relationships turned on their head. Peak demand arrives, but peak pricing is gone. Peak and baseload prices are compressed. Storage plants become uneconomic. Scarcity rents — those extreme highs in pricing on which peaking plant profits depend — decline in size and frequency, a situation known in Europe as the “missing money”.

The green dream in Europe has meant the addition of massive variable generating capacity to zero-growth markets. The upshot is that existing investment in thermal plants can no longer survive. The death spiral is a mere cold by comparison. European utilities that have invested millions if not billions of euros in conventional generating stock are having their bottom line cut from under them.

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According to consultancy Capgemini’s recent European Energy Observatory report, average gas-fired plant utilization rates dropped to 11% in Spain in first-half 2013 and to less than 21% in Germany in 2012. The International Energy Agency says gas plants need a utilization rate of 57% to be profitable. About 130 GW of gas-fired generation capacity across Europe — equivalent to around 60% of total installed gas-fired generation in the region–is currently not recovering its fixed costs and is at risk of closure by 2016, Capgemini said, citing IHS estimates.

And, as in the US, public opposition to coal is strong and the regulatory headwinds fierce. Only Europe is again ahead of the game. As a result primarily of the EU’s Large Combustion Plant Directive, coal-fired generation capacity in Europe is expected to fall sharply. Goldman Sachs estimates a net loss in EU coal plant capacity of 20 GW by 2015, the deadline by which opted out plant must have used their allotted hours of operation (many will have used them up before then).

These developments are really coming home to roost. German utility RWE forecast in November that its profits would be cut almost in half next year by the depressed state of wholesale electricity prices. It will sack 10% of its staff. Chief Executive Office Peter Terium was reported to have described the company as “passing through a vale of tears”, a more poetic but nonetheless analogous process to the death spiral.

It is a topsy-turvy situation. The mothballing and closure of conventional generation plants will eventually drive up wholesale prices, while there will be a big shift in the operational characteristics of the generation fleet as a whole towards intermittency. With environmental levies for renewables subsidies rising in line with the ongoing build-out, consumers will be hit with both higher prices and a decline in reliability. If anything could break the consensus on climate change policy it would be this.

Only a few months ago, the heads of Europe’s major utilities got together to warn that Europe was heading toward black outs. Such is the distrust of big industry that this was taken as an expression of self-interest. But they have a point. The uncontrolled build out of renewables is having radical impacts in Europe. The US stockpile of cheap natural gas notwithstanding, if America’s utilities want a vision of Christmas-yet-to-come, they have only to look across the Atlantic.


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Comments

  1. Ross McCracken at November 25, 2013 4:16 am

    Thanks for the article link Paul. Vague although the wording is in the coalition agreement, as the article points out, it does seem to signal a potential shift in thinking if not policy. Clearly one to watch.

    Simon – I agree hub pricing for gas in Europe would be a step in the right direction, but you’re right to point out that it won’t necessarily lead to lower gas prices for consumers.

    On your comments about markets, I think the issue is more problematic. Markets generally provide efficient solutions (at least in text books) but don’t deliver on costs that are external to market actors, for example climate change objectives, security of supply or even local air pollution — without regulation.

    The challenge is to find a regulatory path that achieves these objectives without too many bad and unexpected economic impacts. It’s a really tough nut to crack. My warning to US utilities is learn now from is happening in Europe and be ready for those unintended consequences.

    I look forward to picking up some of the issues you guys have raised in future blogs.

     
  2. Luís at November 25, 2013 3:28 am

    It is true, the outlook is bleak for traditional electricity suppliers. In order to survive they’ll need policies like the Feudal system on sunshine the Spanish government wishes to introduce. However, this doesn’t mean consumers will get higher prices, the issue is precisely rooted in the fact that they can generate their own electricity at considerably lower costs.

     
  3. Simon Jacques at November 23, 2013 11:38 pm

    Energy Policy in Continental Europe relies upon Renewable Energy magical thinking and scapegoats for high energy prices like popular Gazprom when things go bad.

    The reality cracked is that Eurozone will raise Energy prices by kicking out Fossil Fuel out of their grid, In Germany, Renewable energy bid very low in order to get activated in the grid (thanks to the tax credit and subsidies, they can afford it). Conventional plants produce less MW/year, diminishing conventional their ROI, the baseload quality and putting a lot of congestion issues on grid reliability.

    You can’t talk about Renewables without having a broader take on Gas Market…
    The Eurozone second energy fallacy is counting on Spot LNG to lower Hub gas prices. Spot LNG pricing is much based on Currencies, supply availability, shipping and Cargo factors, relative competitiveness vs other markets. A good example is spring 2012, when Europe gas inventory were low, they counted on LNG imports but LNG found better deal diverting cargoes to Brazil. In fact many times they will just increase volatility, making monthly based settlement higher. Natural Gas Spot pricing will allow European gas hubs price to exceed oil indexation levels, allowing Gazprom and Statoil’s customers to sell gas at a price higher than they paid for it ! Statoil and Gazprom themself will earn bigger margins from higher volumes !

    I will tell you that Local Distribution Companies are gas takers at any price level to meet their contracts, they don’t care to bid to the maximum, customers will the price.

    It will only give NBB and other HUBs more Up and Down Volatility Swing. What really matters from an economic standpoint is each end of the day settlement at the two of the biggest Euro Natural Gas Hub. Primarily because of the NBB is a virtual Hub (cash-settled with no physical delivery), when system is balanced with Zeebrugge, volume imbalances under the spot pricing will be just wilder.

    Moving from oil-indexed pricing to spot gas hub pricing is still a move in the right direction but will not necessarily lead to lower gas bills for Europeans for now because at the other end, Renewable/Green policy is putting setting a floor on energy prices.

    Simon

     
  4. Simon Jacques at November 23, 2013 11:29 pm

    You have an excellent blog at Platts and I would recommend Euro Regulators and U.S regulators to read it.

    U.S has accomplished its greatest achievements with a market based approach. The Power & Natural Gas Markets Deregulation and the Shale Gas revolution are the best examples.

    What can we learn about from European Energy Market: market ignorance will make you a price taker at any price levels ? The only reliable solution is let the market doing its job.

    Simon

     
  5. Paul Nelson at November 22, 2013 4:18 pm

    Remarkably, Germany may, just may, be coming to its senses. The now-forming coalition government has included in its formation document a statement that it will study a requirement that renewable generators be required to guarantee baseload energy to the grid. See the following article:

    http://www.thegwpf.org/coalition-agreement-germanys-green-energy-shift/

    This would reorder the market in a revolutionary manner, if adopted.

     
    • Damon Hart-Davis at November 24, 2013 9:16 am

      These are senses that would value short-term political expediency above all else? Say it ain’t so!

      Rgds

      Damon

       
  6. John Kingston at November 22, 2013 2:55 pm

    Hahaha…thanks, Dan S. We like The Barrel too!

     
  7. Dan S at November 22, 2013 2:04 pm

    It never occurred to me to consider this perspective. Platts blog is sooooooo good its like… brain candy.

     
  8. John Benton at November 22, 2013 4:53 am

    This is a pretty accurate summary of the crazy situation now prevailing in parts of Europe. Unfortunately it can only get worse as the eco Taliban have infiltrated much of the government structures. In the UK we have an eco fanatic called Ed Davey in charge who is intent on selling the country out by following every last edict from his masters BIG GREEN.

     
    • Ross McCracken at November 22, 2013 12:31 pm

      Ed Davey an eco fanatic? I think he would have a good laugh if he read that. My criticism in the article is not with the goals of current policy, but with the disruptive impacts they are having. These appear to be becoming so severe that the general consenus behind the desirability of creating a sustainable low carbon energy system may be put at risk.

       
    • Damon Hart-Davis at November 24, 2013 9:14 am

      Lovely: ad hominem attacks.

      And no, Ed Davey is hardly some eco nutter.

      Time to change the grade of tin-foil in you hat maybe?

      Rgds

      Damon

       

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