What a difference a year can make!

It is Christmas time again. In Germany as elsewhere, Christmas is a festival of lights, with bright electric stars on every home and shop, and ice-cold days, huddled up in the warmth of one´s home with friends and family. A stark contrast to a year ago, when we worried that we would not have the power to provide this splendor.

What a difference a year can make!

These days, with gas savings above 15 percent compared to usual demand, and energy prices much below their peaks in 2022, it seems almost unbelievable. Luckily, the worst-case scenario we feared a year ago has not materialized, thanks to warm weather, government initiatives and high energy prices that have pushed down demand.

However, the ongoing crisis mode has led German policymakers to set up a myriad of initiatives to change the energy system even faster. But quantity does not equal quality: too little time for internal government coordination led to contradictions and therefore uncertainty for the energy world. Examples of this are the price caps and measures in the heating sector. Furthermore, it remains to be seen how the energy-intensive industry will deal with the challenges: transformation or relocation?

At THEMA, we’re thankful for an interesting and suspenseful year, in which we strived to help bring a little more clarity and insights into some of these initiatives!

Three key topics accompanied us throughout the year:

  1. Gas dependency is here to stay,
  2. RES buildout requires a society-encompassing agenda, and
  3. Hydrogen production works only with cheap, abundant electricity (not a surprise, we hope, but one that too often gets lost in the debate)

Gas, the savior and culprit

This year’s discussions at the Christmas table will likely feature quite different topics than last year. Back then, most of our colleagues suddenly found themselves explaining how gas prices also set electricity prices via the merit order or summing up the differences between gas and nuclear power plants. But although gas and hence electricity prices have fallen since 2022, gas prices have kept their important role in the electricity system – and will do so for the foreseeable future.

Gas will continue to dominate German power prices, because of the country’s large need for flexible generation to cover hours with little solar and wind generation. And the closer the country comes to reaching the government’s RES buildout targets, the more flexibility it will need. The higher the production from renewables, the deeper the “Dunkelflaute” valleys between hours of strong RES supply will become. This calls for flexible powerplants to fill these production gaps quickly and spontaneously. The best-tested solution to provide this flexibility are gas-fired power plants. A buildout of such plants is delayed due to the German “debt brake” but will eventually happen.

Today already, a change in gas prices of 1 EUR/MWh directly translates into the same change in the electricity price, according to our sensitivity calculations. This will only change with the introduction of other sources of flexibility. Hence, not in the next decade.

This gas dependency leaves European and German power prices ever more connected to international gas price developments: An Asian gas demand rally or Australian harbor strikes can drive up power prices in Germany!

To better understand the impact of different supply and demand shocks in the gas market, we now also model the European gas trade, putting a spotlight on LNG trade and globally competing demand. The result: German gas prices are prone to supply shocks, but the incoming LNG capacities (both US and Qatari liquefaction and European gasification) improve the situation profoundly. The projected decreasing gas demand will further alleviate the pressure.

Renewables in abundance = an abundance of problems?

2023 has been a promising year for the German RES buildout. Solar has exceeded all expectations with 14 GW of new panels installed, while the offshore wind auctions have brought in so much money that the government could pay the annual power consumption of 30 million households. Only onshore wind is lagging, although signs of future growth do appear here and there.

Despite the partial cancellation of the German climate and transition fund, the government still has enough financial firepower to drive the RES buildout forward. Costs for raw materials are slowly falling again, and the Economic Ministry is even cutting some red tape preventing or delaying plants’ development.

While this still may not suffice to reach the extraordinary 2030 targets, the focus must now lie on what to do with all this renewable electricity: local grids are designed to bring power to villages and homes, not to take up large bursts of solar and wind power. When analysing these challenges, we often draw inspiration from our Norwegian colleagues: They already have a high electrification rate also in the heating and transport sector, work on creative ways to increase distribution grids’ capacities, and make use of all the data stemming from the widely distributed smart meters, heat pumps and EVs.

To build renewables, grids, as well as new demand sources where they are needed, market experts demand “locational pricing”: This would mean attaching a specific power price to small regions, showing where new solar panels could make a good profit (or firms would pay less for their electricity).

To keep things simple, we modelled what it would mean to cut the German price zone in just two new zones this year: one northern zone with a large wind surplus, and one southern zone with high demand. While this setup is arguably more realistic and less detailed than a split into 100 little zones, the analysis still made our analysts’ and computers’ circuits run hot. The results were also not always straightforward:

  • Electricity prices would change drastically, falling substantially in the north, and increasing somewhat in the south. We also found that there is no electricity supply gap in the south: Bavaria, Baden Württemberg, etc. have enough fossil-fired capacity. But, the north has an overcapacity of wind power. If there are no new power lines between north and south, this wind power is locked up in the North, driving down prices there, and often needs to be cut (“curtailed”) to maintain system balance.
  • RES operators´ revenues would change accordingly: Their market-based income would shrink in the north and grow in the south. This further underlines the relevance of installing more RES in the south.
  • Arguments against a split are most often of a very practical nature: A split would change the trading patterns of the entire European continent, as many traders use German power price futures to hedge their own contracts. This may become more difficult should the German price zone be split.

The hydrogen race

The design of power price zones and the buildout of as much renewable capacity as possible are cornerstones of the development of a hydrogen economy in Europe.

Bidding zone designs are relevant because EU regulations demand green electricity for H2 production to hail from the same bidding zone as the H2-producing electrolyser. Also, if the bidding zone fulfils certain emission or RES share rules, the electrolyser can source power directly from the grid – and its H2 still counts as “green”. This makes life for H2 producers much easier. If Germany were split, northern electrolysers would likely be able to source electricity directly from the grid already in the early 30s, for example.

Meanwhile, the renewable buildout is key to achieve the far-reaching European and German H2 targets. The European target of 10 Mt of H2 production by 2030 requires an electricity input of ca 500 TWh – equivalent to almost the entire German power production this year.

Other cornerstones are the H2 transport system and increase in H2 demand: This year has also seen important updates on these two fronts, with the financing of the German H2 “core grid” receiving green light and some funds remaining in the German coffers for industry H2 projects. In Berlin, an electrolyser factory is poised to produce 1 GW of electrolysers each year, with several other factories planned or under construction.

Now, only the question remains: how to produce green H2? As electricity experts, it is of course always our instinct to first look at the power market. But in this case, electricity really is the big deal:

  • It needs to be cheap (electricity is the main price driver for H2)
  • It needs to be green (otherwise the H2 is not)
  • It needs to be available year-round (if run only in a few hours per year, electrolysers are too expensive)

When supporting clients in acquiring enough green electricity to match their H2 production, we find that significant over-procurement is necessary to achieve the necessary number of full load hours for H2 production. This surplus electricity then needs to be sold on the market again, usually at low prices.

Our calculations also show that sourcing electricity directly from the grid won’t be possible in many countries until the 2040s under current regulations.

The energy world is undoubtedly amid a demanding transition: We need new forms of energy and electricity instead of gas, we need to manage the risk of intermittent generation, technological and regulatory uncertainties regarding subsidies, and the availability of green power and hydrogen.

We look forward to helping you navigate through these stormy weathers with more confidence, bringing some more certainty to your decisions, and adding some more clarity on where the path will lead us.

Merry Christmas and a happy new year. Let´s meet in January!

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