Germany’s Unaffordable Wind Power ($0.07/kWh surcharge for $0.20/kWh power, anyone?)

[Update: Germany Stops Fighting Arithmetic and Ramps Up Construction of Economically Sensible Power Generation]

Two years ago we looked at the claim that wind generation can save money for power pool customers.  We found that the supposed savings could be realized only if the elephant in the room – the above-market feed-in tariffs – were ignored.

In other words, the total amount spent on electricity purchases from a power pool was augmented by the additional amounts consumers pay to fund the feed-in-tariff (FIT).  As long as wind generators can bid a low price but receive the higher FIT, then they have an incentive to underbid, thereby reducing pool prices, but not overall costs.

In addition, we looked at what an economically least cost system might look like in Germany over the next ten years.  We found that it features more coal and lignite, keeps most nuclear plants operating, and builds new gas-fired plants.

The annualized differential in total costs for Germany between the no-nukes, no coal and lots of wind forecast pushed by Germany’s Greens and an economically least cost expansion plan amounts to more than $120 billion over ten years and perhaps as much as $200 billion.  A lot of money, in other words.

Update: Since these two posts were published in 2010 Master Resource contributors have made a strong case that Germany’s overinvestment in wind and solar has harmed the nation financially without any compensating improvement in electricity supply.  Compounding the overreliance on wind is the planned phase-out of the country’s nuclear power plants – baseload power that will need to be replaced with something other than wind.

It now appears that Germany has made peace with mathematics and economics, and not just in the energy sphere.  The country has embarked on a major effort to build reliable power plants for the future.

Update:  The burden on taxpayers and ratepayers really hurts in a sluggish economy. The renewable energy surcharge on German electricity bills now exceeds US 7¢/kWh, taking retail prices near US 20¢/kWh.

Investing In New Generation: What Makes Sense?

If a generation resource is a good investment for its developers then it must return a profit to them.  In a normal electricity market this profit comes from supplying a segment of the demand (peak, intermediate/cycling, baseload) from a plant that is efficient technically and financially.

For existing plants and determinations of electricity costs in the here and now we can figure out the average cost of supplying electricity by calculating the weighted average cost of supply for each time period in the market every day.  If the addition of one generation source raises this weighted average without improving service quality or reliability, then it is not economical and would generally not be chosen in a well-functioning market.

But what about the future?  Electricity suppliers must invest large sums in new generation plants with the expectation that these plants will meet demand at the least cost.  This cannot be known with certainty, and mistakes are made all the time, especially when government policy and rent-seeking drive investment choices.

Transmission network operators – those responsible for supply energy and power to grid customers and in charge of the “natural monopoly” part of the power business – try to reduce the risk attendant to future supply by figuring out the least costly way to supply power and energy to their customers in the future, including the wires to transmit the electricity.  They have to take account of a long list of considerations: investment cost, fuel supply, emissions and licensing regulation, proximity to existing load centers and transmission nodes, transmission congestion – you get the idea.

The transmission system operator also has to pay attention to public policy – renewable energy mandates (“portfolio standards”), federal tax incentives (producer tax credits for wind and solar), fuel cycle limitations, feed-in tariffs, powerful politicians who do not want their vistas impaired – in a host of ways that directly impact their views of an optimal future generating system.

What Does the Wise Transmission Operator Do?

A wise investor in generation will first figure out what is economic to build? (ii) what are the physical constraints on the system? and (iii) what limitations will public policy put on otherwise least cost generation choices?

A Case Study of “Germania”[i]

Let us imagine that we have a rather large and wealthy country to play with, one that currently has about 129 GW of installed generation capacity.  Further, we can imagine that this wealthy country, responding to its powerful environmental movement, has decided to (i) phase out nuclear power; (ii) limit future coal power-plant operations; (iii) build a lot (a lot!) of wind generation plants;[ii] and (iv) bring in most of its gas supply from Russia at prices linked directly to refined oil products and crude (i.e., high and volatile).

Such a country would have a great deal of baseload generation capacity – coal + lignite + nuclear – perhaps half of total generation capacity and more than 60% of total kWh generated (US has coal + nuclear capacity of about 40% and current coal + nuclear generation is about 56% of total U.S. electricity output).  Suppose further that green thinking had created incentives (FIT) that pushed wind up to about 20% of total nameplate capacity.  Most of the country’s hydro generation and imports are soaked up by wind mirroring and shadowing.  Exports have grown largely due to the need to dump excess wind generation that occurs when consumption is low – e.g., at night.  The conventional wisdom solution for this overinvestment in non-producing electricity sources is to build additional transmission and pumped storage to disperse the electricity to some other place or time (kind of like the tall stacks theory of emissions reduction).

With all of that generation capacity essentially independent of fuel price trends it is no accident that the cost of generating electricity in Germania is (i) high; and (ii) not responsive to changes in oil and gas prices.  At current world oil prices the average cost of electricity generation in Germania is about 8¢/kWh for total annual costs at generation of $56 billion.

Forget the Policy Constraints, What is the Least Cost Generation System for Germania?

With natural gas still expensive – kind of like burning oil but more efficiently – what does a least cost generating system for Germania look like in 2020, about the time the initial wave of early “teens” investments go on line?

The first thing you do is throw out the phase outs – keep the existing nuclear and efficient coal plants in operation until you have a more cost-effective substitute;

Second, phase out your highest cost oil plants – heavy fuel oil and old combustion turbines (2.6 GW)

Third, build some new, more efficient coal plants (3.8 GW) and CCGT units (4.5 GW), and nuclear (5.8 GW), reduce emissions per kWh by more than 30% in the new coal plants;

Fourth, operate existing wind (28 GW) but do not build new generation from that source.

Total annual generation cost in 2020: $54 billion at 7.5¢/kWh for average supply cost and 7.3¢/kWh for new supply, about 4% lower than current costs.

Update:  Not much enthusiasm for new nuclear plants. In fact the Merkel government has stayed with the 2022 date for phasing out nuclear in the wake of the Japanese tsunami.  Gas remains a troublesome option financially in light of the oil-linked prices for Russian supplies.

Now Get Off Your Free-Market High Horse and Rejoin Our Previously Scheduled Programming

Everyone in Germany’s power sector knows that this least cost system is simply some renegade economist’s fantasy.  Back in the “Real World of Energy Policy”, there are several important considerations that must be accommodated:

Stay clean – phase out at least 25% of older coal and lignite plants, make permitting of new coal plants difficult;

Stay green – stay the course on wind energy; and

No nukes – continue to phase out nuclear power.  Build only enough new nukes to keep the Gauls happy.

{Gee, sounds like one of the leading contenders in the U.S. for Energy Secretary to replace the egregious Dr. Chu.  But at least our guy, Thomas Steyer, coming from a hedge fund, will know a good scam when he sees it.}

Following this path will provide less electricity less reliably and at a higher cost for Germania – about $69 billion annually (at 9.9¢/kWh average cost and 10¢/kWh for new plant supply).

Less coal and lignite – existing units fall to 32 GW from 58 GW, new coal rises to 2.8 GW to make up for some of the lost legacy capacity;

Less nuclear power – existing nuclear capacity falls to 10 GW (from 19 GW), new nuclear capacity falls to 2.0 GW from 4 GW in the least cost case;

More gas – 15.6 GW of new CCGT, up from 4.5 GW in least cost case;

More wind – another 23.8 GW, for a total of 51.8 GW of wind, 32% of total nameplate capacity; and

More imports – enlarged interconnection with Benelux and Denmark/Norway is only cost effective way to shadow additional wind and meet peak demand.

Update:  Germania is likely to continue to push some expansion of wind and solar, but now their preferences have moved toward more coal plants – 26 of them – to supply the country’s baseload electricity demand after the 2022 nuclear phase-out.

Does Green Always Have to Hurt?

Easing off the green pedal a bit creates enough breathing room in Germania to generate a lot of clean electricity at a much lower cost.  A more moderate program, even with 5 GW of new wind, can be done at a far lower cost with just a few adjustments:

Slow the phase out of existing coal and nuclear plants – keep 85% of existing coal and nuclear plants in operation in 2020;

Build new coal and nuclear plants – reduce emissions per kWh and burn less coal overall, and improve the efficiency and security of the nuclear fuel cycle;

Import more – let more medium term supply come from lower cost Benelux and Scandinavian suppliers to mirror/shadow wind and follow load.

Even current oil prices do not hurt as much as in the more aggressive scenario, with $110/bbl crude oil resulting in total annual costs of $58 billion at 8.1¢/kWh average cost and 7.9¢/kWh for new supply.[iii]

Update:  New power plants under construction in Germany through 2020 total 41 GW.  Fully 40% (16.5 GW) are coal or lignite.  Gas accounts for more than 27% (11.2 GW) and wind has most of the remaining new generation at 20% (8.3 GW).  Pumped storage fills out the plant mix at just over 3 GW (7%).  Only those wind plants now under construction will be completed and no new wind plants are even in the planning stage.  This generation expansion plan represents a triumph of mathematics over ideology.

As a Great Philosopher Once Said, “A man’s got to know his limitations”

In a world of unlimited wealth, where electricity can be stored and plants can be built instantaneously on a whim, a complete remake of a large power system seems feasible and even desirable to some.  Back in the real world, where everything takes time, costs money and different sources of electric power are not perfect substitutes for one another, such ambitions are difficult to realize.

Germania set up too many targets on too short a time frame.  The result was a series of conflicting mandates and constraints – close it down; no, we need it, keep it open; will the Jutes cooperate on supply? What happens to our gas supply when “bad weather” rolls in from the East (as it eventually does in Germania)?

A cleaner, greener power supply system is possible over a longer period of time at a far lower cost than a crash program.  Orderly replacement of older coal plants with more efficient and cleaner new ones makes sense given the country’s resources, geography and demand patterns.  As in the US a crash program to overhaul the system will ultimately force increased reliance on older, less efficient coal plants; it ignores microeconomic rationality for chimerical goals and wastes a lot of money and energy in the process.  Or to paraphrase a revered Soviet philosopher, “you may not be interested in markets, but markets are interested in you.”  Germania ignores market forces at its own peril.

Update: Germania has accepted the realities of power plant costs and performance limitations and has hedged its heavy renewable energy bets in favor of gas and coal.  Even with this approach Germania may face poor returns from its gas plants as they will operate of lower than optimal capacity factors to buffer and shadow a higher wind generation capacity.

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