Given Europe’s ambitious renewable energy goals, an expensive overhaul of its electricity market is taking on greater urgency to ensure a reliable supply at affordable prices.
In a nutshell
- The modernization of Europe’s electricity grid will require at least 584 billion euros
- A market overhaul must focus on supply and affordability besides renewable goals
- Governments must show transparency and avoid overregulating the market
At the beginning of February, the German Federal Ministry for Economic Affairs and Climate Action (BMWK) released a report examining the future of Germany’s electricity supply from 2025 to 2030. The report found that the security of supply is ensured. To some, that might have been a puzzling conclusion, considering the country’s electricity consumption will increase significantly from the current 550 terawatt hours (TWh) per year. Meanwhile, nuclear power plants are due to be phased out by April 15, 2023, while the use of coal in electricity generation is due to end by 2030.
A closer look at the report, however, reveals that this conclusion is based on preconditions and best-case scenarios – both for sufficient generation capacity and grid expansion. As the report stated: “Now discipline and consistency are required. We are continuing to resolutely push ahead with the restructuring of our energy supply. This applies to the expansion of renewable energies, grid expansion and the modernization of the power plant fleet.” This achievement will require flexible loads and storage capacities for helping to regulate demand, as well as additional power plants built for the intermittent generation of wind and sun.
Germany’s power consumption currently peaks around 60,000 MWh (megawatt-hours) daily but can jump up to 80,000 MWh during the coldest winter days due to higher gas heating. Then it needs to tap its gas storage and/or import more power from neighboring countries to close the deficit. Last year, Germany had to increase its interconnection capacity for exports from about 30 to 41 percent. This is because it increased its electricity exports to France in exchange for Paris sending more gas to Germany.
Facts & figures
A costly grid modernization ahead
The report also contrasts with other media coverage that the German Federal Network Agency is planning to ration the power supply to heat pumps and EV charging stations to balance and protect the distribution grids from collapse. It highlights the fact that local distribution grids have already become a bottleneck for the energy transition. According to some estimates, the expansion and modernization of the German grid alone would cost more than 100 billion euros. A European-wide investment in its electricity grid, interconnecting 520 million end consumers in 32 countries, requires more than 584 billion euros between 2020 and 2030. The digitalization of the electricity sector and automated grid management will cost 170 billion euros. A cost-efficient investment will become even more important by 2030 as Germany’s net-zero energy transition has been projected to amount to more than $1 trillion by 2030.
Germany’s supply security is not just dependent on its own electricity policies and capacities but also on those of its neighbors. The nation’s electricity sector is part of the European Union’s integrated energy and electricity markets. Until 2022, only Germany and France had been major net electricity exporters. But in April 2022, France became a net electricity importer due to the overhaul of most of its 56 nuclear power plants. With 26 of them still out of operation, French electricity generation dropped by 15 percent in 2022.
In addition, Italy, Spain and France generated 24-36 percent less electricity from hydropower. Water shortages also led to low levels of the Rhine River, an industrial lifeblood with a shrinking transportation capacity. The river is transporting more than 300 million tons of goods every year, including coal for many European power plants. Even Norway is making plans to restrict electricity exports for national security reasons in the event of insufficient water levels for its hydropower.
Also by Frank Umbach
Challenges to a stable electricity supply
Guaranteeing a stable supply of electricity has become ever more important for a secure green energy transition and the functioning of critical infrastructure. With the expansion of intermittent renewable energy sources (RES), the electrification of the transport sector and the expansion of heat pumps in the building sector, lives will become ever more dependent on sufficient generation and electricity storage capacities as well as the expansion of the smart grid network.
The German Energiewende and Europe’s energy transition pathways have highlighted the following challenges for the global green energy transition:
- Insufficient attention to grid modernization and the expansion of a smart distribution network leads to high losses of generated electricity, rising consumer prices and increasing problems of load inflexibility.
- The introduction of smart meters and grid expansion needs efficient management by grid operators for maximizing the system capacity, network efficiency and preventing wasted or lost clean electricity.
- Decentralized power grids need flexible capacities, a sufficient utility-storage capacity, shorter bureaucratic permitting processes and reliable strategies for avoiding land-use conflicts and soaring supply chain costs.
- The decentralization of power grids and the diversification of power bases have also caused new challenges to adequate oversight and network visibility due to limited data for efficient coordination of flexible supply and demand. As a result of outdated grid monitoring systems, many power grids run 20 percent below capacity.
- The introduction of multi-sensing technologies and smart self-healing grids can overcome those bottlenecks and lack of capacities, flexibility, and network inefficiency.
Since last year, new state inventions have enhanced supply security and curbed gas and electricity prices. Power Purchase Agreements (PPAs), for instance, had been introduced for contributing to a secure electricity supply. But PPAs alone are no guarantee for low prices and supply security. Similarly, Contracts for Difference (CFDs) are aimed at guaranteeing prices for plant operators in hedging renewable investments against market risks. But they may be counterproductive as they clash with the need for enhancing energy conservation. They may also send the wrong signals for market-efficient coordination of supply and demand as well as sufficient and timely investments.
Facts & figures
A new EU electricity market design
Against this background, the EU will revise its traditional electricity market design in which the most expensive gas power plants have determined Europe’s electricity prices. These unprecedentedly high prices became unaffordable for both private households and energy-intensive industries in 2022.
According to the latest official EU data, the production of electricity from RES increased by almost 5 percent from 2020 to 2021, but the share of RES in gross final electricity consumption only rose by 0.1 percent to 37.5 percent in 2021. The EU’s share of gross final energy consumption from renewables reached 21.8 percent in 2021, a decrease of 0.3 percent from 2020.
But higher ambitions remain. The new REPowerEU plan of May 2022 has further increased its RES target from 40 percent to 45 percent by 2030. Russia’s war against Ukraine has accelerated the EU’s decarbonization of the electricity generation sector and enhanced the overall efficiency by expanding renewables and hydrogen projects, investing in smart digital grids and automated grid management through real-data monitoring.
However, 15 of the 27 EU member states have still shares below the EU average in 2021. Fossil fuels still accounted for 70 percent of gross available energy in the EU in 2021. While the Union focused on short-term emergency measures last year (with energy costs up to almost 800 billion euros), it now needs to explore strategies to implement its climate and energy targets by 2030, such as its emission goal of a 55 percent reduction by 2030. The EU needs to phase out coal to achieve its emission targets, yet its coal consumption increased for the second consecutive year in 2022. In Germany’s electricity generation mix, the share of coal – contrary to its climate goals – rose again by 8.4 percent up to 33.3 percent.
Lowering power prices need also be part of the response EU strategy to cope with the massive industrial subsidies in the U.S. and China for keeping globally competitive.
Reforming the EU’s electricity market has become of utmost importance with a focus on the following topics:
- Making electricity prices more independent from the short-term costs of fossil fuels
- Speeding and facilitating renewables investments
- Incentivized investment conditions for energy storage and flexibility options to gas
- Enhancing consumer empowerment
- Better protection against market manipulation
Facts & figures
France went from energy exporter in 2021 to importer in 2022
A strictly economically based design
The revision of the EU electricity market design might include a new merit order of lower-cost generators, like wind and solar, rather than natural gas. But the new market design must also guarantee the security of supply, sufficient investment and efficient instruments. An ever-larger penetration of RES and digitalization technologies might further increase electricity shortages and blackout risks. Those incidents increased by more than 50 percent from 33 to over 52 hours in 2021. It makes it more difficult to keep the transmission voltage and electricity supply stable. But digitalization technologies can make system management more resilient and effective.
A group of northern EU member states (Denmark, Estonia, Finland, Germany, Latvia, Lithuania and the Netherlands) has offered a proposal for wholesale electricity market reform. It seeks to retain benefits of the current design, such as the marginal pricing system, and improve it by increasing market liquidity and investments into more energy and storage capacity for its green transition. It also seeks a better balance of consumer tariffs between more volatile short-term wholesale market trends and less volatile long-term contracts. It will additionally offer incentives for flexible demand responses, but without fundamentally changing the processes, functions and price-forming mechanisms
The Iberian or Greek model, introduced by Spain and Portugal last year and joined by Greece and Italy, put a cap on gas and coal for electricity generation, which reduces the price of electricity and limits windfall profits of electricity producers. But the state-led reform model – by focusing on the short-term price risks, signals, benefits and CFDs – has also increased gas consumption and exports, clashing with the EU’s goal of reducing its gas consumption and other long-term benefits. It has caused distortions in the EU internal electricity market, though they remain limited due to the constraints of interconnections between Spain and the rest of Europe.
Considering these proposals, the European Commission was scheduled to provide its own new electricity market design on March 14.
A resilient design accounts for security risks
The complexity of overhauling a European electricity system demands holistic thinking and comprehensive plans. Supply security cannot be separated from prices and future electricity design.
The EU’s energy security is still based on best-case scenarios and the underlying assumption that electricity is a commodity like any other. It does not recognize that electricity will be more than ever the lifeblood of any modern economy. Its functioning will become ever more dependent on a stable electricity supply and a resilient electricity system. When Germany, for instance, published its stress tests for supply security last September, it was based exclusively on changing market factors.
The analysis did not include a much-debated scenario of a large-scale Russian cyberattack on Europe’s electricity system. The Kremlin has demonstrated its intent and capabilities by attacking Ukraine’s electricity system and causing a large-scale regional electricity blackout in 2015. Since Russia’s invasion of Ukraine, triggering sanctions, the West has feared that those large-scale attacks are just a matter of time. Although they have not happened, President Vladimir Putin’s calculations can change. But those scenarios are not included in the solely market-based analyses of supply and demand balances.
The EU’s future electricity system will have to cope with rising cybersecurity risks – including sophisticated state-supported Advanced Persistent Threats (APTs). For enhancing resilience, the EU and Germany will need more costly reserve capacities.
The reformed EU electricity market will need to avoid becoming overregulated with unmanageable state intervention. Instead, the new market design needs to focus on reliable supply, European-wide coordination, affordable electricity prices in bidding zones and sufficient market transparency, which is often lacking in state interventions. As the EU’s new market design will envisage even much more cross-border cooperation, trade and joint infrastructure, also Germany’s future electricity supply security will become ever more dependent on a stable and resilient EU internal electricity market – and, therewith, on the real future capacities and policies of its EU neighboring countries.