Explaining Germany's energy transition 'reality check'

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Eklavya Gupte:

Welcome to Energy Evolution, a Platts podcast by S&P Global Commodity Insights where we dive deep into the energy stories shaping our world today. I am your host, Eklavya Gupte.

And in this episode we're exploring a particularly intricate web of challenges emerging from Germany's evolving energy landscape. This past month, significant shifts in Germany's energy policies have raised important discussions around the reality of meeting ambitious climate targets amidst economic pressures. Just last month, German energy minister Katharina Reicher unveiled a report that is set to guide key decisions for the newly formed coalition government. This so-called reality check suggests that while the government is sticking to its ambitious goal of achieving an 80% share of renewables by 2030, it acknowledges that demand growth is actually likely to be slower than expected. Now, this slower demand means that the expansion of solar and wind will have to be paced accordingly, unlike what current laws dictate. With recent developments in German politics, there are pressing questions now about the future of the country's energy policies and how they will impact both domestic and European climate goals.

Joining me today are two experts, Andreas Franke, editorial lead for European Power and electricity at S&P Global Commodity Insights, and Henning Gloystein, managing director for energy, climate and resources at the Eurasia Group. We'll discuss the implications of the new government's reality check on electricity demand forecasts, the challenges posed by soaring energy costs, and how Germany's evolving policies might align with broader European and global climate and energy policy objectives.

Andreas, Henning, welcome to the Energy Evolution Podcast. Great to have you here. Now obviously we've seen some big developments out of Germany in the last month or so. So my first question is to you, Andreas. Why does the new government in Berlin need a reality check and what were some of the main conclusions from it?

Andreas Franke:

Thanks, Eklavya. After the election in February, the two winning parties, the Conservatives and the Social Democrats started negotiations under a bit of time pressure. They obviously have to reform the renewable energy law very soon. The idea stemmed over the summer months to do a so-called monitoring report on the state of the energy transition. And key focus here is the forecast for electricity demand in 2030. That number, 750 terawatt hours per year, underpins the German EEG law. And that is very obvious that this is far too high. So the reality check is taking the temperature of the power demand forecast in 2030.

And one key conclusion from the report, which was presented in mid-September is that the 750 is far too high. The two external consultancies in this report for the energy ministry looked at various scientific and other consultancy projections, and they put in a new range of around 600 to 700. It could be even towards the lower end of this one. That is about 20% below the set target in the law from which all the other centrally set trajectory targets for solar expansion, for renewable expansions stem from.

It's also the grid expansion, which is obviously the key aspect and potentially the most expensive one. The cost or the estimated cost for the next 10 years has shot up to around 440 billion euros overall. So the new government wants to look at more of the overall system costs of that energy transition.

Eklavya Gupte:

Thank you. Superb summary. And obviously the energy minister picked, I think it was 10 key points from the report. And how would these impact the policy decisions for the coming years?

Andreas Franke:

Yes, so the new focus is overall system costs. It's not the wholesale prices, it's not gigawatt targets. And that's a very complex issue. The first thing you need for this one is the first point in the ministry's conclusions. It's an honest demand assessment to avoid overcapacity. That is likely to refer to the grid expansion, or the speed of the grid expansion, and more immediately on the gigawatt targets for solar and wind in a reform of the EEG, which is needed anyway for 2027 when various state aid regulations expire.

So this new market and system friendly renewables support could mean for instance, that's what the minister hinted immediately at the press conference when presenting that report with the authors, is potentially phasing out the feed-in tariffs for rooftop solar. That's still the majority of the German solar segment. The minister thinks that no longer needs state aid because of the high retail towers for electricity.

Another big thing will be the move in the auctions for large ground mounted solar projects, as well as onshore wind, as well as offshore wind to two-sided contracts for different auctions. That contrasts the current sliding premium support for 20 years.

Other points are synchronized grid expansion. Also of importance here is the coal exit timelines as well as new state aid for new gas plants in Germany as well as the capacity market here. Here, that document by the ministry mentioned a 2027 date. And the government is fast tracking those first auctions for new gas plants to meet the coal exit timelines, especially around 2030.

Eklavya Gupte:

Okay, great. Thanks.

And now, Henning, I'd like to pull you in. Could you give us a bit of a overview on how this could affect the forecast for power demand in Germany and especially at a time when Europe is trying to priorities its industry as we've had soaring energy costs?

Henning Gloystein:

Sure, and thanks for having me. I sympathize with the plan to reassess Germany's electricity demand forecast because there are a lot of factors at play here that are changing fast and that they're quite difficult to anticipate. You have the electrification of transports or electric vehicles that are going to bring in a lot of demand for electricity, but they are also a supply side solution because you can actually sell in a smart grid the electricity back into the grid from a battery. So we need to have a better view of future electric vehicle rollouts.

So for instance, in Germany it's been a little bit slower than was initially anticipated. And currently there are a few signs that it will accelerate really fast next year, but it might be as more models come to market, that come 2027/8, it goes into sort of a strong acceleration. Then you have electrification of heating, which has also been much slower than anticipated, but it will accelerate at some point later this decade.

And then you have efficiency gains. And that is almost always the most surprising factor that happens. So we know that electricity consumption in EVs will increase. We know from electrification it will increase. And then from of course AI and data centers it'll increase because Germany is actually one of the strongest developers of data centers in Europe at least.

But then you have the countering effect of efficiency gains. So my gut feeling is a little bit that the government is right in saying that the demand forecast or demand growth will be a little bit lower than initially anticipated because I think efficiency gains will be stronger than we currently account for. So overall, I think this is a good initiative by the German ministry and I'm cautiously optimistic that this will have a positive impact on Germany's electricity systems.

Eklavya Gupte:

Thank you. And now how would this affect Germany's climate targets? Because obviously one of the big things at play right now is how the commission is trying to rally on the member states to agree on 2040 climate targets, for example. So it'd be good to get on how it's going to affect Europe's largest economy.

Henning Gloystein:

So the climate targets are, I think, and it's not a very popular thing to say, but most net-zero goals are honorable targets rather than laws. I know they are laws by definition at least in Europe. So I think the reality here is that it is a goal. It's a serious goal and I think it's a very important one. And I suspect 2045 is going to be over ambitious in particular because Germany is building, as Andreas already mentioned, is planning to build at least up to 20 gigawatts of new gas-fired power stations. They say they're going to be low carbon and hydrogen ready, but that's really just kicking the can down the road. These will be operating on natural gas, which is a fossil fuel.

So we can get the cleanest fossil fuel that we can get our fingers on. We can maybe think about carbon capture and storage solutions. But the problem here is that CCS is really expensive and it's not going to get cheap anytime soon. And on top of that, you have the cost of fuel here. So gas is relatively costly in Europe, so that means that we're going to have to pay for the gas, and top of that some form of clean gas, whether it's hydrogen or a CCS solution, this is going to make it really primitively expensive, is my view. And so that's going to be difficult.

I mean, Germany is not going to build any nuclear power stations anytime soon. So this makes, I think Germany's full decarbonization quite difficult. We should also keep in mind, as you mentioned, Eklavya, Germany is Europe's biggest economy and biggest producer of heavy industrial goods that are energy intensive, steel, chemicals. I know there's a fear of deindustrialization, and the role of heavy industry might decline somewhat, but Germany is not going to totally deindustrialize in the next 10 years. That's not going to happen. There's too much substance to this. There's too much government support. And it is actually despite high prices, a competitive industry overall.

So they won't vanish, which means they will consume a lot of energy and a lot of this will be natural gas, which will be very hard to abate. I know there's honorable targets here and policies in place here as well. These Klimaschutzverträge, so the climate contracts for difference. And they probably will work, but they will take a lot of time to fully implement. And I fear it will be beyond 2045.

Last but not least is the coal exit. 2030 always looked a bit silly. 2038 looks ambitious. Now that is possible, but if you switch from coal to gas, that is a decarbonization, but it is not a path to zero carbon emission. So there's way to go. And I fear 2045 looks over ambitious.

Eklavya Gupte:

No, thank you. That was really insightful.

And now maybe going back to you Andreas, what has been sort of some of the market impact that would emerge from some of the possible reforms, but how has some in the industry viewed this reality check?

Andreas Franke:

It's difficult to judge especially on the tradable horizon, but just if you look at electricity prices this summer, the key feature is the surprising surge in negative electricity prices, which is obviously driven by, on the one hand, weak demand is still below 2021 levels. On the other hand, the surge in solar, especially during midday hours, you can see rising batteries' price. But that is what the reality check is trying to look in, and solutions that are system efficient, to bring them forward.

In pricing, interesting that the chancellor, Fritvice Merz, he said that EU carbon allowance prices will be the key driver for the decarbonization. And we've seen perhaps also surprise-wise in EUAs in the tradable view up to 2030, you do see that the annual German electricity prices, the so-called call contracts are actually falling quite significantly over the coming years because there is still more renewables to come online.

Those policy decisions on the basis of the reality check won't bite immediately. In some cases for offshore wind, it's unlikely that they will impact anything before 2030. So there's still plenty of projects, especially wind. Solar we can see already is slowing down a little bit. Onshore wind, there's a massive boom ahead of policies under the previous government to unblocking permits, putting them through the auctions. That still needs to be implemented before we can really see impacts, direct impacts from that reality check.

Eklavya Gupte:

Thank you.

And Henning, maybe before moving on to the global context, I thought I'll ask you as well on what has been some of the reactions both from maybe energy firms but also maybe from the larger industries, which obviously as we know are so integral to Germany's economy?

Henning Gloystein:

Yeah, so I just mentioned the price forward curve. It is going down and that's I guess good, but it's not going down fast enough and steep enough.

If you talk to heavy industry, they will say at around 50 euros to 60 euros a megawatt hour, they are really competitive. They could probably export quite competitively and they could grow. 60 to 70 euros a megawatt hour, they have a headache and they probably won't invest in new capacity in Germany. And anything above that, they are in contraction mode. And that basically means that at the moment investing into energy intensive industries in Germany is not an attractive option.

And the problem here I think that Germany has is it really needs investment in capacity and storage, and probably transmission as well. Because actually October is a good example. If you look at the first half of October, it was relatively mild, so nobody really had to heat yet, obviously nobody had to cool either. But even then Germany could not meet its own electricity consumption, where Germany had to import electricity from most its western, southern, and northern neighbors to meet its demand. Because okay, it wasn't particularly sunny anymore, but despite the fact that it was still relatively sunny and windy, we couldn't meet our own demand. And that means we had to import. And of course that means prices go up so that you attract those imports.

Now that's not a security of supply problem. Europe has a competitive and a functioning power grid, but it is a cost problem. And this is the issue. It is the clear signal that average prices are too high, that we need domestic investment in capacity, and we need it in storage to address those negative power prices to balance it out.

The money is there, the policy is now there as well. And now you need the regulatory environment to make that investment attractive so that we don't just have the signals of negative power prices frequently, but high average power prices permanently. Those are red flag signals, they're a signal to invest, but if Germany doesn't create the regulatory environment to make those investments, they will just remain painful signals, and that points towards problems for industry.

I don't want to sound too negative here though. In all I've said with decarbonization and addressing these problems, we know the solutions. They're there. And we have the money. Germany fortunately has this huge investment program of overall a trillion euros over about a decade in defense and infrastructure, and a lot of that will go to the energy sector. So I think we're probably on a good path, but it's high time that we actually start walking down that path.

Andreas Franke:

Those issues are highly complex, and the government already hinted at some potential solutions. For instance, the concept of the industrial power price re-emerged. That was something the former energy minister, Robert Habeck, wanted. Now there's a new EU support framework for industry where governments, EU member states can support industry for half of their annual consumption up to 50 euros. And we have to see how that filters through. That is highly complex. It needs to align with EU state aid regulations.

And we've seen in the direct budget for the German budget for 2026 that even pledges from the coalition treaty like the electricity VAT waiver for households, there wasn't enough money in the budget potentially because industry may need a bit more support. That's what Henning hinted there. But it's interesting that the minister, for instance, promised the steel industry that they can expect price support, electricity price support from 2026 potentially to be paid with 2027 budget funding.

Eklavya Gupte:

Thank you. And now let's briefly look beyond Germany, because obviously one of the things we're seeing in the climate and energy space is a bit of maybe pragmatism. And so how does this new German government policy fit into both the European Union's climate plans? But also how does it compare with China and US, which as we know are going on very different trajectories?

Henning Gloystein:

So I think Germany's overall policies in the energy sector within the EU, they're largely compatible. SO the overall policies set by Brussels and by most member states point in the right direction. It points into investment into more domestic clean generation storage and transmission capacity. And that should bring down prices, and it should reduce import reliance on fossil fuels, which as we've painfully experienced in Europe recently, have become or can become prohibitively expensive and unenlightened. And so it's a clear path set by the European Union and its member states including Germany.

China, interestingly is going down that same path for the same reasons. They've experienced fossil fuel price shocks, not just the one from 2022, but also back in 2011 when Japan's tsunami and the nuclear reactor meltdowns at Fukushima caused price spikes. They're exposed to the same problem, so they are going down this really ambitious path of electrification of pretty much everything. You've already seen that it's possible that China's oil demand has peaked around now. Its gas demand growth has slowed dramatically versus the past year's. It is a national security and a climate policy. So Europe and China are actually closely aligned in this.

And I would argue India is on the cusp of starting to do the same thing. If you go to Mumbai now, you see a lot of electric vehicles made in India driving on the streets now. Just three years ago you didn't see that. But the difference is that China has overtaken Europe as the leading player in this field, and now we're using a lot of Chinese equipment to achieve this. And that in the past used to be the other way around. So that is something policymakers, and regulators, and security folks will have to grapple with in the future.

The United States is now on a very different path. The US is the world's biggest oil and gas producer, and it has not invested sufficiently in electricity generation capacity and transmission over the last few years. The US is developing AI data centers faster than anybody else. So their demand growth is really strong in that field. And so they are facing real energy electricity shortages there. And that is why there's this fever pitch and this craze about building anything, small modular reactors, conventional nuclear power plants, gas fired power stations, everything at the same time, because it's so capital intensive. And of course this sector has so much money that they can do that.

Despite this, we expect electricity prices in the United States to increase quite significantly because they are building demand for data centers out faster, and so electricity demand is rising faster than they can build transmission and power stations. So I think in the United States, the power trajectory, power price trajectory is facing upward, whereas in the European Union it's actually facing downward, including for Germany because I think capacity increases will be made.

Eklavya Gupte:

Thank you very much.

And now Andreas, also wanted to ask you, are there any other countries that do need such a reality check?

Andreas Franke:

Overcasting power demand in the midterm is potentially also an issue for the UK, Great Britain, Spain, or even France. But as we already mentioned, Germany is quite unique in this explicit solar and wind targets in the green energy law. For solar, for instance, 215 gigawatt in 2030. And our analysts here at S&P Global Commodity Insights used their 2030 gross demand forecast of around 600, and the reconfirmed target by the German government to have an 80% share of renewables in 2030 in the power mix, to readjust what that could mean for those targets. And that could be 73 gigawatt less, obviously heavily skewed towards solar. For instance, they would estimate using average wind and solar output, 170 gigawatt solar. So that would lead to a very sharp slowdown in the solar expansion.

The offshore wind targets in 2030 will be lower. There are grid delays anyways. Unlikely that the government target of 30 gigawatt will be achieved in 2030. Onshore is a mixed thing, onshore wind, where there's the first generation of German wind turbines reaching retirement age now. Some have already retired, but for instance, the assumption here from the S&P global analyst was 87 gigawatt installed onshore by 2030, so that German electricity will be 80% renewable. That's slightly below UK clean energy emission projections. The French electricity mix due to this heavy reliance on nuclear is obviously less carbon intensive already. So it has to be seen how potential future changes in government may trigger similar exercises in those European member states.

Eklavya Gupte:

Thank you. No, that's fascinating.

And actually before we close off, is there any other stuff that I've missed out on or any other points that Henning or Andreas you would like to mention as the last words?

Henning Gloystein:

There is actually one thing, and on a podcast sometimes one has to disagree a little bit.

So I don't think Germany is the only country that has a lot of homework to do in this sector. Just in a very brief look around, I think France's dependency on nuclear power is so high that they are in serious trouble. We saw in 2022 when Germany was grappling with this loss of Russian gas, actually Germany was a net exporter of electricity to France because of its aging nuclear fleet, half of it was off. It's aging fast. They won't be able to replace the aging fleet one-on-one. And they've fallen behind in quite a lot of areas.

Poland has even higher power prices than Germany because they have under invested in clean power. And they are still hugely reliant on coal-fired power generation, which the coal is cheap, but the CO2 is expensive. And those net-zero goals will come to bite them quite hard if they don't act fast.

Italy haven't deployed clean power very fast. They have a huge gas dependency which exposes them to price shocks.

Spain had its own little experience early this year, had a huge blackout. They told them very clearly that they might want to invest into more grid connections, more battery storage, and might want to review their nuclear phase out a little bit.

The UK actually, I think is looking okay. They've had quite a consistent policy rollout over the last decades.

So I know we're focusing on Germany today and they've got a lot of homework to do, but I think most governments in Europe have some head scratching to do. And the fiscal constraints are pretty tight, so I think there are going to be future podcasts about all these countries.

Eklavya Gupte:

Thank you both. That was a really fascinating conversation. And thank you very much for your time.

Henning Gloystein:

Thank you.

Andreas Franke:

Thank you.

Eklavya Gupte:

Okay, listeners, that's all for this episode. I hope you found it insightful. Thank you for tuning in.

Now I'd like to send a shout-out to the rest of our Energy Evolution team, including Karen Willenbrecht, Dan Testa, Camilla Naschert, and Christopher Coates. And also a big thank you to our agency partner, the 199, and the Commodity Insights digital content team.

Also, don't forget to subscribe to Energy Evolution on your favorite podcast platform. And if you have any ideas for podcast themes or guests, please fire us an email at energyevolution@spglobal.com.

Until next time, thank you for tuning in.