Follow Us

Blog Back


Is Germany showing us the future of power markets?

This article first appeared in the Energy and Carbon Blog

Germany is attempting something quite revolutionary. It is attempting to create the first real market for power with lots of buyers and sellers in which both sides can react quickly to price signals, on both the demand and supply sides.

In economics, we call this perfect competition and it something that is very good for customers. It is also something we have achieved in lots of other markets but never in power which has been prone to price fixing monopolies and oligopolies across the world for the last one hundred years.

In the traditional world of power generation there is a small number of large generating stations that deliver power to all forms of customer.

So-called spinning reserves are used to balance the grid and to make sure that ever changing demand is always met by fast reacting supply. The wholesale power price at any moment in time is determined by the supply and demand at that particular moment. The demand curve is inelastic meaning that demand is not very responsive to changes in price, implying that any change in demand can lead to a very strong swing in price. As a result there tends to be an enormous difference between power prices across the day. Generally, as power demand increases, more flexible but expensive power units such as gas peakers tend to come online and the prices tends to rise over the course of the day. This system works very well when the bulk of generation is fuel based, and the utility has to make a decision as to what fuel to use. In general, the more expensive the fuel used, the higher the power price will be.

What is very clear and we see this in particular across much of continental Europe is that thanks to the renewable build-up, there is an unprecedented amount of power capacity online, and at certain times of the day, there are significant power “overcapacities” . To make matters worse (for utilities) much of this renewables capacity is not owned or controlled by utilities. Instead these assets are largely owned by individual citizens and by financial investors who are incentivized by mechanisms, such as feed in tariffs, to generate as much power as possible, while the utilities traditionally thrive on their approach of limiting supply. This is very important to understand. Utilities have traditionally operated in monopoly or oligopoly environments, and have been able to influence the wholesale power to their benefit. Now we have real competition in the wholesale power markets and it is one of the reasons why somewhere like Germany now has lower wholesale power prices than all parts of the United States except Mid-Columbia (see below).

The expansion of renewables also means that it is not fuel cost which is the most important determinant of the power price but the weather, which in turn also influences the amount of time other generation capacities, such as gas power stations, are required to come online. If there is no wind or sun, then conventional generation plants have to be switched on to meet power needs. But on sunny or windy days this conventional capacity will likely remain idle.

Utilities have not only have seen power prices fall, but left with stranded conventional power generation assets because fuel costs are above the current wholesale power price. The result is a closure of capacity, as well as the threat that no new conventional capacity will be built without some form of payment above and beyond the wholesale power price, or capacity payments as they are called.

The German government now has another view. Rather than paying utilities to run centralised power plants, in capacity markets, it wants to flexibilise the whole power system. In particular, that means making the demand side more flexible, by allowing energy users and in particular industrial users to react and benefit from power price changes. This means real time power pricing, good communication technology and a liquid power exchange. However, one of the issues for a small business is that wholesale power prices only makes up 20% of the price that they pay, and so even big movements in the wholesale power price will not incentive customers to flexibilise their demand profiles. A possible solution proposed by the consultants, Energy Brainpool, in Berlin is to flexibilise the other costs that make up the end user price (in the case of Germany they are the renewable energy surcharge, CHP bonus and network charges). If there is too much demand then not only will power prices go up but also the various charges. On the other hand, if there is too much supply power prices as well as the various charges will go down.

Of course this may sound like a nice theory and you might it say it will not work in practice. But it is exactly what many intensive German power users are doing (who do not pay much more than the wholesale power price). They are extensively trading power and moving production processes to benefit from the sometime low and even negative power prices. They are also moving certain energy intensive processes to the weekends when power prices are half the already low levels they are during a working week day. And if prices are too high they are lowering supply intake.

This article first appeared in the Energy and Carbon Blog