PAGE 38 THOMAS KUSTERER THE GERMAN ENERGY TRANSITION

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1 PAGE 38 THOMAS KUSTERER

2 THE AUTHOR PAGE 39 Thomas Kusterer Chief Financial Officer EnBW Energie Baden-Würtemberg AG The German Energy Transition Partnership Models and a Reliable Framework as a Basis for a Successful Joint Effort In 2010, the German government announced the most demanding energy concept for a highly industrialized nation, namely the Energiewende or Energy Transition. It sets ambitious targets that involve implementing a sustainable energy system and acting as a global role model for climate protection. In principle, the transition of the German energy system includes specific targets for the expansion of renewable energies, the increase of energy efficiency and the reduction of greenhouse gas emissions. The goal for expanding renewable energies, for instance, is to increase their share in electricity consumption to 35 percent by 2020, 50 percent by 2035, and 80 percent by This implies drastically changing the German energy system from a centralized nuclear and fossil fuel system into a decentralized sustainable and renewable energy system. So far, the existing subsidization scheme for renewables has led to a remarkable growth of renewable energy generation. By the end of 2012, the ministry of environment reported an EEG 1 -supported feed-in of approximately 135,000 GWh 2, meaning that nearly 20 percent of the overall German electricity demand can be met by renewables. The EEG-supported feed-in also resulted in total payments of 22.9 billion for 2012 and is expected to further increase in Because the subsidization of the German Energy Transition is being passed on to consumers, their energy bills have risen steadily, while the transformation of the energy sector should remain affordable for German society. At the same time, wholesale-market prices are considerably affected by the growing volumes of renewable energy. Since mid-2011, wholesale-market prices have decreased by about one-third to approximately 40 per MWh. Both the increase in renewable volumes and the decrease in wholesale-market prices have led to a severe shift in the so-called merit order of power generation, i.e., the ranking 1 EEG is the German abbreviation for the German Renewable Energy Act 2 Source Federal Ministry for the Environment, Nature Conservation and Nuclear Safety

3 PAGE 40 THOMAS KUSTERER of energy sources. Consequently, marginal plants and hence the price-setting power plants are coal- instead of gas- or oil-fired plants, which have resulted in a substantial profitability decline for fossil power generation in Germany. To meet the ambitious targets of the energy concept, the German energy sector has to cope with various challenges: Ongoing expansion of renewable energies Grid connection of basically decentralized renewables Extension of the German transmission grid Enhancement of distribution networks Regulatory and, therefore, financial improvement of fossil fuel plants as flexible backup facilities and as transitory technology Development of energy storage technologies Energy savings due to enhanced energy efficiency As a consequence of transforming the German energy system, the investment requirements, the regulatory framework as well as the need for additional capital have fundamentally changed. THE FUNDAMENTAL TRANSFORMATION OF THE GERMAN ENERGY SYSTEM ENTAILS ENORMOUS CAPITAL REQUIREMENTS In the past, the German energy sector was able to assume the costs of its investments itself, but this has changed dramatically. The transformation of the sector now exceeds the energy industry s financial capacities. Moreover, most of the utilities are faced with great pressure on their profitability and business models while being burdened by high levels of debt. These factors are resulting in negative rating trends across the German utilities that have been noted over the past two to three years. All of the above results in a substantial technical and financial burden for the German energy sector. To ensure a secure and reliable supply, the intermittent and decentralized character of renewables has to be managed in light of a shrinking base load power generation. At the same time, regulatory challenges with regard to grid operations have to be met. The financial burden for the German energy sector as a result thereof is huge. A highly leveraged industry is faced with price declines and severely declining profitability and substantial investment needs. However, the exact scale of the investments required by 2030 cannot be foreseen. Studies suggest investment needs ranging from between 200 billion and 300 billion. These amounts underscore the magnitude and need for external capital, as utilities can no longer fund the sector changes themselves. EnBW is affected by the Energy Transition across its entire value chain. With a nationwide market share of around 10 percent, the extrapolated investment requirements account for 20 to 30 billion over the next 10 to 15 years.

4 THOMAS KUSTERER PAGE 41 RELIABLE FRAMEWORK CONDITIONS A KEY REQUIREMENT FOR INVESTMENTS IN THE ENERGY TRANSITION Due to uncertain legal and regulatory framework conditions, EnBW has already postponed an investment into the Hohe See offshore wind park with a volume in excess of 1.5 billion and a planned output of around 500 MW. Either way, the capital requirements for the transformation of the energy system, including the planned expansion of renewable energies, storage facilities, grids, and smart infrastructure, are enormous and must be met if the goals of the Energy Transition are to be achieved. This will require external capital such as partnership models with financial investors, which will allow them to tap into industry expertise. Currently, regulatory uncertainty exists with regard to the ongoing political debate about the costs associated with the Energy Transition. There seems to be political consensus that the cost implications of the Energy Transition have been underestimated and that there is a need for a regulatory modification. The question that remains focuses on the extent to which this change is going to happen and whether it will also impact existing investments. Other open issues are whether the subsidies of renewables will be adjusted, how the regulated grid businesses will be affected, and whether or not capacity mechanisms or comparable measures will be put into place to cope with the stability aspects. Therefore, clarity is required with regard to the regulatory framework. In light of the long planning and operating cycles of investments in the energy industry, this is the fundamental prerequisite for additional external capital. National and international players can only be attracted if predictable framework conditions, associated investment security, and stable returns can be credibly guaranteed.

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6 THOMAS KUSTERER PAGE 43 ENBW DEVELOPS ATTRACTIVE PARTNERSHIP MODELS FOR FINANCIAL SPONSORS AND SYSTEMATICALLY PURSUES A PARTNERSHIP-BASED APPROACH TO PROJECT DEVELOPMENT Today, sufficient external capital seems to be available despite the disruption on the capital markets. Low interest levels have led to a need for new investment opportunities. Institutional investors, such as pension and sovereign wealth funds, insurance companies, and private-equity capital, are looking for investment opportunities outside fixed income products worldwide. An attractive risk/ return profile is a key factor for these potential investors. In most instances, financial investors are not interested in developing, constructing, or operating on- or off-shore wind parks or grid infrastructure by themselves. This opens up opportunities for all of the parties involved. The intention of these investors is simply driven by the above mentioned historically low interest rate environment. Projects in the energy sector, from investment in grids to investment in on- and off-shore wind parks offer attractive opportunities for such investors due to the regulated or quasi regulated cash-flow characteristics. Consequently, partnership models need to be developed for investors who have previously been less active or not involved at all in the energy sector. The combination of external financial sponsorship with the industry expertise of the utility engaged offers an attractive win-win situation. The financing partner takes the strain of the investment budget of a utility and, therefore, increases the scope for future investments. All in all, this aspect is of utmost importance for utilities as rating pressure limits the scope of further investments. In return, the partners involved receive an attractive return on capital over a long-term period combined with a low and, therefore, manageable risk profile. EnBW is aiming for these opportunities and is focusing specifically on such partnerships. EnBW has developed an attractive participation model for the EnBW Baltic 1 offshore wind park in the Baltic Sea. The project was financed by debt arranged by the European Investment Bank, KfW and a commercial banking syndicate. After successful completion, 49 percent of the shares in Baltic 1 were sold to a total of 19 municipal utilities. EnBW holds a majority stake. EnBW will continue to systematically pursue this approach involving partnership-based project development and joint financing. EnBW will develop and offer a redesigned participation model for the follow-up project, EnBW Baltic 2, and the expansion of the hydropower plant in Gambsheim. The key factor for all projects remains that investments offer an attractive risk/return profile. This must be sufficiently attractive by international comparison to channel investment funding into Germany s transition of its energy system. Moreover, Germany s Energy Transition will only be successful if the regulatory framework is stable and investment-friendly in the long run. A key regulatory element of Germany s transition to renewable energies is the EEG, the German Renewable Energy Act. In light of its major significance, the various arguments in the current political debate about a comprehensive and sustainable reform of the Renewable Energy Act should be carefully analyzed and weighed up. The transition of Germany s energy system is a joint undertaking. The challenges facing us can only be overcome if the German Energy Transition is perceived as an undertaking for society as a whole that includes energy companies, municipal utilities, industry, politicians, investors and consumers alike.