The Economic Impacts of the Energiewende (Energy Transition)

The Economic Impacts of the Energiewende (Energy Transition) Graham Weale, Chief Economist RWE AG, Bocconi University Energy Seminar Milan 6th May 214 RWE AG 3/5/214 PAGE 1

Contents 1. Key features of the power generation industry 2. What is the Energiewende? 3. What kind of economic effects might result from the Energiewende? 4. What impact on power prices? 5. What impact on utilities and new investors in renewables? 6. What impact on consumer prices? 7. What impact on jobs? 8. What Investment is required and what will be utilities new business model? 9. What needs to be done to keep economics in the Energiewende? RWE AG 3/5/214 PAGE 2

Key factors in the power generating sector Range of power plants Technology and cost structure Highly variable hourly demand; hard to store European market with increasing interconnections and market coupling Wide range of operators large (former monopoly utilities) gas companies who moved into power municipalities industrial combined-heat-and power (CHP) operators Hourly pricing in the wholesale market large buyers exposed to this, smaller buyers pay based on averages 18 16 14 12 1 8 6 4 2 Indicative costs of power generation - /MWh Variable Fixed Gas Coal Nuclear Offshore Onshore wind wind Hourly demand - winter and summer PV (N. EU) RWE AG 3/5/214 PAGE 3

The merit-order curve dispatching principle Germany: Merit Order 212 ( / MWh) 2 18 16 14 12 1 8 Oil / Gasoil Gas Hard Coal Lignite Nuclear Renewables / CHP Min load Peak load 6 4 2 MW Average available Wind / PV / Hydro / other Renew. 5 45 4 35 Base / Peak spread:114% RWE RWE AG AG 3/5/214 3/5/14 Slide 4

The Energiewende a plan to move from nuclear and coal to renewables: milestones from 1991 Energiewende 1991 1998 2 22 24 25 29 21 211 212 214 222 25 1st Feedin Law Market Liberalization 1st EEG Double RES share of total energy by 21 Nuclear phaseout by 222 EEG 24 12.5% / 2% power share in 21 / 22 Start of EU Emissions Trading Scheme EEG 29 35% power share by 22 Energy concept Nuclear operating lifetime extension Eckpunkte -papier EEG 212 Closure of 8 nuclear plants and change to nuclear law to close all plants by 222 EEG Reform Last nuclear reactor will be shut down 8% to 9% reduction in emissions, and 8% renewables share in power RWE AG 3/5/214 PAGE 6

Further targets introduced in 211 Firm goals 22 23 Instruments 1 K1 Phase out nuclear power by 222 211 Nuclear Power Law C Reduce greenhouse gas emissions compared to 199 by 4% 55% ETS with German version C1 Increase proportion of renewables (RES) in gross final energy consumption to 18% 3% Renewable heating, and Biomass laws, C2 C3 C4 C5 C6 C7 C8 N1 V1 Supply security - - Strategic Reserve W1 Currently only loosely defined goals C C V Increase the proportion of RES in gross elec. consumption to Reduce primary energy consumption compared to 28 to Reduce electricity consumption compared to 28 by Increase energy efficiency compared to 27 by Reduce heat demand of buildings compared to 28 by Increase number of electric vehicles to Reduce final energy consumption in transport vs.28 by Grid expansion according to ENLAG Limit renewables surcharge to 3.5 cents/kwh Reduce heat demand of buildings compared to 28 Annual rate of energy-saving renovation in housing of 2% Additional construction of firm fossil fuel power plant capacity 35% 5% EEG 2% - Environmental tax, EnEV 1% - Environmental tax Environmental tax and other 2% - laws 2% - EnEV 1 Mio. 6 Mio. Energy and climate funds 1% - Reform car tax - - EnLAG N2 Punctuality of the grid connection of offshore wind farms - - EnWG N3 Increase installed capacity of offshore wind to 1 GW 25 GW EEG - - EnEV - - Not availabe Only indirect loan programme 1 GW - Not available RWE RWE AG AG CEA : 1/4/214 3/5/214 Page 7

which were badly off track after just two years, except for renewables growth Sustainability 1. Achievement of federal government s CO 2 reduction target (-4 %) increasingly unrealistic 2. Share of renewables rising in the case of electricity stagnation in the transport and heating sectors 3. Due to first results from coalition talks the watering down of heating efficiecy targets is likely 78% Grid expansion 1. More than 8% of expansion projects still delayed 2. By 215 a number of offshore wind farms will be completed, but key grid expansion projects for overland transmission of electricty will not be ready until that time 3. At least there is some improvement in sight for offshore wind power connections to the grid 15% Costs/EEG levy 1. With 6.2 ct /kwh the EEG levy has exceeded the government s own threshold of 3.5 ct / kwh by far 2. With the new government at least modest reforms that are targeting at limiting the costs are to expect, so we come to an neutral outlook for the next years, but situation will not improve quickly 22% Security of supply 1. Increasing intervention by transmission system operators in the market to avoid critical situations with the power grid. The situation continued in whole 213. 2. End of March 213 there were some severe situations in the German grid due to very high wind feedin. 5% Source: own calculations Adherence to target path: = 41% RWE AG 3/5/14 Slide 8

German production from 2-223 by fuel mix: renewables essentially replace nuclear power TWh 65 6 55 5 45 4 35 3 Photovoltaics Wind Biomass Run-of-River Other Nuclear Natural Gas Lignite 25 Hard Coal 2 15 1 5 2 25 21 212 223 Source: BMWi Energiedaten, NEP 213 Szenario B RWE AG CEA RWE : AG Weale 13.2.214 3/5/214 Page 9

Uncontrolled build-up of renewables TWh 14 12 1 8 Total PV Wind Biomass Water (exc. PS) 6 4 2 2 22 24 26 28 21 212 RWE AG RWE CEA AG : Weale 13.2.214 3/5/214 Page 1

Observations on the Energiewende? What were the goal(s)? Were they mutually compatible? How many instruments were applied? How effective would they have been? Whom would they have caused to do what? RWE AG RWE CEA AG : Weale 13.2.214 3/5/214 Page 11

Potential policy effects as a result of policy intervention What might a government want to achieve by energy policy intervention Generally? In the case of an energy transformation? Who are the different parties who could be affected? Shareholders Customers Suppliers Competitors of main utilities External markets Jobs market Health of economy What kind of economic effects might be expected? RWE AG RWE CEA AG : Weale 13.2.214 3/5/214 Page 13

The RES subsidy system is distorting the market and is reducing utilities earnings Subsidies bring additional capacity into the market before capacity is needed and without the normal price signals with full costs well over the power price and full costs of new conventional plants with a totally different cost structure which therefore does not react to wholesale price signals (have no relation to costs of renewables) and runs ahead of conventional power plants But needs conventional plants as back-up = Major distortion of the wholesale power market The totally different cost structure of RES poses a great challenge to their market integration High penetration rate lowers the wholesale price and thus increases the required subsidies compared with full-cost based price Renewables earn full costs while conventional plants only marginal costs not sustainable Indicative full costs by type /MWh 18 16 14 12 1 8 6 4 2 Fix costs CCGT CO 2 -Costs Coal Fuel costs Other variable costs Onshore Wind Offshore Wind Source: Investor Relations / Fraunhofer ISE (212) indicative costs RWE AG RWE CEA AG : Weale 13.2.214 3/5/214 Page 14

so that there is missing money for thermal plants; instead there is a similar RES surcharge / MWh Conventional plant costs Revenue recovered Costs and revenues Consumer costs Renewables etc.surcharge (range) Wholesale price Missing money - conventional plants Annualised capex (conv) recovery Annualised capex (conv) CO2 costs Other variable Fixed Costs Fuel Long-term missing money is not sustainable - eventually the full costs of conventional plants needs to be covered so that they can provide back-up The renewables (etc) surcharge is the threat to competitivity, not the wholesale price There is a major transfer of rent from utilities to consumers RWE AG 3/5/14 Slide 15

Impact on power prices German power prices 1. Volume effect of higher than expected RES pushed out merit-order curve (nuclear closures had some offsetting impact) 2. Volume effect of recession also pushed out merit-order curve 3. PV had effect of flattening out daily peak price important part of earning component 4. CO 2 price 5/t vs. expected - 3/t 5. Coal price also lower than expected flattened out merit-order curve /MWh 9 8 7 6 5 4 3 2 1 Indicative full cost of new plant 2 22 24 26 28 21 212 214 216 Peak Base Spread Source: EEX RWE AG 28/4/214 3/5/214 PAGE 18

The PV reduced the mid-day prices which accounted for high share of earnings Progressive reduction of mid-day price through PV-generation [%] 25 2 15 1 27 28 29 21 211 5 1 2 3 4 5 6 7 8 9 1 11 12 13 14 15 16 17 18 19 2 21 22 23 24 Hour of day RWE RWE AG AG 1/4/214 3/5/214 Page 19

The position of the German utilities high capital invested in conventional plants Net Capacity End 212 Indicative capital employed based on 5% new value GW 1 Peak demand bn 7 8 6 4 2 RES (incl.hydro) Other non-res Gas Hard Coal Lignite Nuclear 6 5 4 3 2 1 Big-4 Other Big-4 Other Source: BMWi RWE AG 3/5/214 PAGE 21

Generators suffered not only from price effect but also volume effect vs expectations Actual and expected (as of 25) demand and renewables TWh 7 6 Gross demand expected Gross demand actual 5 4 3 Thermal power supplied by large generators 2 Renewables actual 1 Renewables expected base on trend to 25 Lower residual demand 2 22 24 26 28 21 212 15% lower than expected demand due 6% to recession and 4% to renewables RWE AG 3/5/214 PAGE 22

The result a decline in EBIT, market value and investments bn 25 2 15 1 5 EBIT -35% E.ON EnBW RWE Vattenfall bn 2 16 15 1 5 Market Value -7% 5 27 28 29 21 211 212 213 27 28 29 21 211 212 213 bn 3 Investments 25 2-45% 15 1 5 27 28 29 21 211 212 213 214* 215* Source: Company annual reports RWE AG 3/5/214 PAGE 23

The Consumer Price has been driven up by the surcharge despite a falling wholesale price EEG Subsidies and Consumer Price Surcharge bn 25 2 15 1 5 2 22 24 26 28 21 212 6 5 4 3 2 1 cts/ kwh Offshore charges Levy based on 19 CHP EEG levy EEG Surcharge 3 25 2 15 1 5 Power prices for households (2.5-5 MWh) ct/kwh incl. all taxes 28 29 21 211 212 Consumer Peak price 12 1 8 6 4 2 Power prices for industrial consumers (2-7 GWh) ct/kwh excl. VAT 28 29 21 211 212 Consumer Base price Source: BMWi Energiedaten 21.5.213 and EEX RWE AG RWE AG 3/5/214 CEA - Weale PAGE 25

The structure of consumer prices cts/kwh 3 25 16% 17% 32% 1% VAT Other taxes RES 2 15 13% 22% 16% T&D Energy & retail 1 52% 5 32% Household Industry Household Industry 2.5-5. MWh 2-7 GWh RWE AG RWE AG 3/5/214 CEA - Weale PAGE 26

The renewables policy has led to work for.8% of the German workforce Employees in the renewables sector s 4 35 3 25 2 15 1 5 R&D / Admin Hydropower Geothermal Biomass Windpower PV Unclassified 1998 24 26 27 28 29 21 211 212 213e Earlier Red-Green Coalition had hopes that 5 T jobs would be created by 22 > But loss of jobs (including growth prospects) in other sectors should be deducted Growing number of bankruptcies in renewables area since 211, especially PV but also wind RWE RWE AG AG CEA : 1/4/214 3/5/214 Page 28

Financing the Energiewende: on average 27 bn will be invested annually* Investments by technology groups 212-225 (in bn) 4 3 2 1 212 214 216 218 Biomass and biogas Building energy retrofit CHP Grid total 22 222 224 Wind offshore Wind onshore Batteries PV Remarks High PV investments of ~ 8 bn p.a. until 216; then declining to 3 bn p.a. again rising ca. 22 due to higher retail prices Parallel to this development from 22 onwards also battery investments are rising Wind on- and offshore with relative stable investment flows Stable grid investments of about 7.5 bn p.a. First years characterised by high CHP investments, mainly from private investors Building energy retrofit particularly attractive in the first years due to low interest rate environment Biomass and biogas quickly become unattractive due to shrinking IRRs * Source for pages 17-18: University Duisburg-Essen, Prof. C. Weber und Prof. R. Kiesel. Project with RWE AG. RWE AG 3/5/214 PAGE 3

Three essential elements to the supply 1. Affordability the commodity (kwh) and service level must be delivered at lowest cost Use lowest cost fuels consistent with meeting EU carbon targets and most efficient plants Make use of existing thermal plants to provide service element 2. Supply-security Achieved by the round-the-clock availability of conventional plants and their increasing flexibility Also by introduction of further flexibility along delivery chain smart grids, smart meters etc 3. Carbon reduction Controlled by Emissions Trading Scheme ensures targets are met Achieved by combination of renewables and fuel-switching RWE AG 3/5/214 PAGE 31

The integration of renewables will require a much higher service component Indication of the role for thermal plants in August 222 GW 8 Almost no thermal plant contribution Some 2-3 GW contribution Demand PV 6 Thermal plants Water 4 2 Wind Onshore/Offshore Biomass Mo Tu We Th Fr Sa Su Wind and PV will become the basis for power supply; the remaining plants will optimise themselves around this supply Most thermal plants will be only needed in the future at times of low wind / sun there will be no longer base-load plants Source: Agora Energiewende (12 Thesen zur Energiewende, 212) RWE AG 3/5/214 PAGE 32

Where are the utilities going? Shifting from kwh production to even higher emphasis on service Less conventional production (indicative figures) More effort on service Qualititive Index vs. 21 TWh 7 6 5 4 3 2 1 RES - other Therm - other RES - utilities Therm - utilities 14 12 1 8 6 4 2 Retail Network Trading Ren. firm capacity Therm. flexibility Therm. firm capacity 27 213* 22* 235* 27 213 22 23 RES. = renewables, Therm. = conventional thermal plants RWE AG 3/5/214 PAGE 33

Critical mismatch between cost-structure and price structure potential death of market approach RWE AG 3/5/214 PAGE 35

So what is the solution so that predictable economics come back into play? RWE AG 3/5/214 PAGE 36

THANK YOU VERY MUCH FOR YOUR ATTENTION. Graham.Weale@RWE.com + 49 21 17 17471 or + 49 162 254 4846 RWE AG 3/5/214 PAGE 37