Tough times for European utilities may have a lesson for the US

Europe has taken renewable energy generation further and faster than any other region of the world in terms of system penetration, and now appears to be heading into a maelstrom. Where Europe falls, others will follow. Perversely, the impacts of the successful build out of low carbon generation could put at risk the consensus behind climate change mitigation policies. US utilities should take note: never before has the need for international comparison been so pressing. Ross McCracken discusses this issue in a story that appears in this month’s edition of Platts Energy Economist. 

There has been talk in the United States of the utility “death spiral,” a process in which environmentally-targeted subsidy support enables consumers to disengage, partially if not wholly, from the electricity grid through demand-side management and distributed generation. Utilities, required to invest to incorporate renewables into a centralized system, are left in an unsustainable situation of higher embedded costs and fewer customers.

This talk may not, in fact, be overblown. Europe is way ahead on renewables and evidence suggests its utilities may be travelling further and faster down their own tunnel of doom — a more developed and advanced version of the death spiral. Although different in as many aspects as they are similar, the European experience is highly relevant to what the US has in store.

One example is negative electricity prices, resulting from a buildout of wind. Denmark, the earliest developer of mass wind generation got there first, but Ercot West in Texas wasn’t far behind.

In June, negative pricing took a new twist as it struck across EU borders. Wind and solar in Germany combined with cross-border market coupling to transfer the power surge into France, Belgium and Austria. In a significant but still pale imitation, the same month saw prices at the Mid-C hub in the US plummet toward zero, owing to a combination of strong hydro output and wind generation. The Old World can still do some things on a grander scale than the New.

Negative pricing is just the visible tip of the iceberg. No region in the US has the same solar PV concentration as Germany, where over 30 GW of capacity has been installed, but when they do, they too are likely to see traditional pricing relationships turned on their head. Peak demand arrives, but peak pricing is gone. Peak and baseload prices are compressed. Storage plants become uneconomic. Scarcity rents — those extreme highs in pricing on which peaking plant profits depend — decline in size and frequency, a situation known in Europe as the “missing money”.

The green dream in Europe has meant the addition of massive variable generating capacity to zero-growth markets. The upshot is that existing investment in thermal plants can no longer survive. The death spiral is a mere cold by comparison. European utilities that have invested millions if not billions of euros in conventional generating stock are having their bottom line cut from under them.

According to consultancy Capgemini’s recent European Energy Observatory report, average gas-fired plant utilization rates dropped to 11% in Spain in first-half 2013 and to less than 21% in Germany in 2012. The International Energy Agency says gas plants need a utilization rate of 57% to be profitable. About 130 GW of gas-fired generation capacity across Europe — equivalent to around 60% of total installed gas-fired generation in the region–is currently not recovering its fixed costs and is at risk of closure by 2016, Capgemini said, citing IHS estimates.

And, as in the US, public opposition to coal is strong and the regulatory headwinds fierce. Only Europe is again ahead of the game. As a result primarily of the EU’s Large Combustion Plant Directive, coal-fired generation capacity in Europe is expected to fall sharply. Goldman Sachs estimates a net loss in EU coal plant capacity of 20 GW by 2015, the deadline by which opted out plant must have used their allotted hours of operation (many will have used them up before then).

These developments are really coming home to roost. German utility RWE forecast in November that its profits would be cut almost in half next year by the depressed state of wholesale electricity prices. It will sack 10% of its staff. Chief Executive Office Peter Terium was reported to have described the company as “passing through a vale of tears”, a more poetic but nonetheless analogous process to the death spiral.

It is a topsy-turvy situation. The mothballing and closure of conventional generation plants will eventually drive up wholesale prices, while there will be a big shift in the operational characteristics of the generation fleet as a whole towards intermittency. With environmental levies for renewables subsidies rising in line with the ongoing build-out, consumers will be hit with both higher prices and a decline in reliability. If anything could break the consensus on climate change policy it would be this.

Only a few months ago, the heads of Europe’s major utilities got together to warn that Europe was heading toward black outs. Such is the distrust of big industry that this was taken as an expression of self-interest. But they have a point. The uncontrolled build out of renewables is having radical impacts in Europe. The US stockpile of cheap natural gas notwithstanding, if America’s utilities want a vision of Christmas-yet-to-come, they have only to look across the Atlantic.

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