This is the second in a series of articles by Tim Buckley, portfolio manager at ArkX Investment Management, looking at global clean energy leaders.
In countries such as China and Germany, huge investments are being made to transform these world leading economies so as to best position them for a low carbon future. The benefits of improved energy security, stronger trade balances, growth in employment, technology and industry leadership, not to ignore the associated environmental gains, are increasingly evident. Following on from our review of new Chinese developments, it is timely to review recent advances in the German green economy. Many are world leading and their implications for the global economy in the next few decades should not be underestimated.
The German Government set the scene for its move into reducing its exposure to fossil fuels with a law first introduced in 2000 called the Renewable Energy Sources Act. Having stimulated a number of new clean energy industries, Germany has made enormous progress subsequently towards these ambitious targets. This Act sets a requirement for 35-40% of renewable energy in electricity supply by 2020, not less than 50% by 2030 and 80% by 2050. This Act was updated in July 2011 with new tariffs for renewable energy to take effect from 1 January 2012 (for more detail, see here).
Chancellor Angela Merkel is in our mind a visionary and altruistic world leader, particularly when it comes to cutting Germany’s legacy of fossil fuel and nuclear dependency. We don’t make this comment lightly. Chancellor Merkel has committed the German people to a €8 billion annual renewable energy charge that is rapidly escalating. Post the Fukushima disaster in Japan in 2011, Chancellor Merkel committed to the total closure of the entire German nuclear energy capacity by 2022. With 20.3 gigawatts (GW) of nuclear capacity operating prior to Fukushima, Germany’s nuclear footprint was one of the world’s largest. However, with most of this built in the period 1975-1985, the 25-35 year age of these plants meant that massive capital expenditures would be need to introduce the latest technologies and safety features. Consequently Merkel viewed this capital as being better spent on renewable energies to ensure greater energy security for Germany in the longer term.
To facilitate this change, Germany has created a regulatory environment conducive to the development of renewable energy. Not withstanding the GFC, this has Germany undertake renewable energy capital investments of over €20 billion annually over the period 2009-2011. While much of the funding has been provided under long term asset finance from German banks, led by the state owned KfW Group, this has been facilitated by a guaranteed structure of long term power purchase agreements at fixed long term feed-in-tariffs. The government has provided the regulatory TLC (transparency, longevity and certainty) and private industry and finance have stepped up. The grid operators are bound by law to provide grid infrastructure and access to facilitate renewable energy.
What drives the political will to transform the Germany power industry?
1. Clearly a major motivator is the understandable fear of nuclear disasters. Having a wind turbine on the horizon is nothing compared to having a 35 year old nuclear reactor in a similar location.
2. Energy security is also paramount to the Germany economy. Russia alone supplies some 35% of Germany’s oil and natural gas, and 80% of this gas comes via a pipeline across the Ukraine. Russia stopped supplying gas to the EU on 1 January 2006. As a consequence, Germany clearly understands its reliance on imported fossil fuels is a strategic risk and a drain on the country’s trade balance. In 2010 Germany sourced 16.8% of its electricity from renewable energy sources (102 billion kWh, +8% growth vs 2009), putting it well on track to deliver its target of over 35% by 2020.
3. As a result of the high cost of importing fossil fuels, Germany has a wholesale price of electricity of around €50MWh (excluding both the price of carbon emissions and the cost of renewable energy imposts on consumers), double the A$30/MWh wholesale price in Australia in 2011. Only a year ago (prior to this latest financial turmoil), German power prices were forecast to rise to €60-65MWh by 2013 (A$90/MWh at 2010 exchange rates).
4. Employment and industry – Germany has some 367,000 people employed directly in the renewable energy sector and is home to world leading renewable energy companies such as Wacker Chemie, SMA Solar and Siemens.
5. Climate change – Germany has led Europe’s push to address the issues of carbon emissions’ pollution.
Germany is very active in hydro, biomass and energy-from-waste renewable energy. Here, however, we will focus on solar and wind developments.
Solar Capacity – 50 GW by 2020?
Germany has underwritten the global solar industry expansion for the last decade. This was never more evident that on the 9 January 2012 when the Bundesnetzagentur federal network agency reported that 7.5 GW of solar capacity was installed in the 2011 year, representing 28% of all solar installed globally. This was the most solar installed by any country ever in a single year, and is the second consecutive year Germany has done this (having set the previous record with 7.4 GW installed in 2010, 40% of the world’s total). The German government set a target of 42GW of installed solar capacity by 2020. We believe this target will be well exceeded, and forecast over 50 GW by this date. Even this means that the German installation rate will decline by 40% in 2012 to 4.5 GW and then a further 35% to 3.0 GW pa thereafter. The German government has set a solar installation target of 3 GW pa through to 2020.
Germany’s mandated 20 year solar feed-in-tariff fell by 15% from 1 January 2012 and is on-track for a further 9-15% cut from July 2012 (although we expect this second cut will be brought forward by three months to April 2012 given the massive 60% decline in solar module prices over 2011). This will put the German Feed-in-tariff at €0.23-26/kWh in the second half of 2012, below grid parity at the German retail customer level (€0.25-27/kWh). And this is despite Germany’s limited solar radiation rates that translate into solar capacity utilisation rates of 9-10% versus up to 24% in central and northern Australia. With retail grid-parity likely to be achieved this year in Germany, the feed-in-tariff subsidy structure is likely to phased out entirely well before the original 2018 target set by the German government.
Onshore Wind Farms – 38 GW by 2020?
The total capacity of German onshore wind farm operating by the end of 2011 was 29 GW, 30% of all wind farms operational in the European Union. To put this in an Australian context, this is 1,200% greater than the wind farms currently operational in Australia. Our total onshore wind farm additions in 2011 were some 1.8 GW, in line with Germany’s last three years average. We estimate Germany will have over 38 GW of on-shore wind farms operational by 2020, although the German Wind Energy Association is more optimistic in its forecast of 45 GW by 2020. By 2015 ‘repowering’ (replacing and upgrading smaller, old turbines installed over 15 years previously) will become a major opportunity for further growth. Repowering could add 5-10 GW of additional onshore wind capacity by 2020.
Offshore Wind Farms – 10 GW by 2020?
Germany ranks alongside China and the UK in leading the development of off-shore wind resources. Given offshore wind technologies are being developed at 5-7 MW per turbine (vs 1.5-3.0 MW for onshore turbines), and offshore wind turbine utilization rates of 35-45% are materially higher than the 25-35% experienced on-shore, Germany is leading the world in its push into this newly emerging and highly scalable renewables category. Extreme weather and high installation costs are likely to be overcome with further technology development and economies of scale. Germany is targeting 10 GW of off-shore wind by 2020.
In 2011 Germany was second only to the UK in offshore wind installs, commissioning 108 MW of wind farms in the Baltic and North Seas. This more than doubled Germany’s cumulative capacity to 200 MW by year end 2011. By comparison the UK installed 752 MW, taking the its cumulative capacity to 2.1 GW. In June 2010 Siemens AG and ABB Ltd won billion dollar contracts to install off-shore grid connections for a further 1.2 GW of additional wind farms. Despite a slow start, we believe Germany is well on track to get close to its offshore wind target of 10 GW by 2020.
Siemens has invested a huge part of its €3.7bn annual Research and Development spend in fields associated with offshore wind farms. Siemens not only provides the on and off shore grid technologies and HVDC cabling installation expertise, but Siemens is also the world leading supplier of offshore wind turbines. In 2011 Siemens had a 51% market share across European offshore wind farms, with Vestas at 39%, the only other supplier of any size as yet.
Three German government initiatives are underpinning the ramp-up of offshore wind. Firstly, Transpower, the transmission system operator for the German regions bordering the North Sea, is legally obligated to provide grid connections to all offshore wind developments approved by the government. Second, the Renewable Energy Sources Act (2011) provides a 25% higher starter bonus for offshore wind farms feed-in-tariff (set at €0.19/kWh for 8 years, then falling back to €0.15/kWh for a further 12 years). Third, the government owned development bank KfW Group was tasked by the German government in August 2011 to provide €5bn of financing for off-shore wind farms. An interesting test-case for the Australian Clean Energy Finance Corp! The KfW Group is expected to undertake over €100bn of financing for renewable energy and energy efficiency projects over 2010-2015.
The transformation of the Germany economy
We estimate that by 2020, Germany will have 180 GW of electricity capacity operational vs 156 GW in 2008. Nuclear capacity will more than halve to some 9 GW by 2020 relative to 20 GW in 2008 (on track for the final exit by 2022). Wind farms will represent some 46 GW (8-10 GW offshore and 38 GW onshore) or 25% of Germany’s total electricity capacity, vs 24 GW installed in 2008. Solar PV capacity of 50 GW (vs only 6 GW in 2008) will represent 28% of nameplate capacity. Hydro, biomass and waste-from-Energy will all also continue to make major contributions. This leaves the collective coal, oil and gas fired capacity at some 50 GW by 2020, down 40% from the 80 GW of capacity operational in 2008. We note utilisation rates apply for different technologies, blurring this comparison. Energy efficiency initiatives also play a key role in largely offsetting the continued economic growth of Germany in this period.
One final point. Once grid parity is achieved in wind and solar energy generation, technology innovation won’t then cease. If anything, the resulting surge in installations globally will drive further economies of scale and further installed cost deflation. When a wind or solar farm is installed, the costs are fixed up front, with operating profit margins of 80-90%. The constant electricity price inflation that is feared may not eventuate – the input cost of the wind and sun is constant. Both the oil and coal price have soared in the last decade, so perhaps Germany is looking out a decade and realizing a low carbon economic model may be a hedge against energy inflation?
Tim Buckley is a Portfolio Manager at Arkx Investment Management
Arkx Investment Management focuses its investment approach on a portfolio of high conviction stocks in the listed global clean energy universe. It looks for proven performers with world leading technologies backed by strong balance sheets and priced on sensible valuation metrics. We have investments in some of the companies mentioned (ABB Ltd, Siemens AG, Vestas, Wacker Chemie and SMA Solar).