Germany to activate supply reserve “as soon as possible” – power mix and emissions impact

Following a cut in flows of natural gas from Russia to Europe, Germany will bring coal, lignite, and oil-fired reserve plants into service as soon as mid-July to prioritise gas storage injections over the summer.

ICIS modelling has found that the 10GW supply reserve could take as much as 5-6 billion cubic metres (bcm) of gas out of Germany’s power mix in coming years, were the activation window extended and gas rendered uncompetitive with a financial penalty. A less aggressive scenario in which the supply reserve operates according to normal market conditions would see under 2bcm cut from German gas demand annually, similar to modelling results when the law was first mooted.

German power sector carbon emissions would rise by as much as 20% in 2023. Total European carbon emissions would rise by 4-5% annually, relative to a scenario in which the supply reserve remains deactivated.

Background

Germany and other European countries have begun to diversify away from Russian imports including energy following the invasion of Ukraine in February.

This process will take several years, with Germany relying on Russian gas particularly heavily.

In recent months, the German cabinet has advanced plans to cut gas demand from the power sector in a winter emergency using a supply reserve of coal, lignite and oil plants (analysed by us most recently here).

A drop in flows through the Nord Stream pipeline has rather front run this planning. Initially buyers cancelled some contracts following Russian demands for payment in Roubles, then most recently Gazprom blamed technical issues due to equipment shortages under the sanctions regime. As of this week starting 20 June, the line is flowing just 66mcm/day, around 100mcm/day below capacity. German economy and energy minister Robert Habeck called the flow drop a “political decision.”

Latest developments and analysis

On Sunday 19 June, Habeck announced in a press release plans to activate Germany’s 10GW supply reserve of non-gas-fired capacity as soon as parliament passes the corresponding law in mid-July.

The law’s drafting envisioned only activating the reserve from October in the event of declaring a gas emergency, so this is a major deviation from the plan.

That said, the immediate impact this summer may be lower than the 10GW headline figure would suggest.

Coal plants set for retirement will remain active in the market, but this would have been the case anyway this summer for any plant scheduled to retire in 2023 or 2024.

The 2GW lignite or security reserve plants were to have until 1 October to prepare for their admission into the supply reserve. This could imply a lack of operational readiness for capacity that previously required 10 days of notice to act as the very last line of defence against a market failure, something never previously requested. On the other hand, these plants would generally not be expected to provide emergency backup during the lower-demand summer period.

The latest draft of the law before Sunday also stated that a financial penalty would render Germany’s gas-fired capacity uneconomical following an emergency declaration. Sunday’s press release appears to row this back, stating that the latest price developments are already squeezing gas out of the market.

Another key point that did not make it into the press release is mention of the time window that the supply reserve could be active for, which in the draft law was set at a maximum six months.

In theory, the July activation could put the supply reserve on the clock, with the plants obliged to leave the market again six months later in January 2023.

More likely, Habeck and the government are giving themselves flexibility to extend the mechanism for longer if conditions dictate, with the environmental considerations that prompted proposing a window on the back burner in an energy crisis.

Other measures to reserve gas announced by Habeck include:

• Setting up industrial demand-side management for gas if tightness emerges
• Providing German market area manager THE credit to secure gas for storage
• Helping energy traders with margin payments
• Legislating gas storage fullness levels (e.g. 90% by 1 November)
• Securing floating storage and regasification units (FSRUs) so that Germany can import LNG, although this may not be possible at scale for some time
• Bailing out Gazprom Germania and ensuring the storage sites it owns in Germany are filled

Model set up

We matched the three components of the supply reserve (retiring coal plants, grid reserve, lignite / security reserve) with plant capacity blocks in our long-term power model and took fuel price inputs from our last carbon model run on 8 June.

We then ran three scenarios for 2023 and 2024 in our modelling:

• Base: Germany’s coal phase-out schedule proceeds as agreed last year, and other parts of the supply reserve remain offline
• Supply reserve: we add the additional coal (7-8GW), lignite (2GW) and oil (1GW) capacity to the full calendar years 2023 and 2024
• Supply reserve with gas penalty: we model the additional capacity and further set the German gas price to €150/MWh to knock gas-fired plants down the merit order in Germany only

German generation and gas impact

Activating the reserve would see a combined 43TWh more coal and lignite generation next year in Germany than in our base scenario, and 30TWh in 2024.

This would remove 10TWh (roughly 2bcm) of German gas generation in 2023 and 8TWh in 2024.

Adding the penalty would significantly dent German gas-fired output by a total of around 30TWh (6bcm) each year relative to base.

Oil-fired output actually drops by 2TWh with the supply reserve, suggesting that currently active oil capacity moves down in the merit order below activated lignite and coal. The gas penalty would reverse this to a 1TWh rise relative to base, as gas-oil switching takes place.

In 2023, the gas penalty would not increase lignite generation further, with unretired plants already running close to maximum capacity in normal market conditions. Even German coal generation would rise by less than 2TWh further than just activating the supply reserve.

Europe generation and gas impact

A ceiling for coal ramp up in Germany is due to gas-fired power imported from neighbouring markets, which without a penalty remain in front of some German coal capacity in the merit order.

The impact on gas generation is nevertheless greater in neighbouring markets than in Germany, as cheap lignite and some more-efficient coal replace pricy imports. The supply reserve would hit this by 34TWh (6.5bcm) Europe-wide in 2023 and 25TWh (5bcm) in 2024. Adding the gas penalty lifts this to around 40TWh or 7bcm in both years, but the additional savings are made in Germany.

Emissions

With more-carbon-intensive coal and lignite running, German power-sector carbon emissions would rise by an incredible 20% in 2023 and 17% in 2024 in the supply reserve scenario. These are unrepresentative figures though, as the supply reserve is partly replacing imports of coal and gas-fired generation from neighbouring markets.

Europe-wide, the reserve would increase emissions by around 4% in both years, rising toward 5% with an additional gas penalty.

Market impact

Isolating the supply reserve, the impact is actually bearish for power. Germany is adding market capacity, and fuel-switch ratios favour coal and lignite over gas.

Taking the current Russia gas flow rate as a given, the impact of activating the reserve is also bearish, as this lowers gas demand, which is generally the marginal pricing fuel.

Of course these things do not happen in a vacuum, and the current market and political backdrop is very bullish and precarious, with significant potential for further developments and escalation.

It is worth caveating that we have not run the carbon model in a dynamic loop. Had we done so, the higher emissions would increase carbon prices, which would at least partially work to help increase the competitiveness of gas on the market.