German experience shows that balancing the energy trilemma is no easy business

In order to achieve an energy transition, policymakers must set the right framework towards a free and efficient electricity market, argues the latest WEC Germany report, “Energy for Germany 2012”, which analyses the risks of a highly regulated and subsidized energy market.

The German energy transition is posing unprecedented challenges to the country’s electricity market.  At the heart of the transition, Germany aims to drastically increase the share of renewable energy such as wind, solar and biomass in the energy supply. This was set out in the Renewable Energy Sources Act (Erneuerbare Energien Gesetz, or EEG, in German) of 2000, which requires 45% of energy supply to come from renewables by 2050.  The target was revised up, to 80%, in January 2012, following Germany’s decision to quit nuclear power.

The energy transition raises new questions about government regulation of the power supply. Given the target to expand renewable energy is driven by policy rather than the market, government intervention would naturally play a greater role in determining a country’s electricity supply. However, this reduces market efficiency and competitiveness in the electricity sector.

The German market had seen increasing competitiveness by the late 1990s.  But since the introduction of the EEG in 2000, there has been growing government intervention in the form of subsidies and fixed energy pricing (see figure below).  The EEG is behind most of the electricity produced from renewable sources today. The law lies outside free market mechanisms, and this has reduced competitiveness.

Rather than encouraging competition for innovative, efficient and inexpensive technologies, this forces the sector to vie for subsidies for certain technologies. This creates a significant price burden for households and companies, and in particular for the energy-intensive industry.

A well-functioning price mechanism is the decisive basis for a market economy. Policymakers must set a framework towards a free and efficient electricity market, rather than a regulated economy.