Impacts of German energy policies on the competitiveness of national energy intensive industries

The aim of this paper is to assess the impacts of German energy policies on the competitiveness of national energy intensive industries. The basic idea behind our analysis is that energy policies in Germany create a certain electricity market structure resulting in a certain electricity price, which is a major determinant for the competitiveness of energy intensive industries (e.g. chemicals, paper, aluminum, iron and steel) as energy and electricity constitute a large share in manufacturing costs. The electricity price is the outcome of supply and demand decisions of producers and consumers, with a major supply determinant being the electricity generation technology portfolio. Suboptimal investments within this portfolio are supposed to raise the electricity price and deteriorate the competitiveness of German energy intensive industries. As competitiveness is a relative concept and all world regions are connected via trade, especially in manufacturing, competitiveness occurrences in Germany have direct implications for the competitiveness of energy intensive industries in other European countries, China or the U.S. Our analysis has been motivated by the current discussion about future investment needs of large gas power plants in Germany. Currently, they are crowded out of the electricity market by extensive renewable energy promotion under the German renewable energy law (EEG). This phenomenon is known as the merit-order-effect (Sensfuß et al., 2008). Though, this kind of substitution between electricity generation technologies is in part a desired outcome of that energy and climate policy. But this instant potentially affects the security-of-supply-goal of German and European energy policy, particularly in periods with a low feed-in of renewable energies (high residual load). Gas power plants, like gas turbine or combined cycle gas turbine (CCGT) plants, are essentially employed in periods with a high residual load, because they are the most flexible in terms of adjusting power level (load-following), which is a valuable feature in times of fluctuating wind and solar power. However, gas power plants typically exhibit the highest marginal costs of non-renewable power plants. This poses the question whether the current energy-only market works correctly or not, i.e. whether the electricity price reflects scarcity of peak-load or load-following capacities sufficiently. If it does, investments in gas power plants are redundant, even in periods with a high residual load. If not, the marginal cost based price would be too low to cover the high investment costs (“missing money” problem). Scarcity could lead to temporary price spikes or even blackouts, if grid restrictions rule out electricity imports from other areas. In that case other mechanisms, such as capacity markets, would be needed to also remunerate capacity provision for peak-load or load-following capacities (cf. Finon & Pignon, 2008). In addition, more and more electricity generation takes place in a decentralized manner. Combined heat and power (CHP) plants and self-supply of industry could reduce the need for large gas power plants. It is not clear what this trend means for the average electricity price. In general, large centralized power plants exhibit lower unit costs of electricity generation compared to distributed generation, owing to economies of scale and higher efficiencies. Nevertheless, we are not following the discussion on this kind of issues here. Rather, we take them as a starting point for our analysis and hypothesize that there is underinvestment of large gas power plants. We ask how this specific energy policy situation in Germany affects the average electricity price and how this consequently impacts on the competitiveness of the energy intensive industries in Germany. This is a central question, because manufacturing has become an important determinant for Germany’s recent macroeconomic resilience. Consequently, there is a discussion whether energy intensive industries should be exempted from certain policies in order not to harm their competitiveness. Besides, energy intensive industries also manufacture substantial components for renewable energy technologies (e.g. steel for wind turbines). Evidence on the significance of energy costs for the placement of manufacturing facilities is also given by recent shale gas and oil discoveries in the U.S. and subsequent energy price falls, which have attracted U.S. companies to move their international manufacturing operations back to the U.S. (The Economist, 2013). In a globalized economy, changes of national competitiveness will affect other countries’ competitiveness. We therefore ask who benefits most from the occurring competitiveness shifts and which of the energy intensive sectors is especially affected. For our global economic analysis, a worldwide macroeconomic model is needed, which represents a closed circular flow of income. Therefore we use the NEWAGE model from IER Stuttgart, which is a global multi-sector computable general equilibrium (CGE) model with a detailed representation of the energy sector and disaggregated electricity generation technologies. Due to the total analytical framework of the general equilibrium approach, the interaction of actors on markets of the economy is described in a closed circular flow of income. This allows capturing both direct effects in individual sectors (e.g. electricity) as well as indirect effects (feedback effects) across the economy that are caused by price-induced supply and demand shifts in response to any political intervention. The basic assumption of the general equilibrium approach is perfect competition on all factor and goods markets. Firms buy production factors and sell goods following cost minimization. Consumers buy these goods using their income from selling the production factors following utility maximization. The government imposes taxes and grants subsidies following guidance and fiscal objectives. The equilibrium system is solved for the variables prices, production levels and income. The NEWAGE model is based on the GTAP database and maps the global economy into 10 countries/regions and 16 sectors. The production of goods in the 16 sectors is modeled with CES (constant elasticity of substitution) production functions, where output is produced as a combination of the input factors capital, labor, energy and materials. The degree to which inputs can be substituted for each other is determined by the respective elasticities of substitution, which are based on technical assumptions or taken from the literature. CO2 allowances are an additional input if fossil fuels are used. The assumption of perfect competition may be waived in special markets, as is done for the labor market in NEWAGE to reflect imbalances existing on real labor markets. Therefore, the model considers unemployment, wage rigidities and different grades of labor qualifications (skilled, unskilled). The dynamic approach is recursive-dynamic applying 5-year milestones from 2010 to 2030. Competitiveness can be measured by different indicators, such as trade balance or trade volume per sector and country, or more complex concepts, such as the Relative World Trade Share (RWS) or the Revealed Comparative Advantage (RCA) (see Klepper & Peterson, 2008). The RWTS relates the share of national exports and world exports of a sector to the share of total national and total world exports. The RCA relates the national terms-of-trade of one sector to the total national terms-of-trade. The changes in these indicators reflect the production shifts as a result of changes in the input cost structure of the energy intensive industries, i.e. their competitiveness. For analyzing the impacts of possible underinvestment of large gas power plants on the electricity price in Germany and the competitiveness of national energy intensive industries we conduct scenario analysis in a two-stage approach: 1) Effects of underinvestment in large gas power plants on the electricity price (average price) 2) Effects of electricity price changes on sectoral and national competitiveness of energy intensive industries The first step is to fix the production from new gas power plants to the value of 2010, meaning that there are no further investments than already in place. Then we assess the implications of this constraint for the German electricity price and, as a second step, assess the implications of the electricity price change for the competitiveness of the energy intensive industries in Germany and worldwide. We evaluate these experiments against a reference scenario from 2010 to 2030 where moderate gas power investments still occur, even though there is renewable energy promotion via feed-in tariffs. We calculate impacts for all of the above mentioned competitiveness indicators to check for robustness. The effects are measured in a relative manner, which enables us to control for the arbitrary assumptions of the reference scenario and isolate competitiveness effects. This means that we conduct our analysis producing relative, not absolute results regarding physical or monetary units. Within the general equilibrium approach we are able to capture global adjustment processes responding to the impulse of single sectoral or national policy interventions. Our results indicate which countries in the world profit from these energy constraints in Germany, and which of the energy intensive sectors is particularly affected.