Tip of the Eisberg

Some German energy retailers went under last year, but many more could follow suit in 2022 as the consequences of soaring prices and poor hedging strategies become clear.

Listen to a discussion about whether the existing marginal pricing model is fit for purpose, particularly as renewable energy capacity ramps up and nuclear and coal are phased out. Plus, how will the new German government cope with a potential supply crunch.

Guest:

• Tobias Federico, Managing Director, Energy Brainpool

Transcript

Richard Sverrisson, Editor-in-Chief, Montel: 0:05

Hello listeners and welcome to the Montel Weekly Podcast, bring You Energy Matters in an informal setting as is now tradition in the first part of the year, we speak to Tobias Federico, owner and managing director of Berlin based analy analysis firm and consultancy Energy Brain Pool. Tobias has decades of experience covering energy wholesale markets, and his insights and analysis are always worth listening to. So a warm welcome to you, Tobias.

Tobias Federico, Managing Director, Energy Brainpool: 0:31

Thank you, Richard.

Richard Sverrisson, Editor-in-Chief, Montel: 0:32

How's life in Berlin?

Tobias Federico, Managing Director, Energy Brainpool: 0:34

Actually today we have a really sunny day. New Year was really warm and wet. Which was good also for the electricity prices and New Year. And on Christmas we had actually some snowflakes, which was really nice.

Richard Sverrisson, Editor-in-Chief, Montel: 0:46

Ah, perfect. And how about Omicron? Has that hit in a big way yet?

Tobias Federico, Managing Director, Energy Brainpool: 0:50

Not yet. I think we are not measuring correctly right now, so we don't really know how much Omicron is there, but we do expect quite a big hit in the next weeks.

Richard Sverrisson, Editor-in-Chief, Montel: 1:01

In this week's pod I plan to discuss the current energy crisis as it's been dubbed as, as well as the latest developments in Germany. But let's start off by briefly talking about these unprecedented high prices. Tobi, is it all about gas?

Tobias Federico, Managing Director, Energy Brainpool: 1:15

Not really. I think gas is the main price driver? Absolutely. Starting from the storage levels, which have been quite low in summertime. Plus the political parameters around gas, especially North Stream two. In combination of course with the gas deliveries over the gas pipelines. But we also had an issue regarding the CO2 emission prices because they also jumped quite a lot especially after the UN co meeting in Glasgow. So it's not all about gas, but I think gas was one of the initiators, especially here in Europe.

Richard Sverrisson, Editor-in-Chief, Montel: 1:50

Let's talk about the other factors as well. In the past you've been very vocal about the potential for a supply crunch in the winter of 2022. Is that still your view here? To be honest actually

Tobias Federico, Managing Director, Energy Brainpool: 2:01

I was thinking about that, especially when you do some price forecast and scenario building, and what we have expected is a potential capacity crunch due to missing production capacities. What we have not expected. Is that we are missing out of fuel. This was not part of our scenarios and our scenario thinking, Still we do have a situation. We might postpone it for the next winter. It depends a little bit now how the winter is going to continue, especially temperature wise. So the data plays a very important role, but still we have both. I think we, we have the issue of missing fuel and we are having the issue of a missing capacity within the next years.

Richard Sverrisson, Editor-in-Chief, Montel: 2:48

So has the lack of fuels, the, the extremely high prices, both of gas and. Has that then postponed the crunch, are you're saying? Or has it made it even worse?

Tobias Federico, Managing Director, Energy Brainpool: 2:58

Postponed, not really. But I think it has made it really worse in the sense that there's one additional factor we have not been thinking about. It's not really that, of course, with fossil fuel, we have been thinking it's always there and it always will be there. We never have expected in our thoughts that. There will be a reduction in the fuel supply in one way or the other, due to several reasons.

Richard Sverrisson, Editor-in-Chief, Montel: 3:22

Could you go into those reasons? S

Tobias Federico, Managing Director, Energy Brainpool: 3:24

one, of course is there is, especially when you look into gas and Russian gas delivery, this the political connection. I don't want to speak about geopolitics in specific that's a phrase or word, which has to be used very carefully. But I think the. Potential combination of gas delivery to push political decisions seems to be quite obviously in Germany. Right now and especially with the connection to North Stream two. But when you also look into the long-term perspective, we want to phase out of coal. We are facing out of nuclear energy in Germany. We want to phase out also of gas, maybe one day to switch from natural gas to hydrogen. So how is your thinking when you are one of the biggest gas producers in the world and deliver 40% of the gas to Europe? What's your long-term perspective on that, especially when you have invested billions into pipelines? So I think we are quite clear about our goal in the end where we want to reach our gas power plant production. But we are not quite clear about how do the partners, when you do businesses, feel about it. And so the path is not really clear. The goal is clear, but the path not. Maybe this reaction, especially from Russia's side, is something which came a bit of a surprise of the severeness, of the reaction.

Richard Sverrisson, Editor-in-Chief, Montel: 4:49

Yeah. I think we'll talk a little bit about Nord Stream two later but I, it's very clear that gas is be being used as a political weapon on both sides of the debate, but. If we can go onto the energy crisis Ws, and talk a little bit about the consequences. We've seen example in the uk, 27 energy retailers going outta business. We've seen other suppliers in France and Belgium also struggling Spain. What's the situation in Germany?

Tobias Federico, Managing Director, Energy Brainpool: 5:15

I think the same, but I think it's only the tip of the iceberg, honestly, because we have, we had a few retailers who bailed out of business, at least they did not claim bankruptcy. What they said is that they're stopping the delivery to the customers, which is a weird situation for the customers itself and also for the company. The biggest reason I think for this is that mostly the procurement side on the on, on the, especially very competitive on the price competitive side retailers. Was that their spot market procurement was from, the percentage was much higher than standard utilities or standard suppliers. So we had a few of them bailing out at the end of last year. Now, some of them are also stopping deliveries to the customer. But there, there is the next step. The next step is for conventional utilities, or let's say for this, for the standard suppliers, when they continue with their classical procurement strategies at current price levels, there will be also an increase of electricity prices for their old customers within this year or next year. With the consequence that this increase, assuming that we will have the same price levels we are seeing right now at least for the rest of the year, will be quite huge for the customer. So it's not only that the utilities are facing problems also that the end customers are facing problems. And what we've seen so far have been just numbers, but we haven't seen the results of the numbers in the cash flows of the companies. And that's something we are going to see this year and this might cause quite a lot of problems. That's why I think what we saw is adjusted tip of the aspect.

Richard Sverrisson, Editor-in-Chief, Montel: 6:53

Interesting. So you expect a spate of more bankruptcies in the months to come?

Tobias Federico, Managing Director, Energy Brainpool: 6:57

Absolutely, yeah. But not only from utility side, also from the end customer side,

Richard Sverrisson, Editor-in-Chief, Montel: 7:01

Are these companies going under due to a, due to poor hedging strategies or inadequate hedging. Or is it more complex than that

Tobias Federico, Managing Director, Energy Brainpool: 7:08

being a consulting on the hedging side and risk management side and also on the procurement side? I have to think about what I'm going to answer. The thing is, when you develop a hedging strategy, you should develop the hedging strategy for both market price developments for price increases and price decreases. And the bad hedging strategies we saw, at least in the last 20 years, have been due to the fact that. The customers have been focusing on one side, either increasing pricing or decreasing prices. I honestly must say that the current market situation is completely new to the hedging approach, and why is that? We have very high prices with a huge price volatility in absolute numbers. So we have seen price changes of 17 to 50 euro per megawatt hour in the yearly base contract, and these have been the price levels we've seen for the whole year, not in the daily change. So we have to think about whether the hedging strategies we have been used so far, or also the security levels or the margin accounts. We have been working so far the limits with other com counterparties are still adapt for the current market situation. When the market situation continues much longer. And that's really interesting. So we have to rethink a bit the hedging strategies in total. But of course, some of the players had bad hedging strategies, speaking about either buying all at one time and not buying it in tranches or having a high amount of spot delivery instead of. The future market procurement.

Richard Sverrisson, Editor-in-Chief, Montel: 8:41

It's a very interesting picture and I think, if I stick with a market design debate, do you also think, I see in some countries there is discussions about opening up or maybe reviewing the way the system or the market operates in terms of the marginal price setting. Because when you have so much renewables, due to come in over the next decade, is this really the correct way of operating the market? What's your view here, Tobi? Are we gonna see more discussion, maybe more changes?

Tobias Federico, Managing Director, Energy Brainpool: 9:10

We are going to definitely to see more discussions about it and it's always a thought or a, I think, quite good criticism about the market design of the marginal pricing that the last producing power plant will set the market price. And the second assumption is that the last setting price are the short run, marginal cost of that specific power plant. So that all the other power plants are earning quite a good income. But the last one does not. The question is just on the market design, is the market from its function really designed in a way that it refinances not only the shortterm marginal costs, but also the capital costs of that power plant. And assuming there will be only one power plant, which is price setting, and it's always the same power plant, of course this one will bail out because, and they are not refinancing their investment. So it'll stop producing and then we will have the next one and next one. But in reality, what we are seeing is that it's always a changing type of power plants, which is price setting. And the second reality we are seeing is that usually. At a certain point when we have not so much over capacity left in a certain production hour, we are leaving the idea of perfect competition in the end. And so we are moving away from the short term marginal cost and we are seeing scarcity prices. The discussion for the energy only market is whether these scarcity prices are enough to refinance a power plant, firstly and secondly. Are we going to find investors who are willing to invest in a very risky strategy into peakers? So peak power plants, which are covering the last megawatt hours and maybe earn quite a lot, but this strongly depends on the weather due to the increase of fluctuating renew plan. So I think it's worth this discussing capacity mechanisms, but it shouldn't be the first step we are doing because we have not opened the market design fully for the energy only market tool. Proof it's worthless of refinancing power plants because from the political side, when we saw price spikes, there have been either cut down or the market design on the energy only. Markets changed a little bit. I just want to say one more things about it. The current high prices. Don't or the reason for the current high prices are not capacity or missing production capacities right now, it's mostly due to fuel prices, so we should not compare one, one part of the market design to the other. The difference is that currently power plant producers are earning quite good, but not that much as if we would have scarcity.

Richard Sverrisson, Editor-in-Chief, Montel: 12:02

There's a danger here. We shouldn't be comparing apples and pears, you mean?

Tobias Federico, Managing Director, Energy Brainpool: 12:05

Yeah, right now. So we shouldn't take the current market situation and say, see, we have high prices due to the wrong market design and now we have to speak about capacity markets. We are having high prices right now due to high fuel prices and not due to the problem with the market design. But I'm quite open due to the discussion to start a discussion looking into. A rethinking of the market design. Not that's really necessary, but we have to think about it.

Richard Sverrisson, Editor-in-Chief, Montel: 12:34

So what would be the alternatives that could be on the table? Would it be some kind of contracts for different

Tobias Federico, Managing Director, Energy Brainpool: 12:40

These contract for differences could be in discussion. The question is when we also see what's happening on the long-term perspective. And we want to become net zero. In our CO2 emissions. In the end, we do need a technology which gives us the security that the capacity, production capacity is there in the case. We, we need it when we have a cold winter situation and little wind. So when renewables, and especially fluctuating renewables are not producing right now, it seems to be that this technology could be green hydrogen. Produce electricity out of green hydrogen produced by gas technology power plants. So CCG ts for example. The thing is, what we really need is something where we have the security of the capacity in the case we need it. And around that we should design a type of capacity mechanism. I think the biggest challenge is. Regardless what type of, either we speak about energy only market we speak about is CFD or we speak about capacity payments in, in, in complete different ways that we will not have an over financing, meaning that it seems to be like a subsidy system for certain technologies or those players who have the biggest lobby group and they are able to say how the market design will be to have the highest profit for them. Over financing is something we should avoid in this discussion.

Richard Sverrisson, Editor-in-Chief, Montel: 14:07

It is a political minefield. There. You've got lobby groups all over, people seeking those rents, people wanting those kind of subsidies, but you need to find exactly the right mechanism or the right markets that is suitable for those conditions. But yet know at the same time, to be honest. Do you think that once we get the supplies coming in of gas into Europe whether it's from Nord Stream two or wherever through Ukraine or. Through LNG, that this discussion will ease that, that the concerns will abate because that's not so critical anymore.

Tobias Federico, Managing Director, Energy Brainpool: 14:39

No, I think the discussion will continue, especially because the political ambitions to become net zero much earlier than expected. So the question is, how do electricity prices look like when we do have, let's say, 100% renewable or 60% renewable based on fluctuating renewables and the rest, 20% based on a hydrogen type of production. When we are having marginal pricing, what's the price of hydrogen? Is the hydrogen produced? By fluctuating renewables when they do have negative prices. So what's the cost of hydrogen? So I think the discussion around that will become very interesting especially when we look into what comes after 20, 35, 20 40, 20 47 depends on the year where we want to become net zero. Especially because we are already in the twenties when you are looking for a refinancing period. At least a technolo technological period of your production technology of 20 to 30 years. We have to think about the year 2060 right now. Not 2050 anymore, which in my mindset was not the end of everything, but at least it was the end of our scenarios.

Richard Sverrisson, Editor-in-Chief, Montel: 15:51

I think when we are talking about these changes and implementa implementing a new type of market design, it's not really gonna happen for another 10 years. Would you agree?

Tobias Federico, Managing Director, Energy Brainpool: 16:02

No, but it's even the next 10 years, or when we are speaking about the thirties and deciding about market designs right now which is going to happen then in the thirties, it affects your investment decision today.

Richard Sverrisson, Editor-in-Chief, Montel: 16:14

Of course. Moving on to a different topic to be, as Germany has a new government. What's your verdict so far? What's your view here?

Tobias Federico, Managing Director, Energy Brainpool: 16:21

The government is quite ambitious, which or what ha what has been expected looking into the energy role? Why? What is interesting that right now it seems to be that we have three or four ministries thinking about climate and of course combined with climate energy. And although I have expected that within this government we will have a clear focus on climate and fighting climate change. It's not really clear where the competencies are right now with, within the German government structures. We have to see how it's going to develop. But on the other hand, they're also facing the challenges of real politics. So when you're in opposition and you have great ideas you can talk about it. But when you are then in the reality and governing a country, then it becomes a little bit more complicated. But I think the path is clear. Somehow we must increase investment into renewables, especially fluctuating renewables. So I, I think in this way the government has the right ideas. I hope they are using the right instruments to implement that. But so far, I think their goals are quite ambitious.

Richard Sverrisson, Editor-in-Chief, Montel: 17:28

These ambitious plans, how are they gonna be financed? Is it all through, through subsidies, direct subsidies, or what's the mechanism that the government has chosen?

Tobias Federico, Managing Director, Energy Brainpool: 17:37

And that's a good thing that we have a coalition of three and one is the party of the liberals, which usually are against subsidies in general. Of course, I think subsidies will be replaced by certain type of incentives. There, there was one little finance trick where. The current government used, I think it was 60 billions out of the Corona debt package from the previous government, which has not been used for fighting the financial consequences of Corona. But the current finance minister took these 60 billions and claimed them to be invested into renewable projects or projects fighting climate change. So how they are dealing with this money. It's not really clear right now, but I think it will be not direct subsidies per produce, megawatt hour or something like that. It will be rather incentives for technological innovation and supporting this financially, at least how they're using the 60 billion euros. On. On the other hand, I think the market price development, especially for fluctuating renewables on the electricity market side supports quite a lot investments here. So that's why we might not need any more from the calculation side, but even from the political level side, the EEG fee, so the fixed fee tariff because I think current price levels are incentive enough for fluctuating renewable to be refinanced. At least from the wind onshore. Wind offshore.

Richard Sverrisson, Editor-in-Chief, Montel: 19:07

Do you think this kind of support for fluctuating renewables, could it make PPAs less attractive, for example, in Germany? Because, PPAs are booming in other parts of Europe, but could the plans for green growth in Germany threaten that growth.

Tobias Federico, Managing Director, Energy Brainpool: 19:23

No. Not threatened. I think PPAs are seen as a quite good instrument to replies to replace the fixed fee tariff. Of course, PPAs are connected with certain risks. Which are there, especially because you right now have the financial solvency of at least two counterparties, which are there either the producer on the other, the PPA taker, so that's new. But on the other hand, I think PPAs might be booming, but handling those risks is a little bit different than a, from a governmental guaranteed fixed tariff.

Richard Sverrisson, Editor-in-Chief, Montel: 19:59

Absolutely. And at the same time, you see very high wholesale prices, which, if you could perhaps persuade a bank that you don't need a PPA, just look at the wholesale prices, then maybe that's also another way around it or way to develop these types of facilities.

Tobias Federico, Managing Director, Energy Brainpool: 20:14

Not really. Because banks are really risk averse which is good because they're, they have their financial investments for 10, 15 years and this price bubble, which lasts only for just a little and might last for a year or two years, is definitely not enough for a bank to give a loan on that. It's too short.

Richard Sverrisson, Editor-in-Chief, Montel: 20:35

Absolutely. And also if you are building on the base of this, the bubble as you say, may have burst by the time it's all up and running. Finally, Tobias, Nord Stream two. Has this been a bit of an embarrassment for the German government do you think?

Tobias Federico, Managing Director, Energy Brainpool: 20:48

Not an embarrassment, but as a, as you can see here, it's, I think my personal opinion is that dealing with Nord Stream two anti-political consequences, also geopolitical consequences. It's a very high game, and playing this game is not so easy. And I think the German government, either the government before and the current one is not so used in playing these geopolitical games because geopolitical games have been played outside of Europe, even outside of Germany. And now in being the center of this it's really complicated. So embarrassing, not, it was a time delay. And we do have complete different opinions about Nord Stream two. First, of course, we have the direct consequences of direct gas delivery from Russia to Germany and Germany becoming the gas hub of Europe. There starts the first misunderstanding because most of the parts of the population think that Nord Stream two is gas delivery just for Germany. Which is not true because it's a gas delivery for all over Europe.'cause North Stream one and North Stream two together, they easily can supply at 100% Germany, which is not wanted and not really needed. So Germany will become a gas. The second consequences are of course that what's the role of Russia or the, let's say the new Russia within the world landscape. It seems to be that Putin has now. Complete different view of what has happened, especially when the Soviet Union did break down and this scattering of smaller states around Russia. It's something which obviously in, in this new posture of it, thinking of Putin disturbs quite a lot, especially having a buffer zone between Moscow and Europe. For whatever reason he thinks he needs that. I think in the long term history of Russia, this was always an issue. When you look back to. 300 years having a bigger buffer zone between Moscow and Europe and or at least saying between NATO players and Moscow is necessary to have. So that combination came into the whole discussion regarding Nordstrom too, and that's really high politics and it's difficult. And also then having a individual role looking into the different political parties. With having a friendship or not with Russia, when you look into North Stream one and which has been initiated by Gerda from the SPD and SPD now also is having the chancellor right now in Germany. So it's it's a heritage. They have to struggle a little bit with. So it's let's say it's complicated as to speak in a relationship.

Richard Sverrisson, Editor-in-Chief, Montel: 23:28

Absolutely. Not so much an embarrassment maybe, but they've been thrust into kind of this very high focus and high octane, but also very tricky diplomatic kind of balance here, haven't they? I think

Tobias Federico, Managing Director, Energy Brainpool: 23:40

Absolutely. Absolutely. So playing this game and on a diplomatic floor with. Economic interests and combining that it's very thin eyes, as we say in Germany.

Richard Sverrisson, Editor-in-Chief, Montel: 23:50

So Tobias, thank you very much for, joining the Montel Weekly podcast. It's always a pleasure to have you on board.

Tobias Federico, Managing Director, Energy Brainpool: 23:56

It's always a pleasure for me. Thank you, Richard.

Richard Sverrisson, Editor-in-Chief, Montel: 23:58

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