Driven by low electricity prices and overcapacity, orders for power generating equipment in Germany are approaching an all-time low. What does the future hold for the German power market?

Recent analysis carried out by international market consultancy Frost & Sullivan has shown that the market for power plant construction in Germany has fallen to its lowest level in 15 years. Driven by a combination of overcapacity and the recent liberalization of the power market, investment in new capacity and replacement capacity is almost at a standstill.

According to Klaus Huhn, Industry Analyst with Frost & Sullivan, revenues in this market over the last five years (equivalent to orders taken over the last eight years) have stagnated at approximately a1.5 billion per year. Most of this investment has been in large coal fired power plants and is equivalent to around 1500-1700 MW per year on average. As orders have not picked up over the past two years, says Huhn, revenues will decline or remain stagnant until 2003.

Figure 1. German genset sales, 2000
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One of the causes of this decline in orders is an overcapacity in the German generation market, according to Frost & Sullivan. The current estimated level of overcapacity in Germany is 10 GW. However, while overcapacity can be an issue in regulated markets, it is much less so in a liberalized environment.

“It is difficult to interpret overcapacity, particularly in a liberalized market,” said Huhn. Prior to deregulation, despatch involved matching demand and supply, and ensuring that spinning reserves were adequate. In a liberalized market, capacity is used in different ways: some plants may only run for a short time but will be very profitable. Thus in competitive markets, new capacity additions often exceed what is actually required.

New capacity addition in Germany has also been hampered by a low level of electricity demand growth. Growth levels are currently marginal and are expected to remain so in the short to medium term due to efforts to improve efficiency and structural changes in the German economy, which is moving away from energy intensive heavy industries to more service-oriented industries. “Over the next five or six years, we can’t expect more than one per cent per year or so, so it’s almost stagnating,” said Huhn.

Falling prices

Possibly the biggest impact on the market for power plant construction in Germany has been the effects of liberalization. There is a great deal of uncertainty in Germany over the future of electricity prices, and this has made investors reticent.

Electricity prices in Germany have fallen by around 30 per cent over the last three years, and according to Huhn, potential investors are facing a situation where, based on current electricity prices, proposed power plants have a negative net present value. Potential investors are therefore waiting to see how electricity prices will develop, and if they will recover.

“No-one can say [when] the electricity price will reach the threshold where a new plant would break even again,” said Huhn “It’s difficult to prove it, but at the moment, due to the uncertainty of the development of electricity prices in the future, the investors would expect such a high risk premium that they prefer to be reticent at the moment.”

Nevertheless, most players in the market are expecting the electricity price to recover in the next few years. “In the long run, it has to adapt to the costs. No company, not even the strongest utility in Germany, can produce electricity permanently on a level that doesn’t cover their costs, particularly if they enter into fierce competition with international utilities in the more globalized market.”

The recovery of the electricity prices will depend largely on fuel prices, but will herald the recovery of the power plant construction market.

According to Frost & Sullivan, orders for power plant equipment for the German market will start to rise in 2001, by which time electricity prices will have settled, uncertainty reduced and investors will be able to carry out reliable project appraisals. The rate of growth will not be spectacular, however.

Recovery drivers

Although the market in Germany is approaching a historical low point, there is significant potential there that will soon turn into effective demand once electricity prices have recovered. The most important driver will be the age structure of Germany’s power plant infrastructure that manifests an underlying need for replacement. While 30.4 GW of capacity has been installed since 1980, it only accounts for 38 per cent of total capacity being operated at the moment. Power plants totalling 49.1 GW of capacity, representing over 60 per cent of installed capacity, are older than 20 years.

There is therefore an enormous need for replacement in the years to come. Huhn estimates that around 30 GW will have to be replaced over the next 10-15 years; much of this will be medium-sized coal fired plants that are uneconomic to run. Orders will start in 2001, says Huhn, and while the market will initially be slow to pick up, it will become more dynamic in the second half of the decade.

Further demand for power plant equipment will arise from a need for cogeneration, estimated to be between 5000 MW and 8000 MW in the medium term.

Under the cost pressures of liberalization, combined cycle plants will show a competitive edge over conventional thermal plants as they have lower investment costs, shorter lead times and can operate at a fraction of personnel costs. Frost & Sullivan therefore believes that combined cycle technology will play a major role as the power plant construction market in Germany picks up.

Looking at the future power plant market, CCGT will account for around 90 per cent of construction in the medium term, according to Huhn. It is unlikely that coal fired plant will be built in Germany over this period, although other fuels, such as biomass and waste-to energy plants, will play a role. “I can’t see any coal plant being built in the medium term,” said Huhn, adding, “However, gas prices are strongly dependent on world markets and are coupled with oil prices, so this is a factor of uncertainty.”

Security and stability

With the planned closure of its nuclear power plants, which supply around 30 per cent of Germany’s electricity demand, and with the replacement capacity needed over the next 15 years, Germany could be heading for a ‘dash for gas’. This in itself raises issues of energy security and price stability. In ten or 20 years’ time, most of the world’s natural gas will be sourced from Russia, the Middle East and Algeria. Gas prices will be influenced by politics as well as supply and demand economics.

The competitive market will also attract independent power producers (IPPs), although the extent to which foreign players will get involved in the market is debatable, says Huhn.

There will be opportunities for foreign investors in the industrial power plant market, according to Frost & Sullivan. “Industrial companies are [increasingly] withdrawing from the model of building and operating their own plants, so this is a particular market [for foreign IPPs]. It ensures long-term contracts and reduces the risk of investing in a plant. On the other hand, the industrial company has the advantage of not being exposed to the risk of fluctuating energy, electricity and fuel prices. I think this is a really synergetic model.”

These industrial plants are likely to be combined heat and power plants, mostly with a combined cycle configuration. There is a strong emphasis on combining heat and power production in Germany, said Huhn, and this will be encouraged by the ecological tax which will reward efficient power plants.

A further trend that will emerge when the power plant construction market revives, is a decrease in average plant size. New plants will be in the 300-350 MW size range, or possibly smaller, bringing a more efficient distribution of power. In addition, new technologies such as microcogeneration and fuel cells could be taken up by municipal utilities serving the domestic market. “This will have a good future in Germany. The market share of this type of generation will considerably increase in the long run,” commented Huhn.