Offshore wind parks: Germany’s subsidies are too generous

21 January 2016, by CEN Universität Hamburg

Photo: UHH/CEN

Professor Michael Funke

Climate research in the Hamburger Abendblatt: Michael Funke reports about subsidies for offshore wind parks.

Climate research in the Hamburger Abendblatt: Michael Funke reports about subsidies for offshore wind parks.

Germany’s Energy Transition is now in full swing. The rapid change from atomic energy, coal and petroleum to renewable energies enjoys strong political support and has been greeted with both astonishment and respect at the international level. The initiative certainly appears to be proceeding as planned: for example, offshore wind parks in the North Sea now produce four times as much electrical power as they did in 2014. But what is the price?

In order to facilitate the transition, Germany’s federal government offers considerable subsidies for green electricity – a sensible policy, given that investments in new technologies are risky ventures and hardly profitable in the initial phase. Yet in the case of the offshore parks Germany has paid in too much, as our current study shows.

These incentives to investment are embedded in the Renewable Energy Act, where the federal government guarantees – depending on the water depth and distance from the mainland – fixed purchase prices for offshore energy for a limited time. Whereas the average price on the electricity market was between three and four Euro cents per kilowatt-hour last year, the subsidized prices will remain at 19 cents for the first eight years, then drop to 15 cents for two years; a minimum price of 3.5 cents is then guaranteed for the following ten years.

Potential investors have to deal with uncertainties

This approach offers companies longer-term planning security. But are the level and duration of the guaranteed prices appropriate? That’s a question we at Universität Hamburg’s Cluster of Excellence CliSAP are currently investigating.

To do so, we focus on a prototypical investor who is considering building a wind park. For him or her, comparatively young technologies like offshore turbines entail a number of uncertainties. For instance, how high will the actual construction costs be? Should they wait to invest, since the technology is bound to become less expensive in the future? How quickly will the technology continue to evolve? What percentage of the wind park’s capacity will actually be used – and how high will the market price be once the guaranteed prices no longer apply?

With the help of what are known as real options models, we can attach economic values to all of these uncertainties. We calculate which decisions a rationally behaving investor would make under such circumstances. The outcome was crystal clear: if offered even moderate incentives, they would choose to invest; the German subsidies are simply too tempting.

Less subsidies with the Danish model

In contrast, Denmark is pursuing quite a different approach. Though it promotes the same technology, it uses an auction-based model to do so: first the federal government calls for tenders for an offshore wind park. Interested investors then submit binding offers for a fixed period of time. In their offers, they require guaranteed electricity prices of their own choosing: Company A wants 12 cents per kilowatt-hour, while Company B demands 14 cents and Company C will be willing to build the park at a price of only 10 cents. The tender always goes to the lowest bidder.

In this way, each company prepares its own calculation and bears the entrepreneurial risk. As a result, one can quickly determine at which price the project is worthwhile. Our calculations clearly show: Denmark’s lower subsidies are appropriate.

Germany would have done well to follow Denmark’s lead sooner – which is why similar subsidies are now being planned EU-wide. A corresponding regulation is currently being prepared.

Michael Funke is a Professor of Economics and is currently researching the economic factors of climate change.