Navigant Research Blog

The Road to Clean Energy is Greased With Fossil Fuels

Mackinnon Lawrence — August 14, 2013

In recent months, both the United Kingdom and Germany have initiated fossil fuel expansion plans in the face of coal and nuclear retirements during the next decade.  Although the development plans coincide with ambitious clean energy agendas, the respective governments’ decisive shifts in favor of fossil-based generation stand in direct contrast to their official decarbonization policies in accordance with EU’s Renewable Energy Directive.

Currently in the midst of a comprehensive Energy Market Reform (EMR) effort to spark investment in renewables, the U.K. government has doubled its shale reserve estimates and cut shale production’s tax rate by half.  In Germany, momentum has been building this year behind efforts to expand the nation’s coal fleet, with a number of new projects slated for development across the country.

In both cases, recent developments in oil and natural gas markets have played a decisive role with unpredictable consequences for renewable deployments.

Coffee and Tea

The interplay of oil and natural gas commodities is a funny business.  Although oil’s primary role is to power a massive, worldwide transportation network, traded globally, its fluctuating value serves as a proxy in electricity markets for everything from natural gas prices to power purchases agreements (PPAs).  Natural gas, for its part, is at once a climate change nuisance in its natural state – it is roughly 70 to 90 percent methane by volume, a greenhouse gas 21 times more potent than carbon dioxide – and a climate change boon for countries like the United States, seeking to decarbonize power production with ample supplies of relatively clean-burning natural gas, instead of coal.  It is also a commodity produced and consumed in relatively close proximity.

The indexing of natural gas prices to crude oil – or fixing the traded price of the former to the latter – has helped insulate high-priced renewables seeking a foothold in economies throughout Europe and Asia.  A function of European importers who needed a price reference for newly produced natural gas in the 1960s, the practice remains common through many European and Asian markets.

Although steeped in historical precedent, oil-gas indexing is not without its critics.  It “makes about as much sense as pegging the contract price for coffee supplies to tea prices, adjusted for caffeine content,” commented Michael Lynch in a recent Forbes article.

Tale of Two Countries

Dependent on natural gas imports from Russia, for now, Germany is handcuffed by this reality.  The indexing of natural gas to Brent crude, which has hovered mostly above $100 per barrel since the beginning of 2011 makes natural gas a high-priced commodity.  For a country that derives 22 percent of its total primary energy supply from natural gas, energy independence remains an elusive goal.

Even so, Germany has pursued an ambitious effort to become more self-reliant in energy.  Aided by an aggressive Feed-in-Tariff (FiT) and insulated from cheap natural gas, Germany has seen a rapid uptake of distributed renewables like solar, wind, and biogas.  With nuclear facilities shutting down in the wake of the Fukushima Daiichi accident, and renewables still unable to deliver the scale of capacity expansion needed, the country has been forced to double down on coal.

By virtue of historical circumstance, natural gas prices are not nearly as intertwined with international oil prices in the U.K. as they are in continental Europe.  Though the country is a few years behind the U.S. with respect to exploiting shale gas deposits, natural gas will figure heavily into the future U.K. generation mix.

In recognition of this reality, the U.K. government recently eliminated subsidies that, since its inception, would have been available to dedicated biopower under EMR.  Though biopower is one of the few renewable options that can supply baseload power – a stabilizing force in electricity markets – the U.K. government has always expressed reservations about the cost-benefits associated with dedicated electricity production from biomass.

The contrasting German and U.K. experiences muddle predictions for the future uptake of renewables.  While recent movements in the relative price of oil and natural gas have begun to upend long-held structure in the energy production sector, renewables remain both a beneficiary and a victim.

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