The Rise of Third Parties and the Fall of Incumbents Driven by Large-Scale Integration of Renewable Energies: The Case of Germany.

• Author: Brunekreeft, Gert

1. INTRODUCTION

   Recent years have seen dramatic changes in the electricity supply industry. In 1997 European legislation took the first step to initiate a Europe-wide liberalization process that aimed to gradually open generation and retail for market entry and competition. However, especially in generation, non-incumbent market players were the exception, while the dominant market position of the formerly monopolistic incumbents remained the rule. With the energy transition (German: Energiewende) that began in 2000, this situation started to change significantly. The large-scale integration of the renewable energy supply (RES) has triggered the decentralization of generation and the market entry of new players ("third parties") and has fundamentally changed the supply structure of the electricity sector. Temporary excess capacity and increasing diversity of ownership have intensified price competition.

   What are these third parties and how strong is this development? This article aims to analyze the sector's structural change and its implications for the electricity supply industry. In particular, we will investigate the quantitative effects of third parties in the electricity supply industry (i.e., generation) in Germany. We focus on Germany because RES growth has been and still is exceptionally strong there. Statistical data supports the hypothesis that large-scale integration of RES is a main driver for the rise of third parties and the fall of incumbents. Moreover, the changing face of the sector has had a dramatic impact on the business models of the incumbents that predominantly own conventional generation capacity. The incumbents face what is appropriately called "disruptive challenges" and are forced to change their business strategy.

   Section 2 will define "third parties" and exemplify the term in the context of current market developments. Section 3 will provide an empirical analysis for the rapid emergence of third parties in the electricity sector. Section 4 will analyze the implications of growing RES for incumbents in terms of market prices and load factors for conventional generation and will discuss the consequences for their business plans. Section 5 will offer conclusions.

2. WHAT ARE "THIRD PARTIES"?

   The structural reforms of liberalization and the energy transition have initiated a trend toward decentralization of the electricity sector. This has triggered substantial market entry by new players and changed the roles of existing ones. We use the term "third parties" to describe all the non-incumbent agents in the market. With regard to the growing importance of third parties, three developments are most striking.

   First, following the liberalization of the energy sector after 1996, new competitors entered the market for electric power supply. Competition in the generation market resulted in a decrease of market shares held by the larger incumbents in Germany. Between 2000 and 2004, the four largest German utilities (i.e., the "big four") owned between 80% and 90% of the conventional generation capacities in Germany. However, this share fell to 68% by the end of 2013 (BNetzA, 2014). Shortly after liberalization, competition in the conventional generation market was primary limited to municipal utilities. Diversity increased until more than 100 companies were operating conventional generation in Germany in 2015. Though municipal utilities still owned many generation capacities in 2015, new market parties like companies from industrial production (e.g., Volkswagen, BASF) own electricity generation capacities as well (BNetzA, 2015).

   A second driver for the change in supply structure was the start of the energy transition, marked by the enactment of the Renewable Energy Sources Act (German: Erneuerbare-Energien-Gesetz; EEG) in 2000. The support of RES through fixed feed-in tariffs massively fostered the rise of third parties in generation and has changed the role of consumers in the market. The majority of RES is connected to the distribution level; this is especially true for photovoltaic (PV) power plants. Even the majority of wind farms tend to be connected to the distribution grids. (1) Market entry by non-incumbent market players in distributed generation from RES and small-scale combined heat and power (CHP) significantly altered the supply structure.

   Moreover, RES support has strongly pushed the development of what Toffler (1980) calls "prosumers" (i.e., players that are both producer and consumer), especially in solar power. Consumers that formerly played a passive role have now started to get actively involved in energy production. (2) The growing importance of demand-side management further implies that consumers are becoming active market participants. These can be industrial users themselves, but also aggregations of small end-users. As energy supply starts to become a premium product (i.e., not only the delivery of energy, but the provision of value-adding services, e.g., energy efficiency consulting), new companies start to enter the market and offer all-around energy services rather than merely selling electricity at a standard rate.

   A third development is the movement toward "smartness" in the energy system. The term "smart grids" describes the approach of applying information and communication technologies (ICT) to the electricity distribution networks to increase overall efficiency and reduce the costs of integrating renewables. Smart grids are strongly focused on the regulated electricity networks. Smart markets, on the other hand, combine the market activities of non-regulated market participants to unlock efficiency potential aside from the regulated activities on the distribution grid (e.g., demand-side management) (BNetzA, 2011a). This has not only fostered the market entry of energy-related parties but, increasingly so, that of non-energy-related actors.

   An obvious example is the diffusion of ICT in electricity networks, which is required for smart grids and is supposed to attract new market players from other sectors. With smart grids and smart markets, ICT providers are quickly gaining importance (Erlinghagen & Markard, 2012). They can be mere suppliers, but they can also participate in smart markets independently. For instance, the roll-out of smart meters is a huge market. Most notably, players like Google seem to be keen to get hold of the data from smart metering. Telecommunication companies are interested in providing data infrastructure and data management. Further examples of the changing supply structure are gas suppliers that are beginning to link up with electricity suppliers (e.g., in the context of "power-to-gas"-technology, where excess wind power is transferred into hydrogen or gas (methane) that can be transported over large distances using the existing gas network).

   Finally, although e-mobility is developing more slowly that political plans for it, it may soon play a major role in creating new roles and participants. This could range from users (e.g., taxi or bus companies) to car manufacturers, which could start cooperating with electricity companies.

   The rapid growth of RES has been the most remarkable structural change in the electricity sector. Figure 1 shows the development of RES capacity in Germany since 1990. It clearly illustrates that the strong growth in RES generation started after 2000, when the EEG was enacted. Projections for Germany show that the installed RES capacity of wind and PV alone may reach 175 GW in 2030, which means that capacity would triple between 2013 and 2030 (dena, 2012; BNetzA, 2013).

   Figure 2 depicts the important role of private investors for the two main sources of renewable energy: wind and solar.

   Currently, non-incumbent private investors (e.g., households, energy cooperatives) account for approximately 30% of all investments in RES (in [euro]) in Germany. While private households own roughly 45% of total RES capacity (48% of PV, 50% of onshore wind capacities), incumbents from the energy sector only hold a 12% share of current RES capacity (trend:research, 2013). Institutional investors (e.g., investment funds) own the remaining 43% of RES capacities in Germany.

   Non-energy-related companies that install their own renewable power plants to serve their production facilities play an important role in the development of RES as well. WeiBfloch et al. (2013) suggests that the share of manufacturing companies that own RES has increased from 5% in 2005 to 18% in 2012.

   Private households also act as investors: in 2012, 6% of all households in Germany had their own RES installed, mostly installations with small capacity below 100kW (TNS-Infratest, 2013). Other private investors include energy cooperatives, with about 650 active in Germany (Holstenkamp & Mueller, 2013).

   In the following section, we will provide more empirical evidence for the rise of third parties in Germany and shed more light on...