So Much for German Efficiency: A Warning for Green Policy Aspirations?

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Setting the Scene

Germany has been the economic powerhouse of post-World War II Europe. Over several decades, other European countries looked to Germany for ways to improve efficiency and develop their own economies. This might not be the case any longer. Indeed, when it comes to energy policy, Germany is perhaps the developed country whose recent policies are the most difficult to rationalize. As energy is central to a country’s prosperity, the implications of a misguided energy policy have been far-reaching, with Germany now being one of the world’s worst economic performers among major developed economies. Here we will touch on two major pillars of the German energy sector’s inefficiency, and on their implications for the country’s future economic performance, which will be formative for the overall European economic and energy landscapes.

Playing Russian Roulette With Energy Supplies

Relying almost exclusively on Russia to supply Germany with natural gas through the Nord Stream pipelines is likely to be considered as one of former Chancellor Angela Merkel’s biggest policy mistakes, although policies aimed at shutting Germany’s nuclear plants is another major error. Despite the country’s strong focus on decarbonization, the disruption of Russian supplies after the onset of Russia-Ukraine war resulted in Germany having to run its lignite-fired power plants for longer than expected, providing a signal that short-term energy reliability is as important a factor as reducing emissions in the longer term.[1]

The reliability-emissions reduction conundrum is showing up in Germany’s long-term planning as well. Recently, Germany has taken steps to displace coal in its generation fleet with natural gas, despite the unlikely resumption of supplies from Russia. In order to limit resistance from powerful environmental groups that oppose any kind of investment in nonrenewable energy sources, the German government has been marketing the new gas power plants as climate-friendly since they are expected to be converted to burning renewable-produced hydrogen at some point in the future.  

All of this sits against the backdrop of Germany pursuing one of the most ambitious plans for renewable energy adoption in the world. However, the energy transition — or “Energiewende” in German — has not been the panacea anticipated by its proponents. 

Reconciling Aspirations With Reality 

The fundamental principles of economics are hard to escape. When demand exceeds supply, prices rise. The German economy is very dependent on the manufacturing sector as an engine of growth, and high energy prices are damaging for industry. Moreover, electricity prices in Germany are unlikely to decline any time soon as the adoption of electric cars and the planned expansion of hydrogen production will significantly increase future electricity demand. This will require significant growth of new generation capacity that will need to be demand responsive.

The popular view in Germany — arguing that a faster switch to renewable power should make electricity cheaper since levelized costs for renewable energy have been declining — appears unfounded. Given intermittency-related limitations associated with wind and solar, maintaining a reliable energy system requires additional investments in a mix of energy sources that can dispatch when needed — such as natural gas and batteries — as well as infrastructure to transmit new power sources efficiently. As a result, levelized renewable generation costs are only a fraction of the costs associated with the transition to renewable energy.[2] Large-scale battery storage and gas-fired or even coal-fired power plants need to be available and utilized when renewable energy production falls short due to the vagaries of the weather, which contributes to higher total system costs. To be clear, high energy prices in Germany have been part of the energy transition debate even before the energy crisis resulting from Russia’s war on Ukraine. Selected energy-intensive companies have enjoyed subsidized electricity prices to ensure competitive production. But smaller businesses and households are subject to electricity prices that are among the highest in Europe. 

Despite the strong push for renewable energy, fossil fuel continues to be a large part of German electricity production. As of 2023, oil is still Germany’s largest domestic energy source (35.2%), followed by natural gas (23.9%), renewables (22.8%), coal (16.0%), and everything else (2.2%).[3] So, fossil fuels account for 75% of Germany’s energy use, which is down from 81% in 2010, when Energiewende received legislative support. To be clear, the consumption of fossil fuels has declined by about 24% over the last 10 years, but that is largely in line with the observed reductions in overall energy use in Germany.

On the production side, Germany is almost entirely import dependent for its oil and gas needs, but it produced a little more than half of the coal it consumed on an annual basis in 2023.[4] Germany also imports coal for power generation and steel production. Ironically, the closure of Germany’s entire nuclear fleet, which was finalized in 2023, is likely to keep its coal plants active for some time, or at least until sufficient gas-fired capacity can be brought online, which will serve to increase the country’s overall import dependence. 

Pipelines from Norway and the Netherlands plus liquified natural gas (LNG) from the U.S. have become Germany’s main sources of natural gas supply. But, while the EU imposed sanctions on oil imports from Russia, no such ban was placed on LNG deliveries. As a result, Russia’s LNG deliveries to Europe in 2023 were on par with those from Qatar and Algeria. Thus, the EU has partially substituted Russian pipeline gas with more expensive Russian LNG. Given the connectedness of the EU gas market, this has direct implications for Germany. Moreover, this trend is expected to continue in the coming years, which will likely stoke ongoing debates centered on energy security and transitions.

Prevailing Political Arguments and Their Shortcomings 

Given its ability to make or break governing coalitions in Germany, the Green Party has had a remarkable influence on the country’s energy policy in recent years. The priority to phase out nuclear energy and fossil fuel as soon as possible and at any cost has been at the heart of the party’s political agenda. At the same time, other than the ideological belief that renewables will solve all of Germany’s energy problems, there has not been a clear plan on how to deal with limitations imposed by intermittency, limited storage, and tight electricity transmission. Through political discourse, this ideological belief has also penetrated large parts of German society, who deem the phasing out of all nonrenewable energy sources almost as an existential necessity. 

In 2021, nuclear energy accounted for about 12% of Germany’s annual electricity production.[5] Despite their strong safety record and the increased geopolitical uncertainty associated with other forms of energy, these nuclear plants were shut down prior to their scheduled end-of-life, right around the time when they were needed the most. To make up for this loss, Germany’s utilities must now rely on coal-fired and gas-fired plants to bring dispatchable power to the grid whenever intermittent renewable resources — wind and solar — are not available. As noted above, the cost of back-up generation resources that are required to bring grid stability when intermittent resources are present is not factored into levelized cost of electricity (LCOE) calculations.

An additional challenge concerns the transmission of electricity; again, the cost of additional transmission for renewables is typically ignored by those claiming low levelized costs of renewable power. The green energy transition of the size and scope undertaken in Germany creates a significant challenge since large amounts of green energy need to be transported from coastal regions in the north to the large demand sinks in urban and manufacturing areas throughout Germany. It is projected that the size of Germany’s grid will have to double as a result.[6] Yet, only about 1,740 km out of the estimated needed 12,234 km of new power lines were completed as of June 2023.[7] As in many places around the world, the construction of new transmission lines faces local opposition. For instance, the new electricity line bringing wind power from the north to industry in the south has faced resistance by local communities. As a result, the line will have to be underground, delaying its completion and increasing costs. It seems that the not-in-my-back yard resistance is a powerful force, even in Germany. 

The forceful antinuclear and antifossil fuel stance of the Green Party and some of the Social Democratic Party of Germany appears to boil down to one or more of the following arguments: 

• First, a full and speedy transition to renewables is considered essential in order to fight climate change, which is viewed as an existential threat. 
• Second, nuclear energy is viewed as fundamentally unsafe. 
• Third, it is believed that a speedy and full transition to renewables is the fastest way to German energy independence. 
• Fourth, proponents often advocate that a first-mover advantage will both make Germany a technology leader in renewable technologies and provide an effective moral example for other countries to follow. 

There are several problems with these arguments. 

To begin, Germany is already quite energy efficient and creates a relatively low yearly flow of carbon emissions. In fact, Germany accounts for 1.5% of global emissions and 15.6% of European emissions. Moreover, emissions in Germany have declined by about 24% over the last decade, meaning the lowest-cost emissions reductions have largely already occurred.[8] Hence, actions Germany takes have relatively little impact on global emissions, while potentially imposing a significant cost. 

Paradoxically, as it produces no carbon emissions, nuclear energy could be an important tool in the fight to reduce emissions. Nuclear energy in Germany has an excellent safety record, and several of Germany’s close neighbors have plans to pursue nuclear energy production for decades to come, with some of these power plants to be sited very near the German border. While nuclear power will continue to be imported to Germany, the plants themselves will not be under the control of German electricity authorities.

Regarding energy independence, it is a notion that has persisted in import-dependent nations for decades, and policies championing domestic energy sources have been advocated accordingly. This has not been solely in the interest of renewables; it was a root for expanded use of coal in the past, in the Germany as well as countries such as the U.S. The idea that a rapid scale-up of renewable energy sources, in and of themselves, can lead to energy independence is problematic. Intermittency alone requires other resources to be available to balance the grid, which requires dispatchable sources of power that can be maintained for significant periods of time. Moreover, a significant fraction of energy is not electricity; it is heat. This disqualifies battery storage from being able to handle the entirety of the issue, at least until long-duration storage options are available and scaled and everything is electrified. Neither of these is likely to be a reality in the near term, and cost is a consideration. Admittedly, one could argue that dependence on foreign-sourced natural gas and LNG, oil, and coal compromise Germany’s energy security, but sources of supply matter and dependence on Russian gas has declined. Dependence on foreign-sourced fossil fuel is likely to remain for a while. The portfolio of supplies also matters, and the emergence of the U.S. a major gas supplier has significant energy security benefits.[9]

Lastly, due to labor costs, a rigid regulatory regime, and expensive input prices, the development and production of renewables are already taking place outside Germany. It is unlikely that Germany will be able to compete with China in renewable technology manufacturing in the future. These same high energy and labor costs threaten the German auto industry’s hopes to expand production and export of EVs. The lack of key minerals, processing capability, and supply chains needed for EV batteries also means high dependence on China-dominated supply chains.   

What It All Means: Political Economy and Winds of Change?

The resulting backlash and general dissatisfaction with the experience of the past several years have boosted support for Germany’s extreme-right Alternative for Germany (AfD) Party, which is poised to be a powerful contender to lead Germany in the future, something that was unthinkable a few years back. Several German businesses appear to have had enough and have announced plans to close and/or relocate at least part of their operations outside the EU. Volkswagen and Mercedes are examples of companies that have taken steps to address rising costs and made significant new investments in the U.S. recently, and industrial player Badische Anilin und Soda Fabrik (BASF) announced layoffs and plant closures in 2023 due to high energy costs.[10] The trend is expected to continue and has sent shockwaves through Germany, which has historically prided itself on being the manufacturing powerhouse of the EU.

The price environment and associated economic malaise are not unique to Germany; they are affecting all of Europe. Moreover, they are not the result of Russia’s invasion of Ukraine. That violation of sovereignty has certainly inflicted a significant humanitarian crisis and deepened issues on the continent. But meager economic performance and relatively high energy prices were features of EU economies prior to the Russian invasion of Ukraine. According to World Bank data, from 2013–21 in inflation adjusted terms, the average annual growth of GDP in the U.S., EU, and Germany was 2.32%, 1.57%, and 1.23%, respectively.[11] So, growth in Germany has not only been lower than that of the entire EU, but it has also been significantly lower than the U.S. for a decade. The invasion served to bring a brighter light on issues that were already bubbling under the surface.

Political economy considerations in Germany have made the green transition an ideological affair. When technological and market constraints are ignored in favor of unrealistic aspirations and dogma, reality has a way of kicking back. In Germany, this has resulted in persistent economic underperformance, the fear of growing industrial weakness due to high energy prices, and the potential of political instability through the rise of the extreme right. Given that, especially after Brexit, Germany is at the core of Europe, the consequences for the EU and for the entire continent are far-reaching. To be sure, there is nobility in striving for better environmental outcomes, but if economic health is sacrificed, the backlash will be palpable. How things are playing out in Germany is a reminder that balance matters.

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Notes

[1] For more on the impact of the cut in Russian gas supplies on the EU and Germany, see Gabriel Collins, Anna B. Mikulska, and Steven R. Miles, “Winning the Long War in Ukraine Requires Gas Geoeconomics” (working paper, Rice University’s Baker Institute for Public Policy, August 4, 2022), https://www.bakerinstitute.org/research/winning-long-war-ukraine-requires-gas-geoeconomics; Collins, Kenneth B. Medlock III, Mikulska, and Steven R. Miles, “Strategic Response Options If Russia Cuts Gas Supplies to Europe” (Houston: Rice University’s Baker Institute for Public Policy, February 11, 2022), https://doi.org/10.25613/32SK-5588; and Medlock, Mikulska, and Luke (Leelook) Min, “Natural Gas Balance in Europe: Germany as a Case Study” (Houston: Rice University’s Baker Institute for Public Policy, December 7, 2022), https://doi.org/10.25613/8SKH-J217. 

[2] This point is expounded in multiple publications. See, for example, Robert Idel, “Levelized Full System Costs of Electricity,” Energy 259 (November 2022): 1–11, https://doi.org/10.1016/j.energy.2022.124905. 

[3] Energy Institute (EI), Statistical Review of World Energy, 2024, https://www.energyinst.org/statistical-review. 

[4] International Energy Agency, “World Energy Balances,” https://www.iea.org/data-and-statistics/data-product/world-energy-balances. 

[5] Percentages are calculated from data in the EI’s 2024 Statistical Review of World Energy. 

[6] Vera Eckert, “Germany Needs to Double Its Renewable Energy Output-Grids,” Reuters, last updated January 29, 2021, https://www.reuters.com/article/idUSL1N2K410K/. 

[7] International Trade Administration, “Energy,” in “Germany — Country Commercial Guide,” last modified December 6, 2023, https://www.trade.gov/country-commercial-guides/germany-energy. 

[8] EI.

[9] See, for example, Medlock, Amy Myers Jaffe, and Meghan O'Sullivan, “The Global Gas Market, LNG Exports and the Shifting US Geopolitical Presence,” in “US Energy Independence: Present and Emerging Issues,” ed. Jaffe, special issue, Energy Strategy Reviews 5 (December 2014): 14–25, https://doi.org/10.1016/j.esr.2014.10.006. 

[10] See, for instance, “What If Germany Stopped Making Cars?,” The Economist, July 31, 2023, https://www.economist.com/business/2023/07/31/what-if-germany-stopped-making-cars; and “Germany’s BASF to Shed 2,600 Jobs in Cost-Cutting Drive,” Associated Press, February 24, 2023, https://apnews.com/article/basf-se-germany-business-98a44b0766efea7c85ce0da22a30d827. 

[11] Growth rates are calculated from the World Bank’s “World Development Indicators” (https://datatopics.worldbank.org/world-development-indicators/). 

This material may be quoted or reproduced without prior permission, provided appropriate credit is given to the author and Rice University’s Baker Institute for Public Policy. The views expressed herein are those of the individual author(s), and do not necessarily represent the views of Rice University’s Baker Institute for Public Policy.