By taking over the German lignite assets of Vattenfall, Czech utility EPH shows it believes in the future of lignite in Germany. This raises questions for the German government about its climate policies – and for the Swedish government which has to decide on the deal, writes Julian Schwartzkopff, researcher at energy and climate think tank E3G.

Vattenfall is taking a dim view on the continued profitability of lignite in Germany. In fact, the company is so eager to cut its losses that it was willing to sell to Czech utility EPH at a loss of 2.4 to 3 billion Euros. This would still be cheaper than keeping the assets, the company says in its official press release.[1]

EPH obviously disagrees, otherwise they would not be willing to take over a business that Vattenfall thinks would only lose them money. Can these two views be reconciled? There are several possible explanations relating to EPH’s business strategy and its assumptions about future energy policy developments. All of them are worrying.

Is EPH betting that German climate policy will fail?

According to modelling commissioned by the German think tank Agora Energiewende, all of the power plants that EPH has acquired, except for one unit at Boxberg, would need to close by 2030 for Germany to achieve its climate targets.[2] These closure dates are not official government policy, but they are clearly implied by Germany’s emissions reduction commitments, which are just barely in line with a 2°C trajectory. If the German climate targets were to be revised downward to conform with limiting climate change to “well below 2°C” or even 1.5°C, as the Paris Agreement stipulates, the lignite plants would have to close even earlier.

In a situation where fears over security of supply are high as energy markets across Europe are in transition, securing government subsidies for providing backup capacity could be an attractive prospect for EPH

In a world where Germany meets its climate targets, EPH would be hard-pressed to make a profit with the lignite plants and mines it is set to acquire. Given the currently very low power prices and the high expected follow-up costs of lignite mining, the time window that EPH has to make money with its acquisition seems very narrow. The company therefore has a lot to lose from German climate policy. It remains to be seen how aggressively EPH would be willing to lobby to protect their financial interests. One possible option would be to sue the German government for compensation if a coal phase-out was adopted, similar to the lawsuits that German utilities are currently pursuing over the nuclear phase-out.[3]

Is EPH betting on a taxpayer bailout?

Generating profits by providing capacity rather than power is a declared objective of EPH’s business strategy. The company sees itself joining “a changed market arrangement known as the capacity model”. It specifies that “the UK and Italian markets are the main markets that are in this situation and our interest focuses on them”.[4] In a situation where fears over security of supply are high as energy markets across Europe are in transition, securing government subsidies for providing backup capacity could be an attractive prospect for EPH.

Acquiring Vattenfall’s lignite business seems to extend this strategy to Germany. Indeed, a political deal that was reached last year, and is still awaiting approval by the European Commission, already foresees the creation of a lignite reserve that will reward two units at Vattenfall’s Jänschwalde power plant with 600 million Euros between 2018 and 2023 for shutting down, only to be reactivated in supply emergencies. It is clear to observers that the real reason why this measure was adopted was to stave off job losses that would have resulted from closing these units outright. The ten-day warning period for its activation shows that no one seriously expects the lignite reserve to be able to prevent sudden supply shortages. EPH might be hoping for the German government to adopt a full-blown capacity market in the future, which could enable them to make money with the other units in Vattenfall’s portfolio even after they have become unprofitable.

Given the highly unfavourable outlook for lignite, it is very unlikely that the return generated on the investment in Vattenfall’s assets will be able to meet the profit expectations of EPH’s owners without detriment to German taxpayers, Vattenfall’s current employees and suppliers or the environment

This, however, is fundamentally at odds with the current German government position. Several independent assessments commissioned by the Economy Ministry have found that a capacity market would be unnecessarily expensive and inferior to other solutions in providing security of supply.[5] A subsequent public consultation and Germany’s new electricity market law rejected the idea as well.[6] To attract further subsidies, EPH would thus need to effect a serious change in government policy and use the jobs the plants and mines provide as a political bargaining chip.

Is EPH planning to cut costs that Vattenfall wouldn’t have cut?

EPH is already implementing an aggressive cost-cutting program across its entire portfolio to deal with shrinking profit margins in the fossil fuel business. In their first quarterly report for 2015, they elaborate that the cuts are expected to generate “savings up to EUR 20 million per year ramping up”.[7] It is not clear where cuts might be made in the case of the Vattenfall portfolio, but it cannot be ruled out that downward pressure on wages or reductions in employment would be part of it. There is already an unexplained discrepancy between the “more than 8,000” employees in its lignite business that Vattenfall usually cites[8] and the 7,500 employees that EPH will now take on.[9] Even though EPH has vowed to uphold the current collective wage agreements and to refrain from forced redundancies, it seems that a way has been found to reduce employment without technically laying people off.

EPH might also seek to increase pressure on regional suppliers and contractors, e.g. in electronics, metals and logistics, which provide about half of all lignite-related employment in Lusatia. This is particularly likely as it would not be as visible or politically costly as going up against the highly unionised miners and power plant workers. Vattenfall had already negotiated contracts with suppliers down to a point where “only just under a third of the workforce was paid according to collectively bargained wage agreements or in line with agreements based on them.”[10] It is unclear how much lower EPH would be willing to go, and what consequences this might have for workers in these companies.

It would not be surprising if EPH simply decided to let its German subsidiary Mibrag (which already owns smaller lignite holdings in another German lignite area) go bankrupt

The expensive follow-up costs of lignite mining present another area where EPH might be looking to save money. These costs for measures such as the reclamation of mined land, the creation of artificial lakes and cleaning up environmental pollution are currently estimated at significantly over one billion Euros, and they would all accrue after operations at the sites have ceased. As a highly leveraged company with an intransparent ownership structure operating through intermediate holdings in tax havens,[11] it would not be surprising if EPH simply decided to let its German subsidiary Mibrag (which already owns smaller lignite holdings in another German lignite area) go bankrupt, thus escaping the follow-up costs altogether.

German taxpayers would then have to pick up the bill, as the law currently provides no recourse if the responsible company goes bust.[12] While Vattenfall will pay 1.7 billion Euros to EPH for restoration and rehabilitation costs, there is no strict legal requirement to actually use the money for that purpose.

Not a safe pair of hands

Since its creation in 2009, EPH has quickly expanded its European generation portfolio on the back of considerable borrowing, snapping up fossil fuel assets that other utilities are keen to divest.[13] EPH’s management of Mibrag reveals the extent to which this business model is geared towards short-term profit maximisation. Between 2009 and 2014, unusually high amounts of 16 to 19% of Mibrag’s annual turnover were being transferred to its Czech owners – even in years when the company made losses.

EPH has committed to abstain from such transfers for the first three to five years after the sale.[14] Its management of Mibrag foreshadows what it is planning to do after this time has run out. Given the highly unfavourable outlook for lignite, it is very unlikely that the return generated on the investment in Vattenfall’s assets will be able to meet the profit expectations of EPH’s owners without detriment to German taxpayers, Vattenfall’s current employees and suppliers or the environment. This raises uncomfortable questions for the Swedish government who is set to decide on the deal by the summer – ostensibly to reduce its climate footprint in a socially responsible manner.

[1] http://corporate.vattenfall.com/press-and-media/press-releases/2016/vattenfall-to-sell-german-lignite-operations/

[2] https://www.agora-energiewende.de/de/themen/-agothem-/Produkt/produkt/288/Was+bedeuten+Deutschlands+Klimaschutzziele+f%C3%BCr+die+Braunkohleregionen%3F/

[3] http://www.ft.com/intl/cms/s/0/df44d1ee-e792-11e5-bc31-138df2ae9ee6.html#axzz47DBmMHiQ

[4] http://www.epholding.cz/en/press/eph-has-completed-the-transaction-for-the-purchase-of-e-on-italia-coal-and-gas-generation-assets-in-italy/

[5] http://www.bmwi.de/DE/Presse/pressemitteilungen,did=648264.html

[6] http://www.bmwi.de/DE/Themen/Energie/Strommarkt-der-Zukunft/Strommarkt-2-0/stellungnahmen-gruenbuch.html, http://www.bmwi.de/BMWi/Redaktion/PDF/E/entwurf-eines-gesetzes-zur-weiterentwicklung-des-strommarktes,property=pdf,bereich=bmwi2012,sprache=de,rwb=true.pdf

[7] http://www.epenergy.cz/wp-content/uploads/EPE_report_1Q2015.pdf

[8] https://corporate.vattenfall.de/newsroom/pressemeldungen/2014/braunkohle-tragt-auch-2014-stabil-zu-versorgungssicherheit-bei/

[9] https://corporate.vattenfall.de/newsroom/pressemeldungen/2016/vattenfall-vor-dem-verkauf-der-braunkohlesparte/

[10] http://www.lr-online.de/nachrichten/sachsen/IG-Metall-Vattenfall-Dienstleister-zahlen-zu-wenig;art1047,4253674, E3G’s translation

[11] http://www.stefanschroeter.com/1190-mibrags-gesellschafter-werden-etwas-weniger-undurchsichtig.html#.VyNRYPmyOko

[12] https://www.greenpeace.de/sites/www.greenpeace.de/files/publications/studie-folgekosten-braunkohle.pdf

[13] https://sandbag.org.uk/site_media/pdfs/reports/EPH-Vattenfall.pdf

[14] http://www.epholding.cz/en/press/eph-and-ppf-investments-sign-agreement-for-the-acquisition-of-vattenfalls-german-lignite-activities/