Germany: Soaring Oil Threatens Economy

With prices at the pump breaking records, and electricity and natural gas set to follow suit, experts fear long-term effects

Vitali Minakow has already changed many of his habits to cope with the daily frustration at the gas pump. He takes fewer vacations, rides his bike to work and reaches for the phone instead of meeting friends in person. "I used to just fill the tank up and drive off," says Minakow, a forklift driver from the western German city of Osnabrück. "But that just doesn't work anymore."

Minakow feels trapped. No matter what he gives up, gas prices still squeeze more and more from his wallet. "My salary has stayed the same for years," he says, "but gas just keeps getting more and more expensive."

Germans are experiencing a particularly unpleasant kind of energy crisis. They conserve electricity and gas where they can, but costs for heating the house, driving, cooking and taking a morning shower are making a bigger and bigger dent in the household budget. Since the price of a barrel of oil first broke the $135 mark last week, filling the gas tank of a Volkswagen Golf now costs more than €80 ($125).

A commuter who makes the daily, 65-kilometer (40-mile) commute between the northern cities of Lübeck and Hamburg will fork out an additional €500 ($778) this year just for gas. Heating and electricity bills have also recently climbed to that point that they now account for 40 percent of total housing costs. If the trend continues, utility costs will become a "second rent," complains Franz-Georg Rips, president of the German Tenants' Association.

What is really worrying Germans, though, is the fear that this "oil price madness," as Germany's mass-circulation daily Bild calls it, could become a permanent condition. In the past, energy prices would shoot up but then drop again, and people didn't necessarily feel poorer. Now, though, it seems that Germans' energy bills will continue to grow faster than their incomes and that the price hike for oil, natural gas, gasoline and electricity will begin threatening economic well-being.

For economists and consumers alike, all previous calculations are now out the window. Whereas earlier a majority of experts predicted robust growth for 2008, they now see an economy in serious danger.

A Political Conundrum

In Berlin, too, views are changing. The same politicians who have always made fighting global warming their top priority are now outdoing themselves with suggestions that will take the pressure off consumers. Environment Minister Sigmar Gabriel wants relief for low-income commuters. Erwin Huber, leader of the Christian Social Union (CSU)—the Bavarian sister party of the conservative Christian Democratic Union (CDU)—advocates general tax cuts. Even environmental expert Bärbel Höhn of the Greens—for whom energy prices up to now couldn't rise fast enough—is suddenly calling for limits, preferably through the introduction of "red cards for speculators."

Last week witnessed the first victim of this new mood about the economy: the grand coalition's climate package. The set of measures to limit CO2 emissions was supposed to be passed in the cabinet on Tuesday. But the grand coalition's partners, the center-left Social Democratic Party (SPD) and the CDU, couldn't agree on how many additional costs could still be imposed on their constituents in the face of rising energy costs. Once again, the program was put off.

This new oil and energy crisis is bringing up plenty of questions, and not just for the two main political parties. How can consumers absorb the costs? How much climate protection can be imposed on consumers if the costs of oil, natural gas, gasoline, and electricity are also rising? Should energy taxes be lowered or increased?

These questions are urgent. Energy prices are already rising higher, driven by three simultaneous factors: the growing hunger for raw materials in emerging economies such as China and India; the greed of speculators; and additional governmental charges, including those related to climate protection. According to experts' predictions, the future holds more price increases—and the change will be especially drastic for drivers.

Pain, Not Just at the Pump

Hardly a day goes by without the Chicago Board of Trade registering a new record price for a barrel of oil. And, every day, consumers feel the consequence of this most immediately at the gas pump. Last week, prices for super gasoline and diesel in Germany broke the €1.50 per liter barrier—and there is no end in sight. Experts predict that, by the end of 2009, oil prices could rise to $200 (€129) a barrel. On Wednesday, Airbus CEO Thomas Enders warned that, were that to happen, Germany's aircraft industry would "collapse."

The same development can be seen with the fuel most Germans use to heat their homes. Since 2000, the price of natural gas has shot up around 75 percent and had dramatic consequences for consumers. In many cases, since the turn of the millennium, the gas bill for a three-person household has increased by several hundred euros per year.

And the current year will bring additional changes, according to internal calculations of Düsseldorf-based energy provider E.on, and changes that the industry has never seen. In fact, the company sees a "need to adjust gas prices"—to use the euphemistic corporate jargon—by up to 25 percent.

There is no conclusive decision yet as to exactly when the price increase will be announced and whether it would be better to make this massive jump in one step or two. But it is certain that other companies will follow E.on, the market leader, if they are not already independently planning similar price increases.

The average three-person household would then have to pay around €400 ($622) more for natural gas than it does today. From around their current €1,600 value, heating bills would jump to as high as €2,000. Even energy providers themselves believe that this would reach a magnitude that many households would find very difficult or impossible to bear. In recent years, public utilities have already reported a growing trend of outstanding debts, as more and more customers are unable to pay their bills.

Likewise, for electricity prices, no relief is in sight for consumers or the industry, and the already record prices will continue to soar.

Reduced Power Generation

The reason behind this is not just the fact that competition on the energy market has been slow in emerging or the enormous market power of Germany's four dominant energy suppliers. Dramatic changes in the power-generation industry have also had an effect on prices. The decision to abandon nuclear power made by the former red-green ruling coalition of the Social Democrats and the Greens means that, in the coming years, almost a quarter of Germany's power-generating capacity will disappear. How that lost capacity will be replaced remains an open question.

Throughout the country, there is considerable resistance to new, modern coal plants. Even completely outdated power plants are no longer replaced by the companies that run them because climate-minded citizens' initiatives campaign so intensely against new billion-euro construction projects.

The German Energy Agency recently projected the consequences of this trend and reports that Germany is not only in danger of facing a shortage in the power supply, but also that increasingly scarce capacity will force substantial price increases.

Renewable energy sources, such as water, wind and solar power, will hardly be able to fill these energy gaps looming in the foreseeable future. Even the federal government's plan to secure around 30 percent of the power supply from such sources by the year 2020 is extremely ambitious—and expensive.

In order to reach that goal, the government has been giving generous subsidies to producers of solar power, wind energy and biomass. These energy producers brought in around €7.7 billion ($12 billion) last year on top of what they collected from customers' electricity bills, and this amount will see annual increases that will reach around €12.5 billion ($19.5 billion) by 2013. Subsidies for alternative energy currently cost the average German household around €30 ($47) annually and, in eight years, it will be almost twice as much.

Part 2: The Role of CO2 Reduction

There is another factor that may start driving costs up for industry and consumers in the foreseeable future. Since the beginning of 2008, the government has been auctioning off pollution rights for carbon dioxide emissions. At first, only 10 percent of certificates will exchange hands in this way each year.

But that's just the beginning. As the European Commission imagines it, starting in 2013, all emissions rights for energy corporations will be sold by auction and subsequently traded like gold or stocks. And because considerably fewer certificates will be issued than there will be CO2 emitted in Europe, there is an incentive for companies to implement clean technology or to shut down old facilities early.

In fact, according to a study by the German Association of Industrial Energy and Power Management (VIK), energy providers will have to pay the government between €9 billion and €14 billion ($14 billion and $21.8 billion) every year from 2013 to 2020 for these certificates. Companies will largely be able to pass these costs on to consumers, and electricity costs are likely to climb drastically.

Under these circumstances, it's no wonder that economic researchers are worried about the predicted energy conservation shock. According to the calculations of Claudia Kemfert, energy expert at the Berlin-based German Institute for Economic Research, Germans will spend around €90 billion ($140 billion) this year on coal, oil and natural gas. That's €15 billion ($23.4 billion), or 20 percent, more than they did last year.

"That's a significant cost burden for the German economy," says Kemfert. And, since the additional expenditures of businesses and households for energy mean fewer funds left over to cover other costs, it's also a danger to the economy. Businesses invest less in new machinery, and consumers no longer go out to restaurants and cinemas or refrain from buying new cars, all of which are factors that slow economic growth.

Economists had actually hoped that private consumption would boom this year, and that it would assume the role of the economy's main driving force. For now, though, nothing has come of that, and consumer demand is stagnant.

The Environmental Hit

As they look to the future—and even though the German economy showed an impressive 1.5 percent growth rate in the first quarter—many economic experts are already considerably more pessimistic. The fear now is that this could simply result in the coming crash being all the more severe.

Moreover, according to the latest predictions, the currently high energy prices could seriously reduce this year's rate of growth. That the economy suffers when energy prices rise is hardly surprising. But there could be a second victim of the increasing costs in Germany: the environment.

German Chancellor Angela Merkel had planned to make this week the tentative high point of her environment stategy. Before presenting herself to the world as nature's protector on Wednesday at the UN Conference on Biological Diversity in Bonn, Merkel wanted to finalize her climate-policy masterpiece in the cabinet. The last outstanding decisions were supposed to be resolved, such as how by 2020 Germans would emit 40 percent less carbon dioxide than they did in 1990.

The package of measures is called "Meseberg 2" after the federal government's guesthouse near Berlin. It was there, last summer, that the grand coalition last demonstrated something like a capacity for action.

Now the whole plan—from energy conservation and heating cost regulations to environmental taxation of automobiles—threatens to collapse around Merkel.

A Wedge in the Coalition

Since energy prices started their rapid rise, Merkel's party has developed a phobia of anything that might carry a whiff of further costs to the electorate. "We judge every measure first and foremost in terms of costs for the consumer," says Katherina Reiche, the deputy chairwoman of the CDU's parliamentary group, in describing the party's new line. Using this battle cry, CDU member of parliaments are fighting to cut the conservation requirements in the package as much as possible.

Environment Minister Gabriel's behavior is just as inconsistent. On the one hand, he urges that the Meseberg package be waved through without any cuts. On the other, he advocates for commuter tax relief calculated to help owners of older, less fuel-efficient cars, a demographic he evidently assumes to include a high number of voters for his party, the SPD.

The CDU-SPD coalition is hopelessly at odds with itself, failing to make a decision on stricter regulations for energy conservation or to provide incentives for environmentally friendly cars and trucks. Last week the coalition was unable to reach an expected agreement on a reform of the automobile tax, and the remaining points of the Meseberg package were postponed once again. Now more than ever, it is unclear how the government plans to reach its loudly proclaimed goal of cutting CO2 emissions by a further 20 percent over the next 12 years.

A Silver Lining?

Yet, at the same time, experts actually see in the rising energy prices of the last months a chance to bring the economy and the environment even closer together. It would be wrong, they argue, to try to counteract the hike in oil and natural gas prices by reducing the petroleum tax or environmental taxes. According to their reasoning, Germany ultimately wants to move away from oil, and the increase in prices is sending the right signal.

In their opinion, the right reaction to an increasing scarcity of resources would be to implement the government's climate-protection measures more efficiently than is currently being done. More funds need to be allocated to modernizing antiquated power plants, they argue, and fewer to questionable subsidies for the expensive solar-power industry.

Nevertheless, it appears that the CDU and SPD can no longer agree on a rational energy and climate policy. Instead, both sides prefer to sharpen their battle rhetoric. For example, a high-ranking employee at Gabriel's Environment Ministry says: "The CDU and CSU sit there like the Russians during the Cold War and answer everything with ‘nyet.'"

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