Sebastian Herold, Professor for Energy Economics in Darmstadt, is an expert who is greatly in demand right now. A discussion about a frequently underestimated subject, the vagaries of the merit order principle – and how his graduates are helping to drive the carbon turnaround.

An interview by Kilian Kirchgeßner, 6.10.2022

impact: Professor Herold, do you remember the moment when you noticed that a tsunami was rolling towards you as an expert in energy economics?

Professor Sebastian Herold: Indeed, never before have I received so many enquiries for interviews and talks. But the drama of the current situation unfolded gradually, there were signs last year of the threatening scenario instigated by Russia, and it was already being discussed there in expert circles. I myself published an article at the end of 2021 saying that the low filling levels of Gazprom’s storage tanks here are likely to be a deliberate means of exerting pressure on Europe in general and Germany in particular.

impact: Many among the general public were surprised at how dependent Germany is on energy imports from Russia. Is there anything about the energy crisis that surprised you too?

Herold: Something positive comes to mind: there really is an opportunity to get through the winter without rationing – despite all the hardships that exploding prices represent for many people and also for businesses. But in view of our dependency, which was much lower during the Cold War and has increased more and more over the past years, this is nevertheless an amazing achievement. Think only of the liquefied natural gas that is delivered to ports and then finds its way to Germany via the Netherlands, Belgium and France. This has shown just how flexible the global market is, and that was a very positive surprise.

impact: You’ve been monitoring the energy market for decades. What do you find so fascinating about it?

Herold: There has long been a strategic element and that is what fascinates me. To what extent can you trust someone? Make yourself dependent? I think the strategic and political implications – in addition to the economic aspects – make the topic particularly interesting. I even wrote my diploma thesis on German-Russian natural gas relations.

impact: You studied economics…

Herold: … and energy is an excellent topic for illustrating economic issues. Energy is the basis of the economy, which is coordinated on very differentiated markets: every day, energy companies operate in parallel on wholesale and consumer markets, there are interweavings, dependencies and cross-connections – as can be seen very clearly at the moment when the cost of electricity rises because of the high gas price.

impact: This is due to power plants that are fired by gas and as a consequence produce expensive electricity. Behind this is the merit order principle, which has been on everyone’s lips recently. How often have you been obliged to explain it over the past weeks?

Herold (laughs): I’m explaining it constantly at the moment, recently even in the context of a satirical programme on TV. This principle really is omnipresent in the media right now because it is, after all, behind the sharp rise in electricity prices.

impact: According to the merit order principle, electricity always costs as much as the most expensive power plant demands. If 99 percent of the electricity comes from cheap sources, but the last percent is produced by an expensive gas-fired plant, everything costs as much as this last percent. Isn’t there a better alternative?

Herold: At the end of the day, merit order is simply a special term for completely normal behaviour in the area of supply. It exists in all other markets with homogeneous goods too, but there it’s simply called something else. And the state could, of course, fix or cap prices in order to put an end to the merit order principle.

impact: That sounds like a “but”.

Herold: Precisely: it would be entirely unwise. Firstly, one state intervention always leads to the next, and that would trigger a chain reaction. And secondly, high prices do not just mean that profits are being reaped and distributed somewhere. From the point of view of economics, they show how vast scarcities really are. This immediately has an aligning effect on consumption and guides future investments. Temporary subsidies can help households and businesses in need of support in a much more targeted way than price interventions.

impact: What are the high prices actually doing to the energy sector – is there a sense of euphoria there because there is movement in the market, or is there similar panic to that among many consumers?

Herold: That always depends on whom in the sector you ask. Some are facing the challenge of procuring energy for the coming year – they are naturally under pressure in view of the prices and need to ensure sophisticated risk management. At the same time, the high prices suddenly make projects worthwhile that were commercially uninteresting before, for example in the area of renewable energies. It’s possible now to get ideas rolling here that would previously simply not have been a business case.

impact: Are you noticing a rush on the Energy Economics degree programme now that the importance of this topic is becoming generally clear?

Herold: The topic was already very present before – after all, energy economics and climate protection are two sides of the same coin because the energy sector produces most of the CO2 emissions. Changing this is a tempting thought for many young people. At the same time, there is the highly dynamic energy sector in the background, where many changes will take place in the next few years. This is leading to great opportunities for graduates.

impact: How many students are enrolling at the present time?

Herold: We usually have 30 to 40 students per year on the Bachelor’s programme and around 25 on the Master’s programme. When energy economics topics are particularly in the public eye, this does not immediately increase interest in the programme in the next semester; we only notice this with some time delay from the number of prospective students.

impact: How big is the contribution that energy economics experts can make to the energy transition – aren’t engineers needed more?

Herold: The energy transition won’t succeed if the technology fails to work, that’s clear. But energy economics questions and how energy policy is shaped are the deciding factors in how quickly and how fundamentally the energy transition can be put into practice – and at what cost. They also determine how market stakeholders will deal with each other in the future, what degree of freedom they have, who makes how much profit and whether this profit comes from good ideas and good management in a competitive market or through lobbying and subsequent state intervention. We prepare our students for this environment.

impact: How exactly does this preparation look?

Herold: Our degree programme at Darmstadt University of Applied Sciences has a unique selling point: we teach comprehensive skills both in energy technology and energy economics, meaning that our students attend courses in energy technology held by colleagues from engineering in addition to courses in energy economics, as well as general business management courses. This equips them with an excellent set of tools: in the energy sector, it’s always a matter of thinking about technological and economic aspects together. Our graduates also understand the language of engineers, and that is extremely important because it enables them to tackle and coordinate joint projects.

impact: So your graduates could build a substation?

Herold (laughs): They are, of course, energy economists and not electrical engineers. But having gained suitable professional experience, they can in any case manage a project in which a substation is built.

impact: And when making small talk, energy economics experts are not at a loss for words either at the moment, are they?

Herold: You’re absolutely right: the question of the right time to buy heating oil is an all-time classic. Recently, the focus has been on how high gas and electricity prices can continue to rise. But whether we have profound knowledge of the sector or not: we don’t have a crystal ball either.