Changes are coming in the EU energy market.
The skyrocketing natural gas prices – one of the negative effects of Russia’s invasion of Ukraine and the subsequent reduction in deliveries to Europe – and the resulting increase in electricity prices are generating growing conviction among political leaders that the current market structure is no longer fit for purpose.
“Energy prices are breaking record after record. The consequences for households and businesses are not sustainable,” European Commission President Ursula von der Leyen. said Tuesday at the Baltic Sea Summit in Denmark.
“We need to tackle this, together and urgently,” he said as he joined politicians from eight countries bordering the Baltic Sea.
That is bolstering the hopes of longtime skeptics of the EU electricity market, which sets prices according to a so-called order of merit, with the last input needed to balance daily demand setting the price for the entire market. That has recently been very expensive gas.
“The proposals we are making to change the price formation mechanism are falling on increasingly fertile ground,” Polish Prime Minister Mateusz Morawiecki told the summit. He said he had spoken with the leaders of Denmark, Finland and Estonia, “and all three agree that we really need to bring about a change” that frees energy prices from dependence on Russian gas.
Facing concerns that Russia will shut down its already reduced gas flows this winter, the EU is rapidly increasing its storage: it is now at 80 percent, the level forecast for November 1.
That has calmed prices a bit. One-year electricity contracts in Germany it fell to €625 per megawatt hour on Tuesday from a high of more than €1,000 per MWh on Monday. Dutch TTF gas futures, the European benchmark, fell to €250 per MWh on Tuesday from a high of €339 per MWh on Sunday.
The reforms will be discussed during next week’s emergency summit of EU energy ministers. What is not yet clear is how a change in energy markets would work.
Any short-term intervention is likely to take the form of some kind of price cap and would add to the tangle of national measures already put in place by EU countries, said Cillian O’Donoghue, policy director at Eurelectric, an association commercial. representing 3,500 European public service companies.
“Gas prices play a big role in the price of electricity, and gas prices are exceptionally high, seven times higher than they normally are,” he said. “So finding an efficient way to decouple them has some added value.”
A similar system already exists in Spain and Portugal. The two countries managed to get Brussels to agree in June on a so-called Iberian exception that allowed them to decouple the price of gas from electricity for a year by establishing a maximum gas price of around 50 euros per MWh.
“It has definitely lowered Iberian prices” in the wholesale market, said Cem Bektas, energy markets analyst at consultancy ICIS.
But it has seen an increase in electricity exports to France, where power prices are higher.
That means Spanish taxpayers, whose money is collected by the government and then redistributed to keep prices low, are effectively subsidizing energy for French homes. Madrid and Lisbon have allocated 8,400 million euros to the measure.
The system would work better if it covered the entire block, so there would be no such leaks.
Another option would be to impose a windfall tax on energy producers or utilities, something that Spain, Italy, Romania and Greece have already done and an idea that is gaining traction in Germany, although it is causing tensions in the ruling coalition.
Von der Leyen also wants to renew the design of the electricity market in the long term, which generates even more unknowns.
One option, initially proposed by Greece, would divide the market into producers of renewable energy and fossil fuels. It would then price power from renewables to allow generators to profit less than they currently do from gas prices, keeping the rest of the market as it is. Consumers would then pay an average of the two prices.
Although this would lower energy prices, prices would still be relatively high, while gas would also remain expensive, said Glenn Rickson, head of European energy research at S&P Global. It could also discourage investment in renewable energy, making it less profitable.
Another option is a “pay-per-bid” system, where producers bid on energy contracts that depend on their generation costs, which are much lower for renewables than fossil fuels, including gas.
But producers are likely to simply guess at the price that gas providers are presenting and bid just below that, Rickson said, which again would fail to drive prices down drastically.
This shows the need to tackle “the root of the evil” – Europe’s dependence on fossil fuels from unreliable partners, said Eurelectric General Secretary Kristian Ruby.
“We also need to focus on where the real problem lies and try to address the fact that, at this point in time, electricity market reform…will not change the flow of money that is currently going to Russia,” he said.
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