Energy Price-Fixing Looms over the EU

E urope’s power sector is in a bind. Since harmonizing electricity markets in the mid 1990s, EU leaders believed that the comparatively higher price of natural gas in the wholesale market for energy would spur investment in renewables and thus aid the bloc’s transition to a net-zero-emissions economy. Indeed, the bloc’s “marginal pricing system” is designed such that wholesale electricity prices are set by the last power plant called in to meet overall demand on any given day, a role routinely played by the natural-gas power plants meeting approximately 20 percent of the EU’s electricity demand. The hope behind the pricing system was, in other words, that the forces at work in global energy markets would align with the EU’s ambitious environmental agenda.

But this pricing system is now under severe duress. After undergoing a planned three-day maintenance, Russia’s Gazprom announced on Friday that its Nord Stream 1 pipeline linking Russia to Germany underneath the Baltic Sea, which supplies about 20 percent of the gas Europe imports from Russia, would stay shut indefinitely. Gas storage has attained 80 percent of capacity across Europe, two months sooner than targeted. Meanwhile, the marginal pricing system is delivering too much of the results it was designed to deliver. Power plants running on renewable energy, for instance, are raking in windfall profits from selling power at a market price set by their gas-powered competitors.

The European Commission (EC) is mulling emergency measures in response. EC president Ursula von der Leyen followed several EU heads of state, primarily from Austria and the Czech Republic, in backing a price cap on Russian gas supplied through pipelines. Spain and Portugal already run such a system nationally and are lobbying to extend it to the entire EU. Mechthild Wörsdörfer, the deputy director of the commission’s energy directorate, told a European Parliament (EP) committee that the EC was also considering measures to curb electricity demand. The commission is also reportedly advising member states to tax a share of power companies’ windfall profits — an idea endorsed by Emmanuel Macron — while longer-term reforms to the marginal pricing system are considered.

The precedent set by Spain and Portugal warrants the spotlight. In April, the two countries got the commission’s approval to implement, throughout the following year, a cap on the price of gas used in power plants averaging at around €48.80 per MWh and a corresponding subsidy to companies affected, which is paid for by charges on the electricity distributors the cap benefits. The subsidy has cost an estimated €8.4 billion thus far. With its paltry interconnections to the rest of the continent and electricity bills even more strongly linked to wholesale gas prices than the rest of Europe, this “Iberian exception” was also thought to incentivize investment in renewables. Between June 15 and August 15, the price of gas was €49.85 per MWh lower than it would have been without the price cap, saving consumers around €1.4 billion. Yet the amount of gas used for electricity in Spain has increased from 17 percent to 23 percent between January and July, which Madrid claims was owing to a drought-induced shortage of hydropower.

Given the shortcomings of Spain’s cap on gas prices, the measure the EU is considering will be different. In a draft paper circulated to energy ministers late last week that the Financial Times got its hands on, the EC seemed to suggest that the price cap would not work on an EU-wide basis. Instead, it advised governments to set a price limit on non-gas energy. Such a scheme would involve charging power companies the difference between that agreed-upon limit and their non-gas energy inputs — primarily cheaper renewables — and earmarking the revenue toward financial assistance to households and businesses facing skyrocketing electricity costs.

These two proposed measures — the natural-gas price cap and its more likely alternative, the cap on non-gas power prices — could be complementary, but the latter would be incompatible with existing windfall taxes in Italy, Spain, and Greece. It would be applied to the day-ahead market and would exempt previously agreed-upon deals. Also on the table are other longer-term measures, such as reforming the marginal pricing system to delink electricity bills from soaring gas prices. The success of such reforms would largely depend on how much of its consumption of Russian gas Europe is able to substitute with other sources, which in turn depends on Europe’s demand for liquefied natural gas and the progress made on ongoing infrastructure projects such as the MidCat pipeline linking the Algerian route to Europe through Spain. In the meantime, Europe’s power sector can brace for a heavy dose of price-fixing.