Brussels has recommended member states pass on some of energy companies’ inflated profits to consumers as part of a plan to cushion rising wholesale electricity prices in Europe.
In a draft paper presented to the Financial Times, the European Commission advises governments to set a maximum price that non-gas power producers can book and suggests that they reallocate any excess profits these companies make above that level – a system which would be like a windfall tax.
The recommendations, to be distributed among energy ministers from the 27 EU member states before a meeting in Brussels next week, were leaked days after European Commission President Ursula von der Leyen pledged to take swift action to deal with Europe’s energy crisis .
In a speech after the summer break, she announced short-term intervention – something that could be triggered “very quickly, maybe in weeks” – and announced a longer-term “structural reform of the energy market” that is likely to come next year.
How does the EU energy market work and why are prices so high?
European energy prices are set by what is known as a marginal pricing system, whereby the most expensive power plant used to meet demand on any given day sets the wholesale electricity price for all suppliers.
As such, gas-fired power plants, which still keep lights alive in many countries, tend to dictate the wholesale electricity price for the rest of the market, even though renewable electricity can be produced more cheaply.
Historically, there has been little desire to overhaul the system, even as the share of clean power in the energy mix increased. It was hoped that higher wholesale electricity prices would encourage green energy development by increasing the profit margin for lower-cost renewable energy projects.
But as gas prices have soared to record highs this year – largely because of Moscow’s decision to cut supplies to Europe – so have electricity costs. More and more policymakers are therefore calling for a new approach that allows cheaper renewable energy to be sold at a lower price. Polish Prime Minister Mateusz Morawiecki said on Tuesday that proposals to change the market structure “are falling on increasingly fertile ground”.
The UK government launched a consultation on decoupling gas and renewable energy prices in July. The pressure is now growing in Brussels.
What can the EU do to reduce costs for consumers and industry?
In its draft paper, the Commission rejects options proposed by member states that include caps on electricity or retail gas prices, subsidies to neutralize the cost of CO2 emission allowances for industrial consumers who are already under pressure, or even a suspension of the European wholesale energy market.
Instead, she proposes reducing electricity costs through a combination of cuts in electricity demand and a price cap. The latter would work by charging the non-gas power producers the difference between the agreed limit and the actual market price they receive for energy, which is inflated by the high gas price due to the market structure.
Governments “would be required to share the resulting revenue with electricity consumers to lower their electricity bills,” the document said, using words suggesting the measure would work similarly to a windfall tax.
The price cap mechanism could be applied to the day-ahead markets described above, the paper said, rather than pre-agreed trades such as power purchase agreements and power purchased on futures markets, which was a criticism of broader windfall taxes.
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These measures would come on top of efforts to find alternative supplies – the bloc has replaced around a fifth of its natural gas supply from Russia with fuel from other countries – and to spur investment in renewable energy.
The European Commission declined to comment on the leaked draft.
What are the risks?
The authors of the paper, described as a preliminary assessment of the options on the table, said the non-gas price cap was inconsistent with existing windfall tax regimes, which needed to be scrapped.
Countries like Italy, Spain and Greece, which have already introduced such taxes, could object.
With a view to the long-term structural reform of the market, the EU energy agency Acer has warned against tearing open the market structure. An April report said the EU’s wholesale electricity markets are functioning well under normal conditions, ensuring a secure supply of electricity.
Instead, she proposed a “temporary relief valve” that would automatically cap electricity prices during sudden spikes.
William Peck, an EU electricity market analyst at ICIS, a commodity analysis firm, also warned against overhauling a mechanism that had worked well for decades and was still used to incentivize much-needed clean power investments.
Politicians focused on reforming the electricity market because they could not find a quick and sufficient alternative to Russian gas, he said. “If it were me, I would really focus my energies on the gas supply part of this equation and not tearing up a 20-30 year old market.”
What can we learn from the price cap experiment of Spain and Portugal?
Portugal and Spain reached a political deal with the European Commission in April that will allow them to cap the price of natural gas used in power plants. The measure came into force in May and is valid for one year with an upper limit of 48.80 euros per megawatt hour on average.
The 8.4 billion euros in subsidies that the Iberian countries pay to gas companies are largely recouped through levies on electricity distributors, who benefit from the price cap.
The ‘Iberian Derogation’ from state aid rules was granted by the Commission because their electricity bills are highly linked to wholesale energy prices and they have limited energy links with the rest of the EU. Brussels has also argued that the measure will allow the two countries to expand green energy production.
Spain claims that between June 15 and August 15 the price of electricity was €49.85 per MWh lower than without the price cap mechanism, saving consumers around €1.4 billion.
But the amount of gas used for electricity rose from 17 percent between January and July 2021 to 23 percent in the same period this year. Madrid said this was due to the summer drought, which hit hydroelectric power stations.
The Commission said in its paper that this measure would not work across Europe, also because it could further fuel demand for gas.
What’s next?
No timetable was proposed for the actions proposed in the paper, which was not endorsed by the commissioners.
EU energy ministers will meet to discuss the proposals on September 9th. Officials said Von der Leyen could outline a plan emerging from that meeting in her State of the Union address to the European Parliament on September 14.
Additional reporting by Peter Wise in Lisbon
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