How might EU reform reduce energy bills?

The European Union is preparing to reform its electricity market to end its current unenviable predicament, in which Russian president Vladimir Putin can inflict excruciatingly high energy bills on homes and businesses at will by cutting off the flow of gas through Russia’s pipelines.

As outlined previously in this column, the EU’s electricity market was designed to use gas as a backstop fuel that kicks in when supply from renewables falls short. Through a system called marginal pricing, the gas price sets the wholesale price of electricity from all sources, even those with a lower production cost such as wind and solar energy.

This had been considered a positive policy that incentivised renewable energy production by offering large profits. But the danger of giving gas this role has been belatedly acknowledged in Berlin.

“We’re in a very serious situation triggered by Putin’s manipulations of the gas market,” European Commission president Ursula von der Leyen said in a public debate there this week. “Currently gas dominates the price of the electricity market,” she said. “With these exorbitant prices, what we see is, we’re going to have to decouple.”

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Spain had called for intervention in the market — a rather familiar EU north-south ideological split

Decoupling means removing the role of gas in setting a minimum price for electricity. That sound you hear is a screeching U-turn, including by the Irish Government. On October 25th last year, Ireland was among the signatories of a letter — along with Austria, Germany, Denmark, Estonia, Finland, Luxembourg, Latvia, and the Netherlands — ruling out reform of the EU’s energy market due to surging prices.

Spain had called for intervention in the market — a rather familiar EU north-south ideological split.

High energy costs would be “best addressed through temporary and targeted national actions by Member States, where appropriate, to protect vulnerable consumers and businesses”, the northerners wrote. These interventions could be easily unwound “in the spring, when the situation is expected to revert to average levels”. Officials briefed that this was a short-term crisis and that interfering in the market could have unpleasant unintended consequences in the long-term, such as removing that incentive for renewable energy.

What changed since then? The invasion of Ukraine, and Russia’s repeated cutting of the gas supply to EU countries as it bridles at their support for Kyiv.

“In October you were dealing with what was perceived as market fluctuations but now, with the main supplier of gas being an aggressor, you’re no longer dealing with a ‘market’ playing field,” one official said. “It’s totally at the mercy of Russia to turn off and on that tap.”

Irish officials — along with their German and Austrian counterparts — now consider the market unfit for purpose.

“Electricity is produced today at a price that is much lower than the price at which electricity and gas are sold. There is no longer any link between the cost of production and the selling price,” said Belgium’s energy minister Tinne Van der Straeten. “This European electricity price formation system needs to be reviewed.”

Spain was a forewarning last autumn. It had many low-income households on contracts that directly tracked wholesale electricity markets, and because almost half of its electricity was produced from renewables, the unfairness of paying for all electricity at gas prices was acutely apparent.

But now, the dreaded high energy bills are arriving northwards too. Officials in Brussels swap tales of receiving new household annual electricity bills of more than €7,000 — the Belgian average in April 2021 was €894.75 — as gas trades at close to 12 times its 2021 rate.

European Commission officials are developing proposals for intervention

What can be done?

European Commission officials are developing proposals for intervention. They have a case study available to consider. In April, Spanish prime minister Pedro Sánchez managed to persuade the rest of the EU to allow a so-called “Iberian exception” that let Spain and Portugal cap the price of gas used for electricity at below €50 per megawatt-hour as of June.

The measure helped, but bills still rose as the gas price remained on the march; gas power plants also had to be compensated for continuing to buy the raw fuel at market rates, diluting the effect of the cap. An EU-wide system would have a much weightier impact, however, and Spain is expected to propose the bloc as a whole adopt its system.

Von der Leyen has said the EU-wide intervention would be twofold: an “emergency instrument which would be triggered very quickly”, possibly within “weeks”. Following that, there would be a “deep and structural reform of the energy market, by beginning of next year”. National energy ministers will gather to discuss the ideas in an emergency meeting on September 9th.