Europe: how does the energy market work and how could they limit price increases?

First modification: 09/02/2022 – 18:36

The price of electricity in Europe is closely linked to natural gas. Hence, the quarrels between Russia and the West over the invasion of Ukraine have triggered unprecedented price increases and, more recently, widespread panic over a possible energy crisis.

That is why the European Union is preparing an emergency plan to separate energy prices from the rising cost of gas, while seeking long-term reforms aimed at ensuring that remuneration rewards cheaper renewable energy.

The energy ministers of the countries that make up the community block will meet on September 9 to discuss how to alleviate the burden of high energy prices on companies and homes as a matter of urgency.

But how does the European energy market work and what changes are proposed?

Gas, price fixer par excellence

In the European Union energy system, wind farms, nuclear, coal and gas plants and all other generators bid to sell their electricity; the cheapest sources are awarded first, followed by the most expensive sources such as gas.

The wholesale price of electricity is set by the last power plant needed to meet the total demand. In other words, the gas plants, since they are necessary to complete that necessary supply, usually set the price.

The idea is that, since energy is purchased from all generators at the same price, those that use cheaper renewable sources have a higher profit margin, an incentive for greater investment in the clean generation that Europe needs to reach the climate change goals.

However, countries such as Spain have said the system is unfair, as it means cheap renewable energy is sold to consumers for the same price as more expensive fossil fuel-based energy.

Why have prices skyrocketed?

Gas prices have soared after Russia began reducing the volumes it sends to Europe, in direct retaliation for Western sanctions it has received since its invasion of Ukraine.

Gas prices are determined by global competition, and European buyers are vying with other countries for available non-Russian gas: higher demand and lower supply mean higher prices.

More expensive gas, coupled with other factors such as problems with French nuclear plants and a severe drought in Europe, which hampered hydroelectric production and affected coal deliveries, make energy more expensive.

Price limit and subsidies, among the intervention proposals

The meeting of the energy ministers of the European Union is scheduled for September 9 to discuss how to deal with the gas shortage and its consequent increase in prices. And incidentally, analyze what reforms can be made in the long term.

Some countries have already presented their own proposals, such as reducing demand, providing financial support to households or subsidizing bills, that is, establishing a limit on the price of gas and the States paying the generators that difference with the price market.

Another proposal is to limit the price for generators that are not gas. The jump in energy prices has left windfall revenues for generators with low running costs and the EU is seeking to limit those revenues.

Higher energy prices have affected the pockets of Europeans. In August, inflation in the euro zone was the highest in history, with prices 9.1% higher compared to the same month last year. In energy alone, inflation was 38.3% in the eighth month of the year.

With Reuters and AP