The European Energy price crisis
The power market as a barometer
Unlike other commodities, electricity cannot be stored efficiently. This makes the electricity market an essential tool to balance the overall system and ensure that supply matches demand at all times. Unlike on financial markets, every single transaction on the power spot market leads to a physical delivery of electricity. The electricity price is determined by EPEX SPOT 24/7, and for the whole of Europe.
The electricity price surge we have observed in the second half of 2021 has different causes, some of which are:
High global gas demand as a consequence of the post-covid economic pickup,
Low supply, meaning low wind, lower-than-usual gas storage, hydro-levels and nuclear availability,
High CO2 prices, that drove up further the costs of ramping up conventional power plants.
The prices of the power market fully reflect these fundamentals. The market acts as a barometer. This was also confirmed by ACER in its final assessment to the EU Commission on high energy prices. Instead of breaking the barometer by interfering in the price formation process, it is crucial to address the real causes of the price surge while taking measures to protect the end-consumer.
The market design doesn’t cause high prices
The European continent is in the middle of the energy transition. The move away from fossil fuels has become even more pressing in the context of the war in Ukraine. Transparent and reliable price signals that correctly reflect market fundamentals are the best tool to trigger efficient production and consumption decisions and to drive investments in the right generation capacities. Measures to regulate or structure the market would not preserve this investment signal but distort it, necessarily leading to a standstill of the much needed transition.
The link between the power spot and the gas price
The price formation process on the pan-European Day-Ahead market follows the merit order principle. The most expensive unit that has to be activated to meet the demand sets the price. In turn, this also means that the cheapest units, often wind and solar, are dispatched first.
Only when demand can not be met with the cheapest production methods, the higher priced units are activated. This means that there is no compulsory link between the electricity and the gas price. Gas units only set the electricity price in times, i.e. in hours, when all cheaper production units have been fully exploited.
In addition to the high prices, the electricity market has seen increased price volatility, which is an indicator for the need for more flexibility in the system. This can be facilitated in the form of even closer interconnection between the already well connected markets. It can also be in the form of incentives for certain established technologies, such as battery storage or demand-response units that can flexibly ramp up and down their production and consumption. With the right price signals we can ensure that the flexibility is used in an efficient manner and that providers are remunerated.
The pan-European electricity market is the most efficient one in the world and it acts as a model for other regions.
The solution? Build on the existing solid Market infrastructure
Instead of throwing overboard what has been achieved, stakeholders should focus on the following:
To further integrate the European electricity market, as it is key for Europe’s energy security. This means developing further cross-border trading and flows. Europe’s Power Exchanges ensure the optimal use of all interconnections.
To invest massively in renewables and flexibility sources and efficiently integrate these green volumes in the market. Tailor-made trading tools already exist on all of EPEX SPOT’s markets.
To allow reliable and transparent price signals to emerge, to trigger investments in decarbonised technologies. Price signals should also help electricity consumers to adjust their consumption behaviour.
To protect consumers – such measures are indispensable. They should, however, not undermine the efficiency of the wholesale market. The European Commission has published several proposals, the so-called “tool-box”, that provide relief for end-consumers without interfering in the electricity price formation. If governments change the rules on how prices are set, this would freeze all investments in renewable generation and decrease security of supply. Furthermore, consumers should have sufficient information to choose their preferred level of risk exposure, and be enabled to cover this risk.
The pan-European electricity market is the most efficient one in the world and it acts as a model for other regions. The time has come, not to overhaul it, but to make it fully future-proof.