The largest energy market intervention in EU history

The European Commission on September 14 proposed a plan that would raise € 142 billion in unexpected profits earned by power and fossil fuel companies and redistribute them to struggling consumers who have seen energy costs multiply in recent months. At the same time, the European Union aims to reduce energy consumption through a mandatory 5% reduction in demand during peak hours. The overall goal is a 10% reduction in total electricity demand until 31 March 2023. According to Rystad Energy, these interim measures should do a lot to help the EU population during the winter by avoiding some of the damaging effects of other alternatives that have been discussed in recent weeks. Even so, many details need to be worked out for the plan, if approved, to be effective.

The application of demand measures will be a real test of Europe’s determination: so far, despite high energy costs, overall European energy demand has fallen by only 2% and in the month with the highest price, August, demand it was only 1% lower than last year. The size of the proposed 5-10% reduction should therefore not be underestimated – it will be a huge task for households, businesses and the economy at large to achieve demand reductions of this magnitude – but ultimately the reward would be a significant effect on electricity prices as the overall pressure on supply will be eased.

The second measure of a temporary market capitalization for inframarginal technologies it is also an extraordinary initiative never seen in the liberalized European market. Power generation technologies with lower generation costs than natural gas, including renewable energy, nuclear and lignite, would get a cap on revenue. Some companies that generate energy from these sources have had the opportunity to generate exceptional revenues in recent months, as their energy production costs have remained relatively stable while wholesale energy prices have risen. The commission wants to set this ceiling at 180 euros per megawatt hour (MWh), and the surplus becomes “public revenue”, which under this measure would be distributed to electricity consumers.

Considering the current crisis, these proposals seem a sensible choice, as they try to balance market forces while also taking care of consumers. Many consumers would struggle to make ends meet without any form of compensation during the winter, and the EU is addressing this problem with these new measures. Underlining that all measures are temporary, the EU hopes and stresses that this will not become a “new normal” and that the market will be able to return to its usual dynamics once Europe gets through the winter.

This is the largest EU intervention in its energy markets since its inception. Revenue redistribution and energy demand cuts will require implementation, but with this plan the EU is taking a decisive step in helping people and industry during the winter months. Despite the unprecedented scale and scope of the intervention, it is designed to be short-term and does not address long-term supply problems. The stage is set for larger and potentially more energetic interventions as Europe continues to decouple its energy supply from Russia.

Fabian Rønningen, Senior Energy Analyst at Rystad Energy.

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The Emergency Market Intervention Bill consists of three main measures, as well as several additional initiatives. The plan requires the approval of the Member States.

  1. Exceptional reductions in electricity demand

A mandatory 5% reduction in electricity consumption during peak hours is proposed. This would require Member States to identify 10% of the hours with the highest expected price and take appropriate action to reduce demand during those hours. The overall goal is a 10% reduction in total electricity demand until March 31, 2023.

  1. Temporary limit to the revenues of “inframarginal” electricity producers.

Power generation technologies with lower generation costs than natural gas, including renewable energy, nuclear and lignite, would get a cap on revenue. The commission wants to set this limit at € 180 per megawatt hour (MWh), arguing that a high ceiling will allow operators to cover operating costs and investments. The excess revenue will be collected by Member States and used to help energy consumers cut their bills.

The measure aims to target most of the inframarginal producers, regardless of the time horizon of the electricity market (spot market, forward market, PPA, feed-in-tariffs or other bilateral agreements). Targeted revenue will be collected when transactions are settled or later. The commission estimates that € 117 billion could be redistributed through this measure.

  1. Temporary solidarity contribution on excess profits generated by activities in the oil, gas, coal and refinery sectors

These sectors are not covered by the inframarginal price cap. The limited-time contribution would take the form of an additional 33% tax rate to be applied by Member States on 2022 profits more than 20% higher than the average profit in the previous three years. This measure is expected to raise € 25 billion.

In addition to these three main measures, the commission aims to establish emergency liquidity tools to ensure that market participants have sufficient collateral to meet margin calls and to avoid unnecessary volatility in the futures market. A number of smaller measures have also been proposed.

Estimated revenues of € 117 billion to be redistributed

It is not clear how the EU calculated the estimated revenue of € 117 billion, as this would be a very complex issue that would take input from the evolution of fossil and carbon prices, from the contribution of inframarginal sources in the mix. energy during the winter, spot market exposure of different technologies and countries, as well as the evolving dynamics of the overall demand and supply situation.

The sum of € 117 billion is a staggering figure, which would be diverted from energy producers to final consumers via the governments of the Member States. The measure was criticized for including renewable and nuclear energy revenues that could have been reinvested in more renewable energy. At a time when Europe is in dire need of a greater supply of renewable energy, it seems strange that the EU is “punishing” low-carbon and cheap technologies. This is addressed in the proposal by setting the ceiling at a relatively high level, much higher than where prices were before the 2021-2022 energy crisis. The revenues from low-cost renewables and nuclear power would therefore be substantially higher than before the start of the energy crisis, even with the proposed ceiling.

Doubts remain and questions remain about the details

The purpose of the measures is both to ensure that Europe gets through the winter with guaranteed electricity at all times (mainly addressed by the demand reduction measure), and to make electricity more accessible for consumers.

Another potential market intervention that has been discussed in recent weeks is to directly limit electricity and / or gas prices. This would fundamentally disrupt the balance between supply and demand and would not solve the fundamental shortage of gas supply in the market. Indeed, a direct price cap could worsen the situation as it would not provide any incentive to save gas or electricity and, therefore, would not help reduce electricity demand. With this in mind, the proposed inframarginal price cap would better meet the EU target as it does not change the fundamental balance between supply and demand and at the same time ensures that final consumers get relief from high prices.

Another fundamental question is whether the inframarginal price cap is better or worse than not intervening at all, since it would still create distortions in the market by limiting the profitability of low-cost generators. The EU’s view is that it is currently more important to make sure consumers can pay their bills during the winter than to allow “super profits” for power generators.

While more details remain that need to be ironed out, there will be a recognition that this surgery, despite its magnitude, is designed to be temporary. 142 billion euros for a buffer measure is a heavy bill. If the money were invested directly in the production of renewable energy, such as solar energy, it would create an estimated total capacity addition of 121 gigawatts (GW), enough to cover the annual consumption of coal mining Poland. The current solar capacity of the whole EU is 160 GW. One thing is therefore certain: while this package is substantial in monetary terms and sets a new precedent for intervention, it could prove to be just the beginning for both EU and government spending and intervention in Europe in the coming years.

By Rystad Energy

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