A rising story.
Gas, coal and electricity prices have in recent weeks risen to their highest levels in decades. For example, in Germany, electricity prices leapt last month to their highest level on record, up more than six times from a year ago. In Spain, where gas-fired power generation plays a larger role in setting electricity prices, the increase was even higher.
Why this sharp increase?
There are several reasons for this.
- Last winter was colder than expected. Subsequently, in March, gas reserves were low and need to be replenished.
- Around the same time, the vaccination campaign gained traction, and business activities restarted. Venues reopened, industries amplified their production, consumers spent their lockdown savings.
- In summer and autumn, wind power was lower because of the weather; subsequently, more gas and coal was needed.
Demand is increasing. What about supply?
Supply is growing only slowly. This is due to global effects. In many parts of the world, economic activity has picked up sharply this year. As a result, a lot of energy is required worldwide, and the energy supply cannot rise steeply all over the world at the same time. Notwithstanding this worldwide development, experts say that suppliers could deliver more gas to Europe, especially Russia, the EU’s leading gas supplier. It seems strange that they don’t. Usually, with higher prices, one would like to offer more. Sales and profits would increase.
Why don’t they do it?
One can only speculate about that. Maybe Russia wants to capitalise on the crisis to make the case in favour of their controversial Nord Stream 2 pipeline, the underwater pipeline that was built to transport natural gas from Russia directly to Germany. The project has been criticised for perpetuating the bloc’s dependence on fossil fuels and extending President Putin’s geopolitical influence. The pipeline is now complete but hasn’t begun operations due to bureaucratic hurdles. Russia is pushing for a quick start-up.
Gas isn’t everything. Why has the price of electricity increased at a similar rate?
Now it’s getting a little complicated. The bloc’s wholesale electricity market is based on marginal pricing, also known as “pay-as-clear market”. That means that every electricity producer (whether it is electricity from fossil fuels, coal, nuclear power, wind or solar) bids into the market and offers energy according to their production costs. So there are different costs, starting with the cheapest resources (renewables) and finishing with the most expensive (natural gas). The whole point is that the most costly producer sets the final price of electricity. In times of high demand for electricity, coal and gas power plants need to be switched on to feed into the system. This is why the gas price determines the electricity price.
Can we switch to another system, please?
That would be the “pay-as-bid” system, where the energy producers are free to offer the price they want from the market, not the price based on generation costs. In a position paper, Spain, France, Greece, the Czech Republic and Romania speak out in favour of rule changes in the electricity market. But the European Commission wants to stick to the current regulation. It argues pay-as-bid would reduce transparency and lead to costlier bills. In addition, the commission says, the pay-as-clear market system helps to expand renewable energies. Providers of cheap energy (that is renewable energies) would benefit from this system because the difference between production costs and electricity price is their profit.
Europe cannot do so much about high energy prices because it is dependent on the prices of world markets. Sixty-one per cent of energy available in the European Union is imported. However, there is a big difference between energy prices and customer bills. In some European countries, tax rates and extra levies applied to energy bills make up half of the final price. Until the green shift brings more stability to the market, governments have the resources to counter the effects of high energy prices. In the short term, a mild winter could help.
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