In this article, we will discuss about how electricity prices are hitting record highs across Europe, slamming people with higher power bills and putting politicians on the spot.
Enjoy the read !
The numbers are shocking. In Spain and Portugal, average power prices are around triple their level half a year ago at €175 per megawatt-hour. In the U.K, they’ve reached an eye-watering €183.84 per megawatt-hour — now the most expensive rate in Europe.
Why power prices are so high? A simple answer is they’re carried by soaring natural gas prices, used across Europe to generate a key percentage of electricity. In 2019, some 23% of European Union electricity was generated from gas. But, the story is more complex, involving issues of power market design, long-term climate strategies. Analysts are already warning the crisis will be prolonged and the worst is yet to come.
What’s the problem?
- Since January 2021, natural gas prices have soared by more than 170% in Europe (Figure 1).
- Higher consumptions for residential heating and air conditioning due to a widespread remote working.
- Rallying EU carbon prices fostering a switch from coal to gas, pushed up overall European gas demand in the first and second quarter of 2021.
How are power prices set in Europe?
EU countries trade electricity on wholesale markets where the goal is to cover the energy demand for every single hour of the following day.
The markets follow a marginal model, which means the final price of electricity for the following day is fixed to the price of the most expensive fuel required to meet projected demand. Utilities and big companies buy and sell power years in advance, relying heavily on forecasts about the economy and long-term fuel costs.
What’s sand into the wheel?
The explosion of renewable energy, which is more discontinuous than fossil-or nuclear-fuel generators.
In 2020, renewables generated 38 percent of the bloc’s electricity. Therefore, overtaking fossil fuels to become the leading source of power in Europe for the first time ever. Nevertheless, wind and solar power are incapable of generating enough power to account for 100 percent of demand year, even in the most favorable climate conditions.
The phaseout of nuclear in countries like Spain and Germany also increases the gap between consumer demand and the electricity supply that can be generated by renewable sources. When the demand exceeds the supply generated by clean power, costly fossil fuels have to be used to meet demand. The price of power is fixed to that value. That’s why the spike in natural gas costs is bad news for power prices.
An additional burden: the Emissions Trading System.
Power companies are obliged to take part in the EU’s Emissions Trading System (ETS), the world’s largest carbon market. Based on a “cap and trade” principle. The ETS is designed to set a price on greenhouse gases and help drive decarbonization. For years, the EU ETS stalled at around €5 a ton. However, a growing push to act on climate change has sent prices spiraling. They’re now about €60 a ton (Figure 2) and consumers risk becoming the final recipients of that additional cost.
What happens next?
The big question is whether the current price spikes are a temporary phenomenon or signs of a deeper problem as the EU undergoes an energy transformation.
“The energy supply-demand balance in the EU will be volatile depending on how quickly fossil fuels are phased out and green energy is phased in.” – Think tank Bruegel.’’
In the longer term, EU countries will continue finding themselves dealing with similar situations. Due to the marginal market system, and until large-scale batteries are developed to store renewable energy when weather conditions are unfavorable. Large batteries exist, of course, and that technology is developing quickly, but it will be many years before they can offer serious storage capacity for renewable energy.
The only question that remains is; “What can you do to reduce electricity consumption in order to limit the rise of electricity prices?”
- Why Europe’s electricity is so expensive – politico.eu
- Why Europe’s energy prices are soaring and could get much worse – euronews.com
- What’s Behind Europe’s Skyrocketing Power Prices – bloomberg.com
- Is Europe’s gas and electricity price surge a one-off? – bruegel.org
About the authors
Senior Mechanical Engineer
David de Brouwer
Founder / Managing Director Engibex