The EU Commission on September 14 proposed a plan that would snap €142 billion in windfall profits from energy and fossil fuel companies and redistribute them to troubled consumers whose electricity bills have multiplied in recent months. At the same time, the European Union aims to reduce electricity consumption by 5% through a mandatory reduction in peak demand. The overall goal is a 10% reduction in overall electricity demand by March 31, 2023. Rystad Energy believes these temporary measures should go a long way towards helping the EU population through the winter while mitigating some of the adverse effects of other alternatives avoid has been discussed in recent weeks. Even so, many details need to be worked out for the plan, if approved, to take effect.
The enforcement of the demand measures will be a real test of Europe’s resolve – so far, despite high energy costs, total European electricity demand has only fallen by 2%, and in the price-busiest month of August, demand was only 1% lower than the previous year. The scale of the proposed 5-10% cut should therefore not be underestimated – it will be a daunting task for households, businesses and the broader economy to achieve demand cuts of this magnitude – but ultimately the reward would be a tangible impact on electricity prices as the general Pressure on the offer eases.
The second metric of a temporary market cap for inframarginal technologies is also an extraordinary initiative, unprecedented in the liberalized European market. Power generation technologies with lower production costs than natural gas – including renewables, nuclear power and lignite – would limit their revenues. Some companies that generate electricity from these sources have had the opportunity to generate exceptional revenue in recent months as their electricity generation costs have remained relatively stable while wholesale electricity prices have risen sharply. The Commission wants to set this cap at €180 per megawatt hour (MWh) and the excess will become “public revenue” which would be distributed to electricity consumers under this measure.
In light of the current crisis, these proposals seem like a sensible choice as they aim to balance market forces while taking care of consumers. Many consumers would find it difficult to make ends meet in winter without any form of compensation, and the EU is tackling that head-on with these new measures. Stressing that all measures are temporary, the EU also hopes and stresses that this will not become a ‘new normal’ and the market can return to its usual dynamic once Europe weathers the winter.
This is the EU’s largest intervention in its energy markets since its inception. Revenue redistribution and energy demand cuts require enforcement, but with this plan the EU is taking a crucial step to help its people and industry through the winter months. Despite the unprecedented size and scope of the intervention, it is short-term in nature and does not address longer-term supply problems. The stage is set for larger and potentially more forceful interventions as Europe continues to decouple its energy supply from Russia.
Fabian Rønningen, Senior Power Analyst at Rystad Energy.
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The proposed emergency market intervention law consists of three main measures as well as several additional initiatives. The plan requires the approval of the member states.
- Exceptional reduction in power requirements
A mandatory 5% reduction in electricity consumption during peak periods is proposed. This would require Member States to identify the 10% of 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 by March 31, 2023.
- Temporary revenue cap for “inframarginal” power generators
Power generation technologies with lower production costs than natural gas – including renewables, nuclear power and lignite – would limit their revenues. The commission wants to set this cap at 180 euros per megawatt hour (MWh) and argues that a high cap allows operators to cover their operating costs and investments. The excess revenue is collected by Member States and used to help energy consumers reduce their bills.
The measure aims to address the majority of infra-marginal producers regardless of the electricity market timeframe (spot market, futures market, PPAs, feed-in tariffs or other bilateral agreements). The targeted revenue is collected when the transactions are settled or thereafter. The Commission estimates that €117 billion could be redistributed through this measure.
- Temporary solidarity contribution on excess profits from activities in the oil, gas, coal and refining sectors
These sectors do not fall under the inframarginal price cap. The temporary contribution would take the form of an additional tax rate of 33% levied by Member States on profits in 2022 that exceed the average profit of the previous three years by more than 20%. This measure is expected to bring in an estimated 25 billion euros.
In addition to these three main measures, the Commission aims to set up 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 revenue to be redistributed of 117 billion euros
How the EU calculated the estimated revenue of EUR 117 billion is unclear as it would be a highly complex question taking into account fossil and carbon price developments, the contribution of infra-marginal sources in the electricity mix over the winter and the spot market Exposure of different technologies and countries, as well as the developing dynamics of the overall supply and demand situation.
The sum of EUR 117 billion is a huge sum that would be diverted from electricity producers to end users via Member State governments. The measure has been criticized for including revenues from renewable and nuclear energy that could have been reinvested in more renewable energy. At a time when Europe desperately needs more renewable energy supplies, it seems strange that the EU would “punish” low-emission, cheap technologies. The proposal takes this into account by setting the cap at a relatively high level, much higher than prices before the 2021-2022 energy crisis. Therefore, even with the proposed cap, revenues from low-cost renewables and nuclear energy would be significantly higher than before the energy crisis erupted.
Doubts and questions about details remain
The aim of the measures is both to ensure that Europe can get through the winter with a secure electricity supply at all times (mainly addressed by the demand reduction measure) and to make electricity more affordable for consumers.
Another possible market intervention that has been discussed in recent weeks is the direct capping of electricity and/or gas prices. This would fundamentally upset the supply and demand balance and would not solve the fundamental gas supply gap in the market. In fact, a direct price cap could make the situation worse, as it would provide no incentive to conserve gas or electricity and therefore would not help reduce electricity demand. Against this background, the proposed infra-marginal price cap would better meet the EU objective as it does not change the fundamental balance between supply and demand while ensuring that final consumers get some relief from the high prices.
Another fundamental question is whether the inframarginal price cap is better or worse than not intervening at all, as it would still create market distortions by limiting the profitability of low-cost power generators. From the EU’s point of view, being able to pay consumers’ bills over the winter is currently more important than enabling electricity producers to make “super profits”.
While more details remain to be ironed out, it is recognized that this intervention, despite its scale, is intended to be temporary. 142 billion euros for an emergency solution is a hefty bill. If the money were invested directly in generating electricity from renewable sources, such as solar power, it would create an estimated total additional capacity of 121 gigawatts (GW), enough to meet the annual consumption of coal-burning Poland. The current solar capacity of the entire EU is 160 GW. One thing is therefore certain: while this package is sizeable in monetary terms and sets a new precedent for intervention, it could prove to be just the beginning of both spending and intervention by the EU and governments in Europe in the years to come.
By Rystad Energy
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