Making gas price caps work for consumers: five lessons from Portugal and Spain
The task of tackling skyrocketing electricity prices in Europe has been on everyone’s minds over the summer. Policy makers and economists have been pouring over options for reducing bills and accelerating the transition to a less volatile and cleaner energy market. With winter coming, consumers have been preparing for, and are desperately worrying about, the jump in home energy costs.
The situation for consumers today is dire. The war in Ukraine and the rebound from the Covid-19 crisis has pushed energy price inflation in the Eurozone to an unprecedented 38.3%. The actual rise depends on where people live, for example in Belgium, some analysts believe that an average household could spend up to 8,000 Euro per year for their gas and electricity bills in 2023.
In Italy consumers will be asked to lower thermostats in a bid to maintain enough gas supply for the winter months. Energy costs are huge - not to mention the knock-on effects of rising costs for businesses and production.
EU emergency meeting to tackle energy price crisis
Following on from two major plans to end reliance on Russian gas (REPowerEU) and to reduce consumption and increase storage for the winter (Save Gas for a Safe Winter), the European Commission is now targeting policy measures at the reform of the electricity market.
Today an emergency EU Council meeting of energy ministers will convene to discuss short term emergency interventions and broader structural reform. Europe as a whole must together rise to meet this challenge.
Here, we explain how the energy market design is pushing up consumer bills and share our Spanish and Portuguese members' direct experience of one of the measures on the table - gas price caps.
Energy market design at breaking point
Next to windfall taxes on energy companies or rationings, also the more complex issue of the EU’s electricity market design, managing consumer bills and price caps is now grabbing headlines and put under scrutiny.
This is particularly important because, as with any regulated utility market, the way the EU’s energy market is set up has a dramatic impact on the price end users pay. The EU follows what’s called a ‘Marginal Pricing System’ which is thought to be the best system for encouraging competition and innovation and keeping prices low.
The Marginal Pricing System has shown merits in the past when supply was more stable. Its design was also seen to help with the planned green transition because rewards for low-margin cost generation like renewables was built in. However, the current, volatile supply of gas has led to some unintended, perverse and very costly impacts for electricity end users.
Marginal Pricing System shows its limits in current energy crisis
One feature that drives these perverse effects is the way the marginal pricing system fixes prices. The price is based on the most expensive form of electricity. As gas is a high-priced form of electricity, and because the EU is still so reliant on it, it is very influential in driving up the costs of all electricity across the whole market.
"The skyrocketing electricity prices are now exposing, for different reasons, the limitations of our current electricity market design,"
President von der Leyen, Bled Strategic Forum, 29 August 2022
In the past, when the gas price was not so excessively higher than other generation types, any fluctuations were more manageable. The price of gas, already rising before the Ukraine invasion, is now eye-wateringly high and causing shockwaves throughout the European market.
Euroconsumers acknowledges the merits of the marginal pricing system and is wary of any side-effects that tinkering with the model could incur. However, it was not designed for the current circumstances which is why it is no longer behaving rationally.
“The energy market is overheated and out of control. It’s clear we need to intervene some way or the other in the price setting model, at least on a temporary basis, to mitigate the outsize influence that gas prices have on the overall electricity price. But we have to do this carefully, without losing sight of all possible side effects.”
Els Bruggeman, Head of Policy and Enforcement, Euroconsumers
Capping gas prices: first-hand experience with the Iberian model
One way to address the current effect of gas in the overall electricity bill is to cap the price of gas used for electricity production. Price caps work by governments putting an upper limit on the gas price for power stations. This keeps electricity cheaper by decoupling the gas price from the wholesale electricity market price.
Euroconsumers members’ Deco Proteste in Portugal and OCU in Spain have had first-hand experience of this. In April 2022, Spain and Portugal were given exemption from EU energy market rules so that they could apply a cap and lower the effect of sky-rocketing gas prices in electricity production. This problem was already aggravated in Iberia as a severe drought had impacted hydroelectric power production.
Gas price cap absorbs some of the shock of rising bills
The cap in this ‘Iberian brake’ does not prevent a gas price rise, but at a collective level, it significantly reduces the price for electricity powered by renewable and nuclear energy, which will also result in lower bills.
It can be thought of more as a ‘shock absorber’ than an actual ‘brake’. It also leads to a de facto uncoupling of the gas and electricity price, without needing to make any major adaptations to the marginal pricing system.
Deco Proteste and OCU have welcomed this initiative that has protected consumers somewhat from a serious spike in electricity prices. Their first-hand experience with the Iberian model has also led to some invaluable lessons and insights.
Of course, energy markets are part of a complicated system of supply, generation, transportation and use. In such a system, there are no single shot solutions, and any measure will have various advantages, disadvantages and risks.
However, with all EU energy ministers’ eyes on options - what can we learn from OCU and Deco Proteste as they analyse the consumer experience of a gas price cap?
Five lessons from six months of the gas price cap in Spain and Portugal:
Avoiding cross-subsidisation: The price cap has worked on one level by keeping prices lower than the rest of Europe, but we have seen a surge of electricity exports to France, where power fetches a higher price. That effectively means that Spanish consumers are subsidising power for French households. It’s obvious an EU wide price-cap would be more effective and would stop any neighbouring country benefiting from the subsidies paid for by other countries. The Spanish government has been campaigning for such a market-wide cap for many months.
Make the savings clear: Consumers are understandably worried, and expectations for help are high. Consumers may not be particularly impressed by the reduction on each individual bill - mostly because the charge for their contribution for this mechanism is included with the bill. There is also no way to compare what they would have paid at a non-capped price. The mechanisms to reduce bills are not always straightforward, which has meant consumers feel frustrated or in the dark about what they are paying for, whether it is a fair price, and how long they will pay for it. Much more transparency and explanation is needed on the bills or through consumer campaigns to help them understand the true impact of this measure and get their support going forward.
An open mind on funding the cap: Apart from the presentation and lack of clarity around the additional costs of subsidizing the gas price cap, there is also the question of whether the subsidy could be funded by other means. This should be open for discussion as the crisis continues.
Careful of unintended side effects: As described earlier, the price cap on gas actually acts as a de facto capping of the price for nuclear and renewables. This means that at the moment, all energy producers are getting windfall profits as gas is setting a very expensive price for them to sell at. It is not clear if these short-term revenues are being reinvested in the long-term innovations and infrastructure needed for the green transition.
Gas prices are skyrocketing regardless of origin: Although Russia is the main instigator of this energy crisis, the market effect is that gas prices, regardless of origin are also surging. For example, most of Portugal’s gas is imported from Nigeria, in Spain it is mostly from Algeria. Capping only Russian gas will have too little impact and ignores a market reality.
Europe, rise to the challenge!
Amidst war in Europe and in the aftermath of a global pandemic, this complex and far-reaching challenge is no easy task. What’s clear is that there is no single miracle solution and the way -out will be a combination of many. What’s also clear is that we will need all policy levels to rise to the challenge.
The call for Europe to act is big. Rightfully. Just as with the Covid-19 crisis, we will only be able to face an energy crisis that has thrown us into a war economy if we stick together and act together. We need a strong and firm Europe to protect our consumers and companies. Finding a joint EU approach that can provide affordable energy and maintain momentum for the transition to clean, green energy is needed more than ever.
But member state governments cannot use Europe as an alibi to pass on their own political hot potato of what must be done at a national level. They don’t need Europe to for example shut down some public lighting, speed up support for solar panels or increase transparency on consumers’ energy bills. By calling out ‘Europe’ some also conveniently seem to forget that Europe is not just the Commission or Parliament but includes the sum of 27 energy ministers. They too have a seat at that European table and are part of this crucial European decision making.
In light of the crucial EU Energy Council meeting today, Euroconsumers wants to call out to each and everyone involved to rise above any political games, rise above merely national considerations and rise to the challenge.