Facing soaring energy prices — how the EU is tackling the energy crisis
By Olivier Prigent, cabinet of Viorel Ștefan, ECA Member
With its adoption of the Green Deal in 2019, the European Commission launched a set of long‑term policy initiatives, the overarching aim of which is to make the EU climate neutral by 2050. Various elements of the Deal related to energy and involve, among other things, reviewing the Energy Taxation, Renewable Energy, and Energy Efficiency Directives. Greatly increased energy prices caused by the war in Ukraine threw up yet another challenge for the EU, which had to act quickly, without compromising on its long‑term objectives. What measures did the EU introduce to tackle the high‑energy prices? Olivier Prigent, attaché in the cabinet of Viorel Ștefan, ECA Member, explains how prices are set within the EU electricity market and outlines both the expected impact and challenges of the EU measures adopted by the Council.
Why did both my electricity and gas bills increase in 2022?
Between early 2021 and mid‑2022, my gas bill doubled. This was due to the fact that energy demand increased as most parts of the world recovered from the COVID‑19 pandemic, reigniting consumption, and invasion of Ukraine by Russia. As a result, EU gas trading prices increased 16 fold (see Figure 1).
Figure 1 — Evolution of TTF gas futures
But why did my electricity bill go up as well? First, because the EU generates about one quarter of its electricity using natural gas. Second, because the EU energy market is based on a ‘pay‑as‑clear’ pricing model (see Box 1 and Figure 2). In order to meet power demand at a given time, power producers bid into the market by establishing their price according to their production cost. Renewable energy sources are produced at nearly zero marginal cost (sun, wind and water being either free or cheap), and related bids are therefore usually the lowest. The bidding goes from the cheapest to the most expensive energy source. The cheapest electricity is bought first, next offers in line follow. Once the full demand is satisfied, everybody obtains the price of the last producer from which electricity was bought: this is the market‑clearing price. According to the Commission, this model is the most efficient for a liberalised and ‘well‑functioning’ market. Most EU countries used it before it became anchored in EU legislation. Such a system also encourages energy transition by increasing the profits of the renewable energy industry, which faces high capital costs and low operational expenditure.
Figure 2 — Pay‑as‑clear pricing model (illustrative numbers)
However, a side effect of this model is that, when the price of a given energy source drastically increases, it affects the price paid to all power producers. Since a quarter of EU electricity was being produced from natural gas, the high gas prices pushed all wholesale electricity prices up (see Figure 3). The low availability of nuclear power, due to plant maintenance, and hydropower, due to drought, exacerbated the price increase.
Figure 3 — Wholesale electricity prices in selected member states
What was the EU’s first step in reacting to the looming energy crisis?
In May 2022, the Commission published its REPowerEU plan, a plan for saving energy, producing more renewable energy, and diversifying the EU’s energy supply by way of new targets, cooperation with third countries, and new legislation. Most of these actions are described below.
Where will the money come from?
The REPowerEU plan stated that €210 billion was needed to phase out Russian fossil fuel imports. It was therefore proposed to cover part of this need by using both unspent funds from the 2014–2020 EU budget, and loans and grants not taken up under the EU’s COVID‑19 Recovery and Resilience Facility (RRF) — an instrument originally set up to mitigate the impact of the pandemic. A key principle of this facility is that no investment or reform may harm either the environment or the climate: the ‘do no significant harm’ principle.
In December 2022, the European Parliament and the Council struck a deal on using EU RRF funds for REPowerEU measures. The deal included an exemption from the ‘do no significant harm’ principle for measures that allay the EU’s immediate energy security concerns — in other words, COVID‑19 recovery funds can now be used to finance gas projects.
What did the EU do to ensure security of gas supply and decrease gas bills?
Another immediate reaction of the EU was to start storing gas. In June 2022, the EU imposed minimum gas storage obligations on member states: underground gas storage had to be at least 80 % full before November 2022, and 90 % before subsequent winters. Consequently, EU member states’ storage were filled at higher rates and levels than in 2021 (see Figure 4).
In addition to increasing gas storage, demand can also be reduced. In July 2022, member states agreed on a regulation to reduce gas demand by 15 %. To achieve this target, the Commission suggested actions such as switching fuels for electricity and industrial production, implementing energy efficiency measures, and reducing heating in offices (as many of us have probably experienced). This Regulation was based on Article 122(1) of the Treaty on the Functioning of the European Union (TFEU), which allows the Council to adopt a regulation on the basis of a qualified majority of member states, without formal negotiation with the Parliament, in the event that severe difficulties arise in the supply of certain products, such as energy.
In parallel, the EU diversified its gas supply by securing a commitment from the US to deliver more liquefied natural gas (LNG), and by signing two agreements, one with Egypt and Israel for the export of natural gas to Europe, and another with Azerbaijan to increase cooperation in the field of energy. In 2002, the EU began operating two new gas interconnectors, between Poland and Lithuania and Greece and Bulgaria, to facilitate gas exchanges between member states.
Last but not least, in December 2022, the Council approved a regulation establishing a mechanism for limiting excessive gas prices, a ‘gas cap’, and another allowing joint gas purchases. These two regulations were also based on Article 122(1) of the TFEU. The gas price cap came after weeks of discussion that split opinion across the EU member states as to the emergency crisis measure that should be taken. Some feared that such a cap would divert gas supply to other continents. Council members finally agreed to trigger a cap if prices exceeded €180 per megawatt hour for three days in the Dutch Title Transfer Facility (TTF) gas hub’s front‑month contract, which serves as the European benchmark.
What did the EU do to reduce electricity bills?
The EU encouraged electricity savings as a means of decreasing electricity bills. In October 2022, the Council approved the regulation on an emergency intervention to address high energy prices which included, under the various conditions specified, two demand reduction targets, i.e. an indicative target to reduce overall electricity consumption by 10 %, and a mandatory target to reduce electricity consumption by 5 % during peak hours. Indeed, it is the consumption at peak hours which requires the most burning gas, currently the most expensive source of electricity production, and therefore setting the overall electricity price as per the ‘pay‑as‑clear’ model. In December 2022, the Council also agreed on a regulation to speed up permits for renewable energy projects. Both regulations were also based on Article 122(1) of the TFEU.
What about super profits?
High gas prices obviously benefited fossil fuel companies, and higher electricity prices benefited power producers that did not generate electricity from gas, both of whose revenue and profit increased significantly (see Figure 2), while costs remained the same. To correct these super profits, the Council, in the context of the regulation on an emergency intervention to address high‑energy prices, introduced a temporary ‘solidarity contribution’ whereby fossil fuel companies’ extraordinary profits would be taxed at 33 % in 2022 and/or 2023.
The same regulation caps the market revenue of certain electricity producers (those using mainly renewable energy, nuclear energy and brown coal) in that, even though these lower‑cost producers will still sell their electricity at the market‑clearing price, member states will recover revenue in excess of €180/MWh (see Box 2 and Figure 5). Member states can then use the proceeds of both contributions to support, for example, vulnerable households, renewable energy projects and cross‑border energy projects.
Figure 5 — Cap on market revenue from power generation (illustrative numbers)
What else did the EU do to support households and companies?
In 2019, Directive (EU) 2019/944 on the internal market for electricity laid down the conditions under which member states may use regulated prices to support households and microenterprises. One of the conditions for such public intervention was to set a price above cost. However, in the regulation on an emergency intervention to address high‑energy prices of 6 October 2022, the Council allowed member states to set regulated prices below cost and extend them to SMEs. One means of compensating distributors for this would be for national governments to pay them the difference between the market price and the regulated one.
Was all this effective?
Gas prices in December 2022 were at their January 2022 level. Figure 6 shows the evolution of gas prices in 2022 and summarises the main EU initiatives described above.
Figure 6 — Evolution of EU gas prices in 2022, main events, and EU initiatives to deal with the energy crisis
There was clearly a speculative bubble in March 2022, shortly after the war broke out in Ukraine. However, since Russian gas initially kept flowing to the EU, prices decreased, before starting to increase again before the summer, which is precisely when the EU was filling its gas storage (see Figure 7). This begs the question as to whether the EU inflicted pain on itself by setting over‑ambitious refilling targets. However, prices fell abruptly in September 2022, while the EU was still filling its storage. With prices in February 2023 lower than in January 2022, it may also be argued that some EU measures, or a combination thereof, have been partially effective.
Two other factors clearly played a role in driving down gas prices:
- Europe experienced its second‑warmest year on record in 2022. In particular, the winter in the EU up to at least February 2023 was mild, while the US and Russia froze, with temperatures as low as -40°C in Montana and -30°C in Moscow. This allowed the EU to save gas and keep gas storage levels above 70 % at end of January 2023;
- high inflation rates slowed EU growth considerably in the second half of 2022. Although this is not good economic news, the sluggish growth also meant decreased energy needs.
Figure 7 — Comparison of EU gas prices and gas storage levels in 2022
Has the problem been solved?
So, with gas prices lower than in January 2022, is the EU energy crisis behind us? Well, as Figure 1 shows, gas prices are still around three times higher than they were at the beginning of 2021. Second, most households will not see an immediate decrease in their energy bills because most domestic energy prices are regulated and governments have shielded them against part of the price spike. Third, some households and SMEs renewed their energy contracts last summer, when prices were at their highest; they are therefore now stuck with prices that may lead them to the verge of bankruptcy. Fourth, some inland member states may still face difficulty in finding alternatives to Russian gas pipelines because they have no interconnections with LNG hubs. Last but not least, the EU will need to refill storage facilities to 90 % of capacity in the spring of 2023 to prepare for next winter.
What other challenges does this bring?
As explained above, the Council used Article 122(1) of the TFEU to adopt regulations quickly, bypassing the European Parliament. That was efficient, but prevented democratic debate on regulations with far‑reaching consequences in not only the field of energy, but also in that of taxation, in the only EU Institution that is directly elected by EU citizens. ExxonMobil actually took the EU to court in December 2022 over the 33 % ‘solidarity contribution’ to be paid by fossil fuels companies. It claimed that this contribution was a ‘tax’, and challenged the use of Article 122(1). One can also wonder whether certain temporary adjustments to the electricity and gas markets (e.g. the capping of electricity revenue) might actually be made permanent via the electricity market reform the Commission is due to propose in March 2023.
The current energy crisis provides an opportunity to speed up the energy transition. However, to satiate our addiction to gas, COVID‑19 recovery funds assigned to REPowerEU could be used to finance new gas projects. It was stated in ECA review 01/2022 that ‘fossil fuel subsidies hinder or increase the cost of the energy transition’. New gas infrastructure that will be operated for decades before ultimately becoming stranded could spoil this opportunity to achieve a faster energy transition.
This article was first published on the 1/2023 issue of the ECA Journal. The contents of the interviews and the articles are the sole responsibility of the interviewees and authors and do not necessarily reflect the opinion of the European Court of Auditors.