The largest intervention in the energy market in the history of the European Union

The European Union Commission on September 14 proposed a plan that would strip €142 billion of windfall profits made by energy and fossil fuel companies and redistribute it to hard-pressed consumers who have seen energy costs double in recent months. At the same time, the European Union aims to reduce energy use through a mandatory 5% cut in rush hour demand. The overall goal is to reduce total electricity demand by 10% through March 31, 2023. In Rystad Energy’s view, these temporary measures should go a long way in helping EU residents through the winter while avoiding some of the adverse effects of other alternatives that have been discussed In recent weeks. However, many details must be worked out for the plan – if it is approved – to be effective.

Enforcement of demand measures will be a real test of Europe’s resolve – so far, despite rising energy costs, overall European energy demand is down just 2% and in the most expensive month, August, demand is only 1% lower than last year. So the proposed 5-10% reduction scale should not be underestimated – it would be a huge task for households, businesses and the broader economy to achieve demand reductions of this magnitude – but in the end, the bonus will have a noticeable impact on energy prices as the general pressure on supply will be relieved.

The second measure of the provisional market value of inframarginal techniques It is also an extraordinary initiative unprecedented in the liberalized European market. Power generation technologies with lower generation costs than natural gas – including renewables, nuclear and lignite – will determine their revenues. Some of the companies that generate power from these sources have had exceptional revenue potential in recent months, as their power generation costs have remained relatively stable while wholesale electricity prices have soared. The commission wants to set this cap at €180 per megawatt-hour (MWh), and the surplus becomes “public revenue”, which under this measure will be distributed to electricity consumers.

Given the current crisis, these proposals seem like a reasonable option, as they seek to balance market forces while also taking care of consumers. Many consumers will struggle to make ends meet without any form of compensation during the winter, and the EU is taking these new measures head-on. By highlighting that all measures are temporary, the EU also hopes and assures that this will not become the ‘new normal’ and will allow the market to return to its usual dynamics once Europe gets through the winter.

This is the largest single intervention by the European Union in energy markets since its inception. Redistribution of revenue and reductions in energy demand will require implementation, but with this plan, the European Union is taking a decisive step in helping its residents and industry during the winter months. Despite the unprecedented scale and scale of the intervention, it was designed to be short-term and not address long-term presentation issues. The stage is set for larger and possibly more forceful interventions as Europe continues to disconnect its energy supplies from Russia.

Fabian Roningen, Senior Energy Analyst at Rystad Energy.

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The Emergency Market Intervention Bill consists of three main measures, as well as several additional initiatives. The plan requires the approval of member states.

  1. Exceptional reductions in electricity demand

A mandatory 5% reduction in electricity consumption during peak hours is proposed. This will require Member States to identify 10% of the hours with the highest expected price, and to take appropriate measures to reduce demand during those hours. The overall goal is to reduce total electricity demand by 10% through March 31, 2023.

  1. Temporary revenue cap on “inframarginal” electricity producers

Power generation technologies with lower generation costs than natural gas – including renewables, nuclear and lignite – will determine their revenues. The commission wants to set this cap at €180 per megawatt-hour (MWh), arguing that the higher ceiling would allow operators to cover their operating costs and investments. Surplus revenue will be collected by member states and used to help energy consumers reduce their bills.

This measure seeks to target the majority of sub-marginal generators, regardless of the electricity market time frame (spot market, forward market, power purchase agreements, feed-in tariffs, or other bilateral agreements). Target revenue will be collected upon settlement of transactions or thereafter. The commission estimates that 117 billion euros could be redistributed through this measure.

  1. Temporary joint contribution to excess profits resulting from activities in the oil, gas, coal and refining sectors

These segments are not covered by the Inframarginal price cap. The time-limited contribution will take the form of an additional 33% tax rate levied by member states on 2022 profits that are 20% more than the average profit over the previous three years. This measure is estimated to raise 25 billion euros.

In addition to these three main measures, the Committee aims to create contingent liquidity instruments to ensure that market participants have sufficient collateral to meet margin requests, and to avoid unnecessary volatility in the futures market. A series of smaller measures have also been proposed.

Redistribution of estimated revenue of 117 billion euros

How the EU calculated the estimated revenue figure of €117 billion is unclear, as this would be a very complex question that takes input from fossil resource and carbon price developments, the contribution from non-marginal sources to the energy mix during the winter, and immediate market exposure to different technologies and countries, as well as On the evolving dynamics of the general situation of supply and demand.

The sum of 117 billion euros is a staggering sum, which will be transferred from power generators to final consumers through the governments of member states. This measure has been criticized for including in revenues from renewable and nuclear energy that could have been reinvested in more renewable energy sources. At a time when Europe is in dire need of more renewable energy supplies, it seems odd that the EU “punishes” cheap, low-emissions technologies. This is addressed in the proposal by capping at a relatively high level, much higher than what prices were before the energy crisis in 2021-2022. Thus, the returns from low-cost renewables and nuclear energy will be much higher than they were before the energy crisis, even with the proposed cap.

Doubts remain, and questions remain about the details

The aim of these measures is to ensure that Europe goes through the winter with a guaranteed energy supply at all times (dealed primarily by a demand reduction measure), and to make electricity more accessible to consumers.

Another potential market intervention discussed in recent weeks is a direct cap on electricity and/or gas prices. This would fundamentally upset the balance of supply and demand and would not solve the fundamental shortage of gas supply in the market. In fact, setting a direct price cap could aggravate the situation because it would not provide any incentive to save gas or energy, and thus would not help reduce electricity demand. With this in mind, the proposed cap on the network infrastructure price would better meet the EU’s target as it does not alter the basic balance between supply and demand, while at the same time making sure that end consumers get some relief from higher prices.

Another fundamental question is whether capping below the range 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. The European Union considers it now important to ensure that consumers can pay their bills during the winter rather than allowing “super profits” for power generators.

While there are still more details that need to be ironed out, there will be an acknowledgment that this intervention, despite its scale, is designed to be temporary. 142 billion euros for a measure to close the gap is a huge bill. If the money were invested directly in renewable energy generation, for example solar power, this would create an estimated total capacity added of 121 gigawatts (GW), enough to cover the annual consumption of coal-fired Poland. The current solar capacity for the entire European Union is 160 GW. So one thing is for sure: while this package is significant in monetary terms and sets a new precedent for intervention, it may prove to be just the beginning of spending and intervention by the EU and governments in Europe in the coming years.

by Rystad Energy

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