15. September 2022
EU takes unprecedented step with 5-10% cut in power demand and redistributing €142 billion in energy profits
The EU Commission on 14 September proposed a plan that would pull in €142 billion in windfall profits earned by power and fossil fuel companies and redistribute it to hard-pressed consumers who have seen their power costs multiply in recent months. At the same time, the European Union aims to cut power use through a mandatory 5% reduction in peak-hour demand. The overall target is a 10% cut in total electricity demand until 31 March 2023. In Rystad Energy’s view, these temporary measures should go a long way in helping the EU’s population through the winter while avoiding some of the detrimental effects of other alternatives that have been discussed in recent weeks. Even so, many details need to be worked out for the plan – if approved – to be effective.
Enforcement of the demand measures will be a real test of Europe’s resolve – thus far, despite the high energy costs, overall European power demand is down just 2% and in the highest-price month, August, demand was just 1% lower than the previous year. The scale of the proposed 5-10% reduction should therefore not be underestimated – it will be a monumental task for households, businesses, and the wider economy to achieve demand cuts of this scale – but ultimately, the reward would be a noticeable effect on power prices as the overall pressure on supply will be eased.
The second measure of a temporary market cap for inframarginal technologies is also an extraordinary initiative never seen in the liberalized European market. Power generation technologies with lower generation costs than natural gas – including renewables, nuclear, and lignite – would get their revenues capped. Some companies generating power from these sources have had the possibility to generate exceptional revenues in recent months, as their power generation costs have remained relatively stable while wholesale power prices have surged. The commission wants to set this cap at €180 per megawatt-hour (MWh), and the surplus becomes “public revenue”, which under this measure would be distributed to electricity consumers.
Considering the current crisis, these proposals seem like a sensible choice, as they seek to balance the market forces while also taking care of the consumers. Many consumers would struggle to make ends meet without any form of compensation through the winter, and the EU is addressing this head-on with these new measures. By highlighting that all the measures are temporary, the EU is also hoping and emphasizing that this would not become a “new normal” and the market will be allowed to return to its usual dynamics once Europe is through the winter.
This is the single largest intervention by the EU in its energy markets since its inception. The redistribution of revenue and cuts to energy demand will require enforcement, but with this plan, the EU is taking a decisive step in helping its population and industry through the winter months. Despite the unprecedented size and scale of the intervention it is designed to be short term and does not address longer term supply issues. The stage is set for bigger and potentially more forceful interventions as Europe continues to decouple its energy supply from Russia.
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The proposed emergency market intervention bill consists of three main measures, as well as several additional initiatives. The plan requires approval from the member states.
1. Exceptional electricity demand reductions
A mandatory 5% cut in electricity consumption during peak hours 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 target is a 10% cut in total electricity demand until 31 March 2023.
2. Temporary revenue cap on “inframarginal” electricity producers
Power generation technologies with lower generation costs than natural gas – including renewables, nuclear, and lignite – would get their revenues capped. The commission wants to set this cap at €180 per megawatt-hour (MWh), arguing that a high cap will allow operators to cover their operating costs and investments. The surplus revenue will be collected by member states and used to help energy consumers reduce their bills.
The measure seeks to target the majority of inframarginal generators, regardless of electricity market timeframe (spot market, forward market, PPAs, feed-in-tariffs, or other bilateral agreements). The targeted revenue will be collected when transactions are settled or thereafter. The commission estimates that €117 billion could be redistributed through this measure.
3. Temporary solidarity contribution on excess profits generated from activities in the oil, gas, coal, and refinery sectors
These sectors are not covered by the inframarginal price cap. The time-limited contribution would take the form of an additional 33% tax rate to be levied by member states on 2022 profits that are more than 20% higher than the average profit over the previous three years. This measure is estimated to collect €25 billion.
Beyond these three main measures, the commission aims to establish emergency liquidity instruments to ensure that market participants have at their disposal sufficient collateral to meet margin calls, and to avoid unnecessary volatility in the futures market. A series of smaller measures were also proposed.
Estimated revenues of €117 billion to be redistributed
How the EU has calculated the estimated revenue figure €117 billion is unclear, as this would be a highly complex question taking inputs from price developments of fossil sources and carbon, the contribution from the inframarginal sources in the power mix over the winter, spot market exposure of different technologies and countries, as well as the evolving dynamics of the overall supply and demand situation.
The sum €117 billion is a staggering amount, which would be diverted from power generators to end-consumers via the member states' governments. The measure has been criticized for including revenue from renewable and nuclear energy that could have been re-invested into more renewables. At a time when Europe is in desperate need of more renewable power supply, it appears strange that the EU would “punish” low-emission, cheap technologies. This is addressed in the proposal by setting the cap at a relatively high level, much higher than where prices were before the 2021-2022 energy crisis. Revenues to low-cost renewables and nuclear would therefore be substantially higher than before the energy crisis set in, even with the proposed cap.
Doubts linger and questions remain over details
The point of the measures is both to ensure that Europe gets through the winter with ensured power supply at all times (mainly addressed by the demand cut measure), and to make electricity more affordable for consumers.
Another potential market intervention that has been discussed in recent weeks is to directly cap electricity and/or gas prices. This would fundamentally disrupt the supply and demand balance and would not solve the fundamental shortfall of gas supply in the market. In fact, a direct price cap could make the situation worse as it would not provide any incentive to save gas or power, and would therefore not help reduce electricity demand. With this in mind, the proposed inframarginal price cap would better fulfil the EU’s target as it does not change the fundamental supply and demand balance, and at the same time makes sure that end-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 distortions in the market by limiting the profitability of low-cost power generators. The EU's view is that it is currently more important to make sure consumers can pay their bills through the winter than to allow “super profits” for power generators.
While there remain more details that need ironing out, there will be an acknowledgment that this intervention, despite its magnitude, is designed to be temporary. €142 billion for a stop-gap measure is a hefty bill. Were the cash directly invested into renewable power generation, for example solar power, it would create an estimated total capacity addition of 121 gigawatts (GW), enough to cover the annual consumption of coal-burning Poland. The entire EU’s current solar capacity is 160 GW. One thing is therefore certain: while this package is considerable in monetary terms and sets a new precedent for intervention, it may prove to be just the start for both spending and intervention by the EU and governments in Europe in the coming years.
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