Anders Brønd Christensen
September 24, 2023
The energy crisis added EUR 336 billion to EU electricity bills in 2022
New Ramboll research finds that the natural gas and CO2 prices were the two biggest contributors to the record-high electricity prices in 2022. But that’s not the full story.
In 2022, Europe witnessed an energy crisis with extremely high electricity prices.
While the high prices have been covered extensively in the media, the crisis also exposed more fundamental cracks in Europe’s electricity market design.
That is the stark conclusion in a new whitepaper from Ramboll energy modelling experts Søren Møller Thomsen and Victor Juarez and head of gas infrastructure, Per Jørgensen.
They find that the biggest contributor to the energy crisis was the skyrocketing price of natural gas. But a higher CO2 quota price, the result in part of a switch from natural gas to coal, and record-low output from the French nuclear fleet, as well as drought in Europe severely limiting hydropower all contributed to a perfect storm, causing European electricity prices to peak at an unprecedented 600 EUR/MWh in the summer of 2022.
In total European consumers paid 336 billion more for electricity in 2022 than they would have had the price drivers been at their 2019 level.
We spoke to Søren Thomsen and Victor Juarez to understand what their research can tell us about why electricity prices suddenly soared and what consumers can do to safeguard against extreme prices in the future.
The cost of volatility
What does your model tell us?
Søren Thomsen: “We were really interested in understanding the root causes of the energy crisis, so we developed our electricity market model that allows us to simulate the price of electricity under different conditions. We use 2019 as a reference year, as that was the last ‘normal’ year before Covid. By changing different parameters – for example, by using the 2019 gas price but leaving all else equal – we can isolate each cost driver. This allows us to see the influence of each key price driver and how they each influenced the electricity price.”
Why is the electricity price so sensitive to high natural gas prices?
“Europe’s electricity market uses the marginal pricing principle, which means the last plant to produce electricity sets the price. Although gas plants do not produce all that much energy, they set the price in many hours because they are the most expensive.”
“That also means you had other sources of electricity, like nuclear and wind, which did not see their operational costs go up, but which received a far higher revenue because the price was set by plants that were very expensive to operate."
Victor Juarez: “The main advantage of the marginal clearing price mechanism is that it helps effectively allocate resources by matching supply and demand. But as we show there is also a vulnerability built into the system."
“For consumers, these hourly price fluctuations enable us to adjust our electricity consumption to low-cost hours whenever possible. This benefits the overall system and promotes sustainability, as cheaper hours often align with higher renewable energy generation.”
The market simply cannot react fast enough to high CO2 quota prices – it may only add to inflation.
“While the day-ahead market is just one of several electricity markets, long-term markets exist as well. These markets, which include organised futures markets and bilateral contracts, allow market participants to establish prices for buying or selling electricity in the future. Many companies use these markets to hedge their production or consumption, mitigating exposure to the short-term price volatility of the day-ahead market. Unfortunately, for many end consumers, accessing these hedging opportunities through retailers has been challenging. Fixed-price contracts in the retail market have been cancelled or renewed with price increases, limiting their ability to take advantage of these options.”
The cost of quotas
You also find that the CO2 quota was the second-biggest contributor to the high electricity prices. Why is that?
Victor Juarez: “The EU ETS scheme is a cap-and-trade quota system. As the number of available quotas is reduced over time, the price goes up. But because of the high price of natural gas, we have also seen a switch back from natural gas to coal, which is more polluting. A more polluting power sector uses more quotas, which increases the demand and therefore the price of each quota.”
“The CO2 quota price was around 70% higher in 2022 than in 2019. According to our model results, had the CO2 quota price been at its 2019 level, the electricity prices in Europe would have been 14% lower on average.”
Søren Thomsen: “This is of course also a bit sensitive because it speaks to the political nature and design of the quota scheme. When quota prices peak at, say EUR 100 per tonne on a short-term basis, we may say ‘this is good because it helps drive decarbonisation’, but we cannot in the very short term build new power plants or offshore wind power to alleviate it.”
“In the energy sector it takes a long time to build things, so here the case can be made that, the market simply cannot react fast enough to high CO2 quota prices – it may only add to inflation.
A discussion of the right CO2 quota price-level and market structure in Europe is needed, as well as clarity on future CO2 quota prices. The best way forward to ensure reduction of emissions while keeping electricity prices low requires a discussion."
Prepared for the next spike
Is there anything consumers can do to protect themselves from future price spikes?
Victor Juarez: “One option is to secure fixed price agreements, rather than variable tariffs. This limits exposure to sudden shifts in electricity prices, and it is an element in the electricity market reform package proposed by the European Commission [In March 2023, ed.], in which retailers are mandated to provide options for fixed price contracts.”
“Another way for consumers to protect themselves against high electricity prices is to invest in behind-the-meter solutions – generating power themselves with or without storage units. For regular consumers this could mean installing solar PV on their roof where regulations allow and large industrial consumers may invest in onsite solar PV or wind turbines. This can make consumers less vulnerable as they consume less electricity from the market."
Understanding the electricity market model
The electricity market model mimics the European day-ahead market. The electricity price is found by matching supply and demand and setting the price at the level of the last, and therefore most expensive, electricity source.
The model enables Ramboll to change the variables impacting the electricity market – the price of coal, natural gas and CO2 quotas, and the output of renewables, hydro and nuclear power – to answer questions like: what would the electricity price have been if the natural gas price had been the same as in 2019?
Want to know more?
M: +45 51 61 12 49
Senior Director Business Development
+45 51 61 87 76
Søren Møller Thomsen
M: +45 51 61 24 21
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