Another Extraordinary Energy Council: where to from here?

European energy markets have been ravaged this year. Since the Russian invasion of Ukraine sparked Western sanctions and retaliatory gas delivery cutbacks, the cost of electricity has soared across the continent. Yesterday, the latest of a handful of extraordinary energy council meetings on the crisis took place in Brussels, seeking solidarity through better coordination of gas purchases, exchanges of gas across borders and reliable price benchmarks, as the Council of the European Union put it. With a less-than-excellent outcome, we are dedicating this week’s #FridayFeature to taking stock of the current situation, and more importantly, considering where we can go from here.

Where are we?

As it sits, we are heading into a relatively mild winter which can be interpreted as good news for markets. But problems remain. Next winter, gas supply is already expected to be more critical than this year. On top of that, climate change has not relented and the energy transition towards a net zero economy by 2050 requires a large volume of investments. Unfortunately, the current investment rhythm is far from what is needed to deliver this objective on time, and the energy crisis is not providing investors with any certainty, either. In fact, the opposite.

What we are experiencing in Europe is a crisis, to be sure, but a crisis caused by the price of gas, as shown in our #PowerBarometer22. With our current marginal pricing mechanism, the price of electricity that has soared this year is set by the cost of generating the last unit of electricity that satisfies demand. Right now, that unit is generated by gas. The European Commission has made attempts to address this problem with a cap on inframarginal revenues (read, all lower-cost generation technologies that are not gas), but this really addresses the symptoms rather than the underlying problem.

We see this in our own calculations that show earnings before tax, depreciation and amortisation, or EBITDA, of the five major utilities in Europe, up 28%, are nowhere close to the massive increase in the five major oil & gas companies’ EBITDA of 127%. This spread has clearly maimed investor confidence as the Euro Stoxx Utilities index has lost 7.93% of its value while the Euro Stoxx index for Oil and Gas is up a whopping 17.12%. Indeed, the cap has been supplemented by a “solidarity contribution” (read, tax on fossil generation), although the brunt of the impact has still been felt by utilities, not oil and gas companies.

What is more, the implementation of the inframarginal cap has been haphazard at best. We have been witnessing a patchwork of national implementation measures, rather than a coordinated implementation, that is harming the internal electricity market and undermining investments in much-needed renewable and low-carbon infrastructure. Poignant is the fact that power purchase agreements (PPAs) for renewable energy projects are down from 8.5GW last year to 3.5GW this year, as shown by the RE-Source Platform , thanks to a loss of investor confidence.

What has the council decided?

In short, not a lot changes today’s circumstances. Earlier this week, the Commission proposed a market correction mechanism for the gas market. While we have been calling to address the root cause of the energy price crisis for months, such a proposal admittedly lacks any teeth. The implementation conditions mean that the cap would not have been triggered even at the highest gas prices observed this summer. Against this backdrop, the meeting featured widespread disapproval from Member States, both for and against, resulting in deferral to yet another extraordinary emergency Energy Council meeting to take place on 13 December.

The "gas price cap” however, was not the only point on the agenda. Measures on permitting and joint gas purchasing were also up for discussion, and in fact, informally agreed to. On permitting, agreement came on the RES emergency, temporary measures to faster permitting in the coming 18 months, marketed as the “RES Booster Package”. Unfortunately, the package falls extremely short of unlocking the necessary volumes in the next two years. The focus remains on small-scale installations and repowering projects. As for the gas provision measures, the energy sector is carefully assessing the consequences and possible flaws of the text.

Additionally, these agreed-upon measures will not go into effect until an agreement is reached on a “gas price cap”, anyways. Fragmentation remains. Many countries do not agree on the “gas price cap”, and even when they do agree on measures, such as permitting and joint purchasing, implementation at the national level often lacks coherence and the intended impact is lost in obscurity. Alas, not much has changed since before the extraordinary council.

Where can we go from here?

As outlined in the REPowerEU strategy, the solution to this crisis is clean, direct electrification. We need a massive, immediate deployment of renewables. However, regulatory uncertainty is having a real impact on investments in renewables. To this effect, in a letter sent earlier this week, we have urged the Commission to provide clear guidance and examples of best practices to Member States on how to properly implement proposed regulations. Failure to do so will continue to undermine investor confidence at the very time when it is needed most and could have negative consequences for the security of supply and gas consumption.

Specifically, on rolling out the renewable capacity required by #REPowerEU, the permitting improvements need to go much further. While granting “Overriding Public Interest” status is a constructive provision, its application for pending procedures and list of technology and areas that could benefit from it remain optional for Member States. Failure to use it for existing pipeline projects will make the provision void.  The Spanish case says it all: today Spain has 140 GW of combined RES generation stuck in the permitting pipeline when we only need 60GW to reach 2030 targets. Overcoming this barrier will be vital to instilling confidence in investors, and thus a recovery in the PPAs market and wider renewables rollout. Now, co-legislators have the chance to agree on an assertive long-term permitting framework in the finalisation of their positions on the Renewable Energy Directive. The Plenary vote takes place in December and the Council is also expected to finalise their opinion in the coming weeks.

Beyond that, on 15 December, the Council will begin discussing the future of the electricity market design. Subsequently in Q1 2023, the Commission is expected to adopt its proposal for a new electricity market design. What we call for here is the protection of the current marginal pricing mechanism. It is essential to understand that the current market design is not the cause of the high electricity prices. The current market design based on merit order and marginal pricing has ensured the short-term optimisation and operation of the energy system while delivering significant benefits for consumers. The benefit of this system is clear. As highlighted in EU Agency for the Cooperation of Energy Regulators (ACER) ’s Final Assessment of the EU Wholesale Electricity Market Design, welfare effects of the internal energy market, cross-border trade, and efforts to integrate electricity markets over the last decade delivered approximately €34bn per year in benefits for consumers.

The way out of the energy crisis is not an easy one but there are things we can do. The key is a coordinated effort, something that we are currently lacking. Nonetheless, some thoughtful consideration of policies now can absolutely set us up for achieving 2030, and indeed 2050 targets, while protecting customers and keeping investors engaged in the transition.