European electricity market: "We need a reform to stimulate low-carbon investments and guarantee supply"

Source: LeMonde, The world | by some french dudes? and translated by Google

Posted january 6, 2023 at 06:00, updated at 06:00

Due to soaring electricity prices, several opposition representatives, from the Rassemblement national to La France insoumise, including the Republicans, are calling for an exit from the European electricity market to lower consumer bills. , citing the example of Spain and Portugal. While qualifying this market as "badly done for a very long time" , Emmanuel Macron promised, Thursday, January 5, for the second half of 2023 "a reform of the electricity market so that it depends [on] production costs" .

How does this market work? As electricity cannot be stored, the principle of the European system consists in guaranteeing the balance between supply and demand for electricity on a European scale, by calling on the least expensive means of production as a priority. When it is no longer enough, other means are brought in, always favoring the least expensive. But the market price depends on the cost of production of the last plant to come into operation, which is often gas-fired. The more the gas plants are in demand, the higher the market price. This is the case this winter, due to the shutdown of many French nuclear reactors and the war in Ukraine, which has caused gas prices to soar.

Several European countries using a lot of gas to produce electricity, such as Germany and Italy, the European electricity market, which sets a single price regardless of the means of production, may therefore seem unfair for a country like France which has a large nuclear fleet .

But is the European market solely responsible for the current price spike? Are Spain and Portugal really out of it? Would France have an interest in following their example? Interviewed by Le Monde , Nicolas Goldberg, expert at Colombus Consulting, delivers his analysis.

What is wrong with the European market?

Many of the reproaches made to the European market are in fact the result of a misunderstanding. What some politicians are saying is that electricity prices are pegged to gas prices because of the Germans and that's why their prices are high, but that's not true. This system has one virtue, which is that the balance between supply and demand is achieved at the lowest possible cost. Each producer has an interest in offering the lowest price in order to receive the marginal tariff [the difference between the cost of production and the tariff for the last kilowatt-hour produced]. This can, of course, generate excess profits, but they are currently taxed and this taxation feeds the tariff shields. The reproaches of political leaders are therefore unjustified and the Germans have nothing to do with it.

On the other hand, what can be criticized for this system is that it encourages the sizing of production capacities as accurately as possible. Today, France sometimes imports electricity when it could produce it, quite simply because it is cheaper. The European market guarantees this ability to import at the best price, which is a good thing for consumers. But that does not encourage us to invest in production capacities, which reduces our room for manoeuvre. When you encounter a problem such as corrosion of nuclear facilities or gas supply difficulties, there is a risk of a shortage, as we can see today. This is the reason why opposition leaders who do not understand this functioning or want to use it for political ends are asking for a way out, citing, wrongly, the example of Spain and Portugal.

Precisely, have these countries really left the European electricity market?

No, that's completely wrong. They remain fully integrated into it, but have obtained a temporary exemption which allows them to cap the wholesale price of gas and reduce consumer bills by only 10% to 15% because the cost of the device is re-invoiced to consumers. But this is also what other Member States of the European Union [EU] do indirectly with tariff shields financed by taxing excess profits . The French government tells us of a saving of 20%. It is therefore more effective than what Spain is doing, without the perverse effects .

One country has indeed left the European market, it is the United Kingdom. It is still connected to the European network and continues to import electricity, but negotiates it over the counter and the tariffs are necessarily higher than if it had remained there and decoupled from the rest of the EU. Strangely, the political leaders who want to get out of it do not cite this example...

So France would have no interest in leaving it?

The answer is clearly no, for two reasons. The first is that it lacks electricity today, which has not escaped anyone. However, the European market makes it possible to import massively at the best price, a price harmonized at European level. When France is an exporter, on the other hand, he guarantees us that there will always be outlets, even when our nuclear power stations are producing at full capacity, because this electricity is cheaper than fossil fuels and France can use these interconnections to export. In this case, we don't hear anyone saying that we have to get out of it.

This European market therefore has a double benefit: when we have overcapacity, it allows us to export at very good prices and bring in foreign currency; when we are short of capacity, which is rather the case at the moment, our supply remains guaranteed at the best price. The interconnections have also shown their good functioning this winter.

Should it, despite everything, be reformed?

I think it is necessary. The market was developed in a logic of great liberalisation, at a time – the 1990s – when the fight against climate change was not the primary concern and when the European electricity system was very overcapacity. It contributed to the closure of means of production, in particular coal-fired power stations, but did not encourage investment. This system is myopic. It does not encourage looking at things in the long term.

We need a reform to stimulate investment in low-carbon production and guarantee security of supply, which would also limit the effects of speculation. In normal times, the European market protects us from it, because there is no reason to speculate when security is guaranteed; this was not the case this summer, when the risk of a shortage emerged, which opened the way to speculation. Among the avenues for reform, there is therefore that of imposing prudential rules on electricity suppliers so that they hedge themselves in the long term and are less subject to the ups and downs of the market.