Bloomberg: The challenges of the EU emergency plan for the energy crisis

With the energy crisis deepening and winter approaching, the European Union plans to take emergency measures to deal with rising electricity costs hitting businesses and households.

The goal of the Union, as reported by Bloomberg, is in the short term to limit prices and in the long term to change the way energy is priced by decoupling the price of natural gas from that of electricity. Officials are scrambling to put together a plan, but how that will be achieved is not yet clear, as some significant challenges must be overcome.

One problem is that each country relies on a different energy mix, from fossil fuels to pioneering renewables, so a one-size-fits-all approach is unlikely to meet everyone’s needs. Another key question is who will foot the bill – whether it will be through government funding or extra taxation of producers.

Bloomberg proceeds to analyze some possible measures that could include the emergency plan to deal with the energy crisis that the EU is drawing up and the challenges that must be overcome. Particularly:

Spain style ceiling

Spain and Portugal were the first to defy EU competition rules and cap natural gas in order to lower electricity costs. The EU’s antitrust arm said the support would take the form of a payment that would act as a direct grant to electricity producers to finance part of their fuel costs.

The main downside is that lower prices may lead to more exports on cross-border connections to countries such as France. This option would work better if the cap were set at EU level and would be more effective in countries that use more natural gas. Intervening directly in markets is also unpopular with traders.

In Portugal, the government recently stated that the cap system has set prices on average around 17% lower than they would have been in the market without such a mechanism.

Taxes on producers’ surplus profits

With record prices, electricity producers are making big profits that have caught the attention of European policymakers. The UK has already imposed an extraordinary tax on the profits of oil and gas companies, but has avoided extending it to the electricity sector.

German Economy Minister Robert Habeck suggested considering a short-term tax on the “excessive” profits of energy companies.

One problem could be how “excess” earnings are defined. After all, high prices affect European utilities differently. For example, Germany’s Uniper SE needs a huge state bailout as it struggles to cover the cost of replacing the natural gas it lost due to cuts in flows from Russia.

“The measures will likely include taxes on excess profits,” said Ipek Ozkardeskaya, senior analyst at Swissquote Bank. “If this happens, energy companies could react by cutting production, risking further deepening the energy crisis,” he added.

Energy separation

Limiting the influence of natural gas on electricity prices by separating production from renewable energy sources and nuclear power plants from production from natural gas and other fossil fuels has been outlined in detail by Greece. This essentially means lower revenues for clean energy, reflecting its lower production costs.

Decrease in demand

The EU has already agreed and set a voluntary target to reduce gas demand by 15%, but more could be done to coordinate the reduction.

Import price limitation

Italy has long called for a cap on the price of natural gas imports from Russia to limit soaring energy costs. However, countries such as Germany – which is the largest importer of Russian natural gas – appear wary, something Moscow would have to agree with. The US is pushing for a similar cap on Russian oil, but that too faces huge hurdles.

Stable renewable energy sources

Many wind and solar plants already have long-term contracts to sell energy at a fixed price. Those that haven’t can reap huge profits when energy prices are high, but they also face risks. Such as prices falling to zero when there is an oversupply of solar and wind power – something that will become increasingly common as new units join the power grids.

Separating renewables from the natural gas market would be welcomed by many producers and investors if achieved through the extension of CFD subsidies – which set prices – as they would help stabilize energy prices below current levels and they would provide guarantees for future investments.

“From a stability and investor perspective, we would like to see more use of the CFD mechanism, rather than pricing renewable energy based on the cost of natural gas,” said Richard Crawford, head of energy income funds at InfraRed Capital Partners.

Natural gas disconnection

The UK government is considering changes to the wholesale electricity market that would prevent the fluctuating cost of natural gas from determining the price of power produced from cheaper renewables, while introducing incentives for consumers to draw power from the grid when demand is low or supply is increasing. Options for decoupling natural gas include creating a separate market for renewable energy, as well as regional pricing.

But changing the way energy is priced is an extremely difficult feat. Among the biggest risks is causing unintended consequences or deterring future investment.