Is an intervention in the electricity market necessary?

At the beginning of the year, just under 114 euros were due on the European electricity exchange in Leipzig for one megawatt hour of electricity for delivery in one year. At the end of August, the price shot up to almost 1,000 euros per megawatt hour – only to fall back to 550 euros a few days later. What is currently happening on the electricity exchange also has something to do with the increased gas prices, but not only.

While public utility companies or larger companies largely stock up on electricity years in advance, they have to buy from the so-called "spot market" in the event of short-term changes in demand – for the next day or even for the same day. The so-called "merit order principle" plays an important role in the formation of this electricity price, in which the most expensive electricity supplier – who is still needed to cover demand – determines the market price for all others.

"It starts with the cheapest provider with solar energy, wind energy, then comes coal and at some point we end up with gas, which is currently one of the most expensive to produce," says Michael Blumenroth, commodity analyst at Deutsche Bank. The electricity price itself then results from the price that the most expensive provider can offer for the next day.

Gas price drives electricity price

The share of renewable energies in the electricity mix in Germany was around 49 percent in the first half of 2022. However, in order to cover the entire electricity demand – and above all to cover the peaks – power plants operated with gas are still necessary. But the price of the fossil fuel has skyrocketed since Russia launched a war of aggression in Ukraine, as gas supplies to Europe were severely curtailed. The gas price is therefore a very important driver for the electricity price, says Mirko Schlossarczyk from the energy consulting company Enervis.

According to Schlossarczyk, the price of electricity has risen much faster than the price of gas in recent weeks. The price increases could not be explained by the gas price alone. There is unbelievable nervousness and hysteria on the market. This is coupled with the fears of some market participants who have open delivery quantities. They would have to cover these and "of course enter the market at any price".

In addition, almost half of all nuclear power plants in France are idle due to maintenance work and a lack of cooling water. This intensifies the shortage on the European electricity market. France is actually one of the most important electricity exporters in Europe and even had to import electricity due to the situation.

When will price increases end up in households?

"This enormous price increase inevitably reaches the consumer," says Schlossarczyk. Not immediately, but in the coming year – but at the latest in the year after next – they will hit the end consumer. However, wholesale prices are not passed on to households one-to-one. Almost 40 percent of the price for end consumers consists of taxes, duties and levies. 22 percent are due for network charges and meters. 38 percent is for electricity purchasing, service and sales, which are dependent on the market.

Market opinion is mixed as to whether the turbulence in the power market will continue. Measures are already being discussed in politics as to how the European electricity market could be reformed or regulated. EU Commission President Ursula von der Leyen has already said that skyrocketing electricity prices are showing the limits of the current electricity market design. "That's why we are now working on an emergency measure and on a structural reform of the electricity market." Robert Habeck has also already announced that he will decouple the electricity price from the rising gas price.

Energy price cap in Germany?

In other EU countries, progress has already been made. In Spain, for example, an energy price cap for the use of gas in electricity production will apply until May next year. Immediately after the introduction, the price of electricity fell. A model for Germany too? From a social and socio-political point of view, it is of course a problem that energy prices continue to rise, according to Schlossarczyk. He warns, however, to intervene in the market with hasty shots – above all because it is a European market.

In Spain, this has led to comparatively cheap electricity being produced from gas-fired power plants. This cheap stream would then flow to France. "That means there are no savings effects." Instead, even more gas will be converted into electricity. "And that is of course an absolute false incentive." Especially since the basic problem – the shortage of electricity – would not be solved, according to energy expert Schlossarczyk.

Other considerations are to ask the beneficiaries of the high electricity prices to pay. These include wind and solar power operators who generate electricity more cheaply. If their profits are skimmed off, however, they will not be available for the urgently needed investments in renewable energies. However, these would be important in order to squeeze gas-fired power plants out of the electricity mix and bring prices down in the long term. The faster you get away from the gas price, the better, says Blumenroth from Deutsche Bank. Expanding renewable energies as quickly as possible is the topic of the hour.