Evolution of electricity prices
Since the end of 2020, the wholesale electricity market prices have maintained an upward trend, reaching new record highs. This is mainly due to the continuous increase in prices in the international gas market, and the increase in carbon pricing.
According to a report published last month by OMIE, the electricity market operator that manages the day-ahead and intraday electricity market in Spain, the price per megawatt hour has reached the highest recorded to date.
To see the trajectory of the price of electricity, below are 2 very illustrative images:
Monthly evolution of electricity prices in Europe – 2021 (€ / MWh)
Average monthly electricity prices in Europe – February 2022 (€ / MWh)
These figures show clearly the delicate situation that Europe is experiencing with respect to the electricity market. In the case of certain countries, such as France and Italy, the price of a megawatt/hour has almost quadrupled in 6 months.
We cannot understand the increase in the price of electricity without analysing the close relationship that it has with another source of energy: gas. Fluctuation in the gas market affects the price of electricity since there is a marked interdependence between both markets.
What is the relationship between electricity and gas?
The production of electricity depends on different factors, one of which is gas. This fluid determines the price of electricity, despite the fact that it only represents a small part of electricity generation. The price of gas holds so much weight in the price of electricity due to the current system of price fixing in the wholesale market. In short, the most expensive technology, gas, directly or indirectly affects the price of all electricity, wherever it comes from and regardless of its cost (which is very low in the case of solar power, wind power, or water from reservoirs). When wind and water are scarce, the brand also affects the price.
Although gas generated electricity represents only 13% of electricity production, its increase in cost is amplified in the wholesale electricity market, and half of the increase in the price of electricity is attributed to gas. Consequently, the prices of both markets have experienced an increase never seen before, with prices 10 times higher than in years prior to 2021.
The question now is: why has the price of gas tripled, and how does it affect the electricity bill?
A simplistic answer would suggest the short-term costs associated with the energy transition to a green planet. However, this statement has further implications, that we will see below.
Deciding factors for the increase in the price of electricity
In Europe, there have been three key factors that have led to this unprecedented increase:
Firstly, Russia, and its gas shipments to Europe
In the context of a growing global demand for gas, especially from Asian countries, Russia has considerably limited its imports to Europe, causing a constant increase in the price of European gas. Russia wants to limit itself exclusively to complying with its long-term gas delivery contracts, and to fulfil the existing needs of its population.
Despite this, the main reason for the price increase in Europe is the delay in the launch of Nord Stream 2. This gas pipeline is Russia’s newest method of sending gas to Europe, and will increase the capacity of the current route, Nord Stream. However, due to compliance issues with German legislation, Germany has delayed its construction, causing demand to outstrip supply, and prices to rise.
This situation, which was already an issue at the end of 2021, is currently worsened by the armed conflict that is taking place between Russia and Ukraine.
Russia is the country with the most gas reserves in the world, thanks to the installations on the Yamal Peninsula that contain over twice the reserves of the EU. Consequently, Europe is heavily dependent on Russian gas. Unsurprisingly, about 40% of imported natural gas comes from Russia.
There is also a great dependence in Europe on Russian gas, as about 40% of imported natural gas in Europe comes from Russia.
In addition to this energy dependency, we cannot ignore the fact that the prices of natural gas from Russia have skyrocketed, as the West has tightened economic sanctions against Moscow. This situation affects the price of electricity.
Secondly, the price of gas in Europe.
Currently, the increase in gas imports from Norway has not been able to meet European demand, which has meant that the price of European gas has been exposed to the international markets for Liquefied Natural Gas (LNG). This resulted in the TTF index (the European gas reference price) surpassing the Asian LNG reference price in mid-December 2021. Several LNG shipments were therefore diverted to Europe, slightly alleviating demand.
Due to demand and the different gas flows, gas prices experience constant fluctuations, and always with an upward trend. As we have mentioned before, this has a direct impact on the price of electricity.
Thirdly, the increase in CO2 emissions prices (carbon pricing).
With the aim of encouraging investments in sustainable alternatives and achieving the objective of reducing CO2 emissions by 55% before 2030, the European CO2 emissions market has proposed a series of legislative initiatives that increase the price of CO2 emissions. This rate has reached over €60/tonne, which represents a 200% increase compared to 2020.
If we focus on the rise in electricity prices, in addition to the increase in gas, it is also necessary to highlight the continuous increase in the price of CO2 emissions.
- The price of electricity continues to be inflated by increases in the price of gas, and by the increase in CO2 emissions, reaching all-time highs in all three areas
- If the capacity of renewable energies fails to meet more of the demand, electricity prices will continue to be closely linked to the evolution of the gas market, and to emissions pricing
- Forecasts predict that the gas price will remain high until at least mid-2023
- The markets estimate that electricity prices will remain above €100/MWh until the end of 2023, followed by a gradual reduction year after year