Six flaws in the EU Electricity Emergency Tool and how to fix them –

Tomorrow the European Commission will present its proposal for a so-called electricity emergency tool – a mechanism to claw back unexpected profits from electricity producers and use the money to support electricity consumers. Ingmar Schlecht, Lion Hirth and Christoph Maurer evaluate the proposal.

Ingmar Schlecht is a research associate at the ZHAW Winterthur and head of the consulting firm Neon Neue Energieökonomik. Lion Hirth is Professor of Energy Policy at the Hertie School in Berlin and Director of Neon. Christoph Maurer is Managing Director of the consulting company Consentec.

Since it was first announced, the idea of ​​a clawback mechanism has been hotly debated. The feasibility of such an instrument was questioned given the complexity of the European electricity market.

Contrary to popular belief, this market includes not only the coupled day-ahead auction on power exchanges, but also other short-term markets such as intraday and balancing markets, over-the-counter trading and a whole range of long-term financial markets.

Portfolio-based bidding and self-dispatch imply that it is impossible to link bids to physical assets.

Electricity producers often hedged their production on futures markets years ago and effectively fixed the prices at that time, so that the current spot prices are not a good indicator of the producers’ profits.

The key element of the Commission’s proposal to address these challenges is a temporary revenue cap on all realized revenue from so-called “inframarginal” electricity producers such as renewables and nuclear, regardless of which market they sold the electricity to.

In our view, the proposal has many advantages over alternative interventions that have been circulated in recent months. It intends to leave the wholesale price unaffected and is therefore less likely to hamper incentives to save energy or distort export flows to neighboring countries.

It is important that this avoids excessive natural gas consumption and thus does not drive up gas prices.

While the approach seems correct, we think there are six specific ways to improve it: exclude new investment, base it on physical production, treat financial markets appropriately, use a technology-specific cap, capture less than 100%, and use a floating cap.

First, investments in the new generation should be exempted from the cap, especially investments in renewable energy. This crisis is basically an energy supply shortage, and every generator that is built will shorten the crisis. It’s far better to give investors big incentives than discourage them from investing by threatening to cut their profits.

Second, collection of revenue from short-term markets should be independent of which market is used. Instead, it should be calculated from physical production. These metered amounts should be multiplied by the day-ahead price, regardless of where and at what price the companies sold their electricity.

This gives companies the incentive to sell their electricity where it is highest. It also mimics the design of existing contracts for difference.

Third, the instrument’s treatment of financial futures and futures markets should change to reflect the fact that they are financial contracts that are settled against spot prices. Profits derived from futures transactions should be recognized independently of actual performance.

Instead, these should be calculated from the installed capacity. This is to prevent producers from stopping production in order to evade the obligation to pay. Financial losses from hedging must also be taken into account. Businesses should be compensated for such losses, but these should be offset against spot market earnings.

Fourth, the cap should be differentiated by technology, as some technologies receive more crisis-related windfalls than others: not only gas, but also coal prices (and coal transport costs) are at all-time highs – but the costs of nuclear, lignite and renewables have not changed .

Fifth, the cap should not capture 100% of the revenue above the cap, but a smaller proportion, say 90%. This sets decisive incentives for planning power plant maintenance.

Sixth, the cap should not be a fixed number but expressed as a formula that “floats” with carbon and fuel prices. Otherwise, an increase in raw material prices would force power plants out of the market, so that they would have to be replaced by gas-fired power plants.

With these six changes, the instrument of the revenue cap could, in our opinion, significantly relieve European electricity consumers and at the same time leave the wholesale electricity market intact.

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