The decoupling between the Iberian electricity markets and the rest of Europe demanded by Spain and Portugal and accepted by the European Commission is fulfilling its promises: the prices per MWh on the wholesale markets are today three times lower. Would this plead for a disintegration of the single electricity market, a return to national markets in which those who do not rely on gas would reap the fruits of this backward movement? Not so fast…
This mechanism has a cost: the subsidies granted by the governments of two countries to the gas used to run the power stations, even if they do not pay for it in full. The plan guarantees that electricity producers buy their gas at 40 euros per MWh from July, then gradually more (+5 euros per MWh per month) to reach 70 euros per MWh at the end of 2022.
The subsidy put in place almost exclusively benefits the Iberian Peninsula. This de facto decoupling is made possible by the weak interconnection between the Iberian Peninsula and the rest of the continent, otherwise all of Europe would get its supplies from the Spaniards and the Portuguese. Moreover, the subsidy is not entirely financed by the Spanish and Portuguese States. Buyers on the wholesale market of cheap Spanish or Portuguese electricity will also have to return part of their earnings. It will also be partly supported by the increase in the flow of electricity between Spain and France to the point of creating a congestion income for which the network operator is remunerated. This artificially inflated financial flow will have to be refunded to the States. This mechanism gives the impression of taking back with one hand what the other hand has given, but above all it makes it possible to limit the amount of State aid while striving to remain effective. And we see that it works: since then, the price of the Iberian MWh has settled at a level very much lower than that of the rest of Europe and everyone wins (in Spain and Portugal at least) in appearance.
State aid
The Commission has accepted this breach of the laws of the market and this state aid because gas prices strongly affect electricity prices, which in turn have strong economic consequences in Spain and Portugal (as everywhere else). These are safeguards. In its decision, the Commission highlights the isolation of Spain and Portugal: it is impossible for the other countries to drink indirectly from the subsidized Iberian gas. This therefore means that such a measure is inapplicable in highly interconnected countries such as Belgium and even France. Because the marginal French unit is most often a nuclear or hydraulic power station, with a very low production cost: France, if it might isolate itself from the rest of Europe and obtain a similar agreement from the Commission, would gain without doubt but might no longer export its electricity either (when neighboring countries need it). Neighboring States (the prices observed today in France are, in fact, still a little higher than here).
The vices and virtues of marginal cost
That’s the whole dilemma, purposely isolating a national electricity market from the rest of the continent has drawbacks. In addition, the marginal cost mechanism (it is the operating cost of the last plant started up to ensure the balance between electricity supply and demand which sets the price on the wholesale markets) has now been decried. , over time, has shown other virtues: that of promoting renewable energies, the marginal cost of which is almost zero since they run with the wind or the sun. As long as fossil fuel power plants are needed to balance supply and demand, these power plants determine the price and bring a comfortable margin to renewable energy producers (to the point that they should no longer be subsidized) and this encourages them to be installed more. This reasoning was reasonable with stable wholesale prices per MWh of around 50 euros per MWh observed over the last decade, not with the current prices ten times higher. The margins become indecent.
The Iberian gas subsidization mechanism was indeed provided for by the Commission in its communication of 18 May (1), which provides guidelines for intervening in the energy market in the short term. The Commission had consulted the sector. No one wants to fundamentally jeopardize the operation of the electricity market. We gain too much in security of supply, says the Commission, and in efficient use of resources since the cheapest and least polluting production is exploited first (renewable). But as all the experts agree that the price of gas will remain very high for at least the next two years, the Member States of continental Europe (very largely interconnected) must together find a measure similar to that of Spain and of Portugal, under penalty of plunging all citizens and businesses into deep economic distress. If it is only a question of subsidizing the gas of the few production units with the electricity gas necessary to ensure the balance between supply and demand, the gain obtained will exceed the expense. The operating cost of gas-fired power stations subsidized in this way decreases and drives down wholesale market prices: a Spanish-style situation is obtained on the scale of intercontinental Europe, despite its interconnection.
(1)Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions — Short-term energy market interventions and long-term improvements in the design of the electricity market, May 18, 2022, COM (2022) 236 final.