Emergency measures to mitigate high energy prices: Where is the EU Commission heading?

1. Introduction

On Friday 9th September 2022, EU energy Ministers held an extraordinary meeting on the energy situation in the EU with two exchanges of views. The first discussion concerned Ministers’ preferences on different policy options to alleviate the burden of high energy prices on citizens, public services, businesses and industry, which could be implemented at the EU-level in a short timeframe. During the second discussion, Ministers then presented the state of play of the preparedness of their country for this winter.

For the first exchange of views, the discussion was mainly based on (i) a presidency background paper highlighting several options for short-term actions that could bring relief to the energy situation and (ii) non-papers from the Commission providing a preliminary assessment of options for emergency measures to reign in soaring electricity and gas prices.

Following this discussion, the Commission is expected to act in four main areas: (i) capping the revenues of electricity producers that face low production costs; (ii) a possible price cap on gas; (iii) measures for a coordinated electricity demand reduction across the EU; and (iv) measures that would help solving the issue of decreased liquidity.

Pending the Commission proposals, this Newsflash highlights the main measures discussed last Friday and puts them into perspective compared to (i) the REPowerEU Plan and the short-term emergency measures and options for long-term improvements of Energy Markets presented by the Commission in May 2022 (discussed in our previous Energy Newsflash here); and (ii) the relevant non-papers and other background information that have circulated last week.

2. Forthcoming Commission proposals

Based on the Commission’s own contribution and following their first discussion, Ministers invited the Commission to:

1) Propose measures aimed at capping the revenues of inframarginal electricity producers with low costs of production and at introducing a solidarity contribution from fossil fuel companies to be used to mitigate the impact of high energy prices on customers.

• The Commission had already considered in May 2022 that, in line with the Communication “Security of supply and affordable energy prices: Options for immediate measures and preparing for next winter”, taxation or regulatory measures which are aimed at removing inframarginal rents of certain baseload electricity generators could be justified as a short-term intervention measure (see here). The Commission already stated then that such a measure should be non-discriminatory and designed in line with the guidance provided in Annex 2 to the REPowerEU Communication of March 2022 which specified, among others, that:

- Such a measure should be limited and tied to a specific crisis situation.

- The measure should not affect the formation of wholesale electricity prices based on marginal costs expressed by the merit curve, hence preserving the efficiency of price signals for short-term operational decisions. In case of any doubt, lower levels of excess gains should be clawed back to avoid impacts on price formation.

- Long-term price trends resulting from structural market developments and the carbon price signal from the EU ETS should not be affected, so as not to interfere with long-term price signals.

- The additional inframarginal rents should be clawed back only in the time periods when gas plants were marginal and to the extent that such additional inframarginal rents were effectively earned by inframarginal units.

- The measure should not distinguish different generation technologies. It should include any inframarginal units operating in the hours of application of the tax, e.g., inframarginal rents from hard coal and lignite-fired generation, renewables (including hydropower) and nuclear.

In its non-paper of September 2022, the Commission further explained that:

- The implementation of such a measure could either be mandatory for all Member States or optional.

- The cap could most easily be applied to the organised day-ahead market.

- Member States would be obliged to share the resulting revenues with electricity consumers with a view to lowering their electricity bills. This measure could therefore be linked to the measure on demand reduction if Member States use the resulting revenues to incentivise consumers to do so.

- The measure would have to be designed carefully so as to avoid capacity withholding by generators or blocking potential new entry technologies. The amount of the cap is particularly relevant in this respect.

- Capping inframarginal prices can lead to a situation where investors do not believe in their ability to recoup investment costs in periods of high electricity prices. This can increase the need for public support. Risk can be mitigated by setting the cap at a level that still provide incentives to invest in decarbonised technologies.

2) Propose emergency and temporary intervention, including gas price cap. Specific measures in this regard should also help limiting the impact of high gas prices on EU electricity markets and energy prices for customers. Such measures should aim at benefiting European consumers to alleviate social and economic consequences of the current high energy prices, and European companies in order not to endanger their competitiveness, while preserving the incentive to reduce gas and electricity consumption and the market signal for decarbonisation.

• A gas price cap was also already envisaged by the Commission in May 2022 as a short-term intervention measure. The Commission explained that solidarity mechanisms in case of a national security of supply emergency may also trigger the need for an administrative price for gas to be established in parallel, such as a maximum regulated price for natural gas delivered to European consumers and companies (EU price cap) to cover the period of a declared Union emergency. This type of price intervention would be limited to the duration of the EU wide emergency situation. The Commission specified that one possibility would be to limit price formation during this disruption scenario by capping the price on European gas exchanges, but that such a price cap could in general be introduced in different ways and could intervene at different levels of the gas value chain (see here).

• In its non-paper of September 2022, it is further explained that:

- The Commission analysed two possible instruments of emergency wholesale price caps on gas. The first instrument would involve a price cap on imported gas from Russia and the second instrument would entail an administrative pricing during emergency in the particular European region most affected by the disruption of Russian supplies (‘red zone’) to prevent a spiralling of gas wholesale prices (and the contagion effect on wholesale electricity prices).

- These instruments could be applied separately or cumulatively, as they are not dependent on each other and aim at different results.

- As regards the first option (i.e., limiting the import price of Russian gas via a price cap):

o Such a measure would involve the introduction of a price limit for imports of Russian gas and provide certainty on prices and volumes in the market (if the agreement is expressed both in terms of prices/volumes). Its main aim would be to limit the revenues Russia earns from selling gas to Europe. It would also make it less attractive for Russia to trigger price increases via partial disruptions or market manipulations which would help to limit volatility and uncertainty on the gas market once the Russian price cap would be settled.

o Different options would be possible: (i) introduction of a legislation to set-up a maximum price cap on the gas bought by Russia (close to the sanctions model); or (ii) creation of a single buyer entity that would negotiate specific volumes against specific prices with Russia.

o To be implemented in an efficient and meaningful way, this measure requires the fulfilment of certain conditions, to carefully consider the pros/cons, an in-depth analysis as to its level, to determine the specific timing for its implementation, etc.

o In any event, this measure should only be considered if the EU is ready to accept a full disruption of Russian gas supplies. The added value of this measure is mainly on reducing Russian revenues and prices volatility rather than necessarily lowering EU gas prices (unless Russia would increase supplies) and should therefore been understood as a quasi-sanction measure against Russia.

- As regard the second option (i.e., applying administrative pricing in a region most affected by the disruption of Russian suppliers):

o The disruption of Russian gas supplies impacts unevenly the security of supplies in different Member States. Consequently, different price implications in different regions are likely to occur.

o Therefore, some Member States might temporarily cap the wholesale price of gas as an emergency measure, in order to avoid an unnecessary spiralling in wholesale prices in their regional zone that would not attract additional gas.

o The Commission envisaged under this second option a mechanism where European regions could be labelled according to the severity of the impacts of the disruption with red (higher exposure to disruption) and green zones (lower exposure to disruption). The red zone would be made up of Member States where prices could strongly rise above the prices observed on the Title Transfer Facility (TTF) index (see also the non-paper on TTF) following a full disruption of Russian gas supplies and eventually entering into the emergency level. The introduction of an administrative price with a cap would occur in this whole red area. However, the decision of implementing the cap would require the agreement of all Member States in the area. For this scheme to have a chance of working, it would require that the bigger Member States in the red zone are part of the scheme.

o The price cap on wholesale transactions in the red zone would be dynamic and be set in reference to the TTF price.

o Different options were analysed by the Commission: (i) a uniform price cap within and between zones; or (ii) a uniform price cap between zones with possibility to trade. Both options face several challenges. They rely on the willingness and agreement of all Member States in the red zone to work. It would be critical to ensure a common understanding with Member States on pros and cons and the appropriate analytical basis.

o Finally, the Commission also recalled that Member States can also apply price cap for retail consumers, as this is allowed in the Gas Directive, which was already used by Member States pre-crisis and which is part of the existing toolbox at national level in the current crisis context. However, the Commission stated that a price cap remains an auxiliary measure and does not address costs of gas as input for the economy (and its inflationary effects) and electricity production and the fundamental questions raised in the context of the current crisis as highlighted in its non-paper. The Commission also stressed that the higher the wholesale price the bigger the costs to pay by the public budget or the supplier to finance such retail price cap.

3) Present a proposal incentivising coordinated electricity demand reduction across the EU in order to relieve pressure on electricity generation and address energy scarcity and high energy prices. In this respect, Ministers agreed that credible and coordinated demand-reduction initiatives are vital to improve the resilience of the EU economy ahead of the winter. Furthermore, Ministers took stock of the new legal tool to reduce gas use in the EU by 15 % until the next spring and measures taken by Member States in this respect.1

• This measure is also in line with what was proposed in May 2022. Indeed, the Commission already stressed in May that Member States should incentivise demand reductions in line with the actions proposed in the EU ‘Save Energy’ plan (see here).

• In its non-paper of September 2022, the Commission further clarified that:

- The aim of a coordinated demand reduction would be to affect overall consumption of electricity and peak demand and hence to directly lower consumer prices.

- If properly designed, a coordinated demand reduction in electricity should also lead to lower EU gas consumption for electricity generation. Smart demand-side flexibility technologies and services that lower demand in a time-dependent way when electricity is produced by gas, at peak times, will be incentivised.

- These demand reduction measures can take different forms, such as (i) the introduction of tender schemes under which particular consumer categories offer to stop and/or shift consumption from moments of peak load, or (ii) the introduction of demand reduction objectives for certain consumer categories.

- Financial incentives or compensations to affected market participants would be needed. The cost would depend on the design of the measure (number of participants, level of compensation).

- National implementation would require introducing the necessary demand reduction schemes. Depending on design of the schemes, State aid clearance may be needed.

4) Design emergency liquidity instruments that would ensure that market participants have at their disposal a sufficient collateral to meet margin calls and that would address increased volatility in futures markets, and consider reviewing relevant guidelines to integrate the rules on safeguards.

• Such a measure was also envisaged in May 2022. The Commission already specified that if such emergency liquidity support measures contained State aid, those interventions needed to take place in full respect of the respective provisions. Moreover, the Commission stated that these measures needed to be limited, proportionate and transparent and must be targeted to avoid excessive distortions. The Temporary Crisis Framework for State Aid could be used by Member

1 Council Regulation (EU) 2022/1369 of 5 August 2022 on coordinated demand-reduction measures for gas, OJ L 206, 8.8.2022, p. 1–10.

Strelia Energy Newsflash – September 2022

States for their targeted measures. Finally, Member States need to ensure that those measures would not undermine the sanctions regime imposed on Russia (see here).

• In the presidency background paper of September 2022, Member States considered the possibility of:

- An immediate credit line support for market participants experiencing very high margin calls, including the case for specific solution at European level, for instance through ECB.

- Modifying the trading rules on energy exchanges, such as modifying temporarily the regulatory requirements for collateral in electricity trading including revisiting automatic price ceilings adjustments.

- Temporary suspensions of European power derivatives markets or subject the trading of futures to specific bands.

• In this respect, it has been recently estimated that Europe’s power producers face at least EUR 1tn in margin calls.

3. Other key takeaways

In addition to the four main above-mentioned measures, Ministers also discussed the following points.

• Concerning the medium/longer-term improvements to the market framework, Ministers invited the Commission to swiftly pursue the ongoing work on the review of the electricity market and to propose adjustments to the functioning of electricity markets supported by an impact assessment as soon as possible.

• Ministers stressed the need to accelerate the decarbonisation of the EU's energy system and reduce dependency on fossil fuels, particularly from Russia.

• Ministers called on the Commission to present an extended and broadened scope of the Temporary Crisis Framework at least until 31 December 2023 for liquidity support measures, measures covering increased energy costs and for aid supporting the accelerated deployment of renewables and the decarbonisation of the industry. Investment and financing conditions need to be further improved and alleviated to allow for a comprehensive and swift roll-out of gas alternatives.

• Ministers took note of the Commission’s update on the enhanced outreach to international partners and reliable suppliers to increase gas deliveries and agreed that coordinated EU action should be intensified. Ministers encouraged further work on the voluntary EU Energy Platform on gas, LNG and hydrogen, in order to secure the EU's energy supply at affordable prices. Ministers also encouraged further work to develop LNG transhipment and the network of energy interconnectors.

• While reiterating their commitments to cost-effectively meet our commonly agreed GHG emission-reduction targets, Ministers discussed possible options how to make use of the EU ETS in addressing current high electricity prices and noted the effort by the Presidency to swiftly advance the negotiations and find a solution on the Market Stability Reserve in the context of the REPowerEU initiative.

• Ministers also took stock of the improved situation of gas storage and preparedness in Europe. The EU has already reached a significant level of gas storage, the capacities are now filled at 83 %, which should, together with the solidarity mechanism in place, and the recently adopted Regulation on Coordinated Gas Demand Reduction contribute to a safe winter and reduce the need for additional gas imports in the coming months.

4. Conclusion

It can be concluded that the next steps to be taken by the Commission are quite in line with its previous set of proposed actions in May 2022. However, as the forthcoming Commission proposals could directly impact the functioning of the market, the task of the Commission will not be an easy one. The proposals will need to be in line with the current market design and other legal frameworks (such as competition law, State aid rules, etc), so that they do not disrupt any further the energy market, while also already paving the way to the upcoming Commission’s adjustments proposals to the functioning of the electricity market.

The Commission proposals are expected to be submitted in the coming days, by mid-September 2022.

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