Spain and Portugal cap gas prices – thereby lowering electricity bills

Spain and Portugal are the first in Europe to cap gas prices and make electricity cheaper by law. Starting in May, prices per megawatt hour will be lowered from €90 to €50. This is the result of intensive negotiations with the European Commission on an exemption from the liberalized European electricity market.

Spain and Portugal announced the agreement after meeting with the European Commission’s Vice-President for Competition, Margrethe Vestager, in Brussels at the beginning of May. The agreement will span 12 months, starting with an average price of €40 per megawatt hour (MWh) and gradually increasing to €50. This price is far below the current market price for gas, which is more than €100 per MWh in wholesale. However, the planned price cap is higher than the €30 per MWh price initially demanded by the two countries. Instead, the EU raised it to €50.

According to Spanish Ecology Minister, Teresa Ribera, the details of the agreement with the European Commission will follow in the next few days. Next week, they will submit the agreement to the Spanish Council of Ministers for approval.

For 40% of households in Spain and Portugal: halved electricity bills

In March 2022, the European Council approved the “Iberian derogation”, which allows both countries to adopt special measures and avoid the impact of extremely volatile gas prices on electricity bills.

The derogation was justified by the two countries’ relatively weak connection to the rest of the European electricity grid. They also rely more on renewable energy sources than other EU-states, which means that they are less dependent on natural gas. Spain in particular is described as an “energy island”, compared to the rest of the EU.

Special case, Spain: Electricity bills follow the daily prices of the electricity exchange

As early as last autumn, electricity prices in Spain were hitting historic heights. Costs were already an eye watering €220 per MWh. One year earlier, it was still about €40. But how did it come to this? Russia’s war against Ukraine was still a long way off.

The reason lies in differing pricing structures and different contracts. In Austria or Germany, for example, there are annual advance payments for electricity. Flexible tariffs also exist in these countries, but are comparatively rare. In Spain, however, electricity prices immediately reflect the fluctuations of the stock market. Therefore, after gas prices fluctuated in autumn – determining the price of electricity – prices skyrocketed.

Necessary changes in Europe

As a first measure, the Spanish government under Pedro Sanchez lowered the VAT on electricity from 21 to 10%. When it became clear that this would not be enough, it advocated a price cap. For Austria, such a regulation could halve the price of electricity, as the former Verbund board member and former chancellor Christian Kern estimates. Kern thinks the Iberian initiative is right in any case:

“Electricity and gas markets must be decoupled. If many people no longer know how to pay their heating costs, society must say: that’s not possible!”

In addition to the rapid expansion of renewable energy, Europe needs a different market architecture – so that not a single gas-fired power plant can drive up the price.

It is unclear whether the “Iberian exemption” will now lead to imitators. France, too, is less dependent on natural gas. But it relies heavily on nuclear energy – also a cheaper alternative than natural gas. France has therefore also promoted the decoupling of electricity and gas prices in recent months. In Austria, the Ministry of Finance briefly questioned the linking of the electricity price to the expensive gas price on Friday, but backtracked a few hours later.

General problem with the price of electricity: Fossil fuels determine the price of electricity for everyone – even if it could be cheaper

For background information on how the electricity market works: electricity is not storable, which is why the energy suppliers have to buy and feed into the grid exactly as much electricity as people consume on any given day. If they buy too little, the grid collapses. If they buy too much, they have thrown money out of the window.

The energy suppliers only have to buy the last peaks every day on the European electricity exchange. It is this small percentage of electricity that is now driving up the price. “The central problem is that the price of fossil raw materials determines the exchange price, and this is passed on to the electricity price for consumers,” says energy expert Josef Thoman. This is the main reason for the current price increases.

On the electricity exchanges, they determine the price according to the “merit order model”: The power plants feed electricity into the grid one after the other. At the beginning, for example, there are often solar, hydro and wind power plants with the cheapest production costs. After that, more expensive power plants will be added until the current demand is covered. The price of the last power plant to feed in determines the electricity price.