I received an email from energy expert Mike Parr this week that should worry anyone concerned about Europe's political future. Mike, of course, comments here regularly. He told me:
Natural Gas price @ Rotterdam TTF right now: €73/MWh.
It was in the range €40 to €50 for much of the summer.
I would not be surprised by €150/MWh by November or December on the basis of this.
He then explained the potential consequences for electricity prices:
Electricity marginal wholesale prices are now in the range €150 - €200. If gas hits €150 then electricity will hit €300/MWh.
I am not suggesting that these forecasts will necessarily prove correct. I do not think Mike is, for certain. Forecasting energy prices is notoriously difficult. But Mike's warning highlights an issue that I have discussed many times, and which policymakers still refuse to address.
That issue is marginal electricity pricing.
The problem is straightforward. Electricity does not all cost the same amount to produce. Nuclear, renewables, hydroelectricity and gas-fired generation have very different cost structures.
Mike notes the particularly absurd consequence of this in France. Most French electricity is generated by nuclear power, which he estimates has a production cost of around €60/MWh. And yet French wholesale electricity prices can be driven far above that level because the marginal price of electricity is determined by much more expensive generation, with cross-border markets transmitting that price between countries.
That makes no economic sense from the point of view of consumers.
Nor does it make sense from the point of view of society.
It does, however, make considerable sense if the objective is to maximise the income of electricity producers who can sell electricity generated at relatively low cost at prices determined by much more expensive gas-fired generation.
That is why marginal electricity pricing matters. If gas prices rise sharply this winter, the consequences will not simply be higher gas bills. Electricity prices could rise with them, even when much of the electricity being consumed has nothing whatsoever to do with gas.
The resulting increases in electricity prices would not represent an increase in the cost of producing much of that electricity. They would instead represent an increase in economic rents being extracted from consumers because of the way in which the electricity market has been designed. That distinction matters enormously.
Governments will undoubtedly claim that they are powerless in the face of international energy markets. They will say that global gas prices have risen and therefore energy prices must rise. But that would only tell part of the story. Governments might not control the international price of gas, but they absolutely can control the rules under which electricity markets operate.
Those rules are political choices. They can be changed. The refusal to change them also has consequences.
If Mike's pessimistic forecast for this winter is anywhere near right, millions of households across Europe, and in the UK, could once again face substantial increases in energy costs. Businesses would face higher costs as well. Inflationary pressure could return. Governments might respond with subsidies, funded ultimately by taxpayers, whilst leaving the underlying pricing mechanism untouched. We have seen this before.
The public will then be told that there is an energy crisis when part of what they are actually experiencing is an electricity market design crisis. That matters politically. And Mike puts the point starkly:
There will be a political impact.
He suggests that a sufficiently severe winter energy crisis could contribute to Marine Le Pen reaching the Élysée Palace in France in 2027 and the AfD gaining considerably greater political power in Germany.
Whether those particular predictions prove correct is not the issue. The direction of the political risk is entirely plausible.
The problem is, people do not distinguish neatly between energy market design, international gas prices, electricity generation costs and government regulation when they cannot afford to heat their homes.
They just know that they are poorer.
They also know that their government appears unable or unwilling to do anything about it.
And they know that somebody appears to be making money from their hardship.
That combination creates political anger, and we should have learned by now what happens when democratic governments repeatedly tell people that nothing can be done about problems that are, in reality, the consequence of political choices.
The far right thrives on precisely that sense of powerlessness. It tells people that the established political order has failed them. Unfortunately, when governments refuse to reform obviously dysfunctional markets, they provide evidence that appears to support that claim.
There is an alternative.
Electricity prices need to reflect the costs of the electricity actually being produced rather than allowing the most expensive marginal producer to determine the price paid across the market.
Excess economic rents arising from the current system should be eliminated.
Renewable and nuclear electricity should provide consumers with the benefit of their lower and more stable production costs.
And governments should accept responsibility for designing energy markets that serve society rather than pretending that those markets are forces of nature over which they have no control.
This is not just an energy policy issue. It is an economic justice issue. It is an inflation issue. It is a democratic accountability issue. And, potentially, it is an issue about the survival of democracy in parts of Europe.
If politicians continue to impose unnecessary economic hardship on people because they refuse to change market rules that politicians themselves created, they should not be surprised when people eventually reject the political system responsible for those rules.
Electricity market reform is not, therefore, some obscure technical issue. It could become a political necessity.
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The gov needs to be looking at this again and doing it now, and not preparing excuses for not doing so. You can bet the opposition will capitalise on any increases by saying they would subsidise bills in the same way they supported domestic energy customers in 2022 when prices spiked as a result of Russia’s invasion of Ukraine. No doubt Reform will promise free energy on the back of cancelling all welfare payments and deporting everybody with a foreign accent.
Either change the pricing mechanism now, or put forward a plan to subsidise energy costs now, before it happens, or suffer the easily predictable consequences which might actually bring down the gov.
I had an email from Ecotricity this week warning me that they will be doing more data sharing with credit reference agencies if we get behind with our bills. So they are smelling the coffee, as private fuel debt rises further.
Electricity, marginal pricing and AI.
If you’ve ever wondered why they’re so keen on AI (giving the crafted answer) ask it about electricity marginal pricing. I quote “Marginal pricing can lead to lower energy costs because it prioritizes cheaper energy sources, like renewables, in the market.” But why don’t we pay for the actual resources we use?
Marginal energy pricing is an EU wide policy.
I agree with Mike that this winter could be tough and even see interruption to gas supplies. Industry will shut first, I was in higher education during the 70s and we sat in dark lecture rooms without heating. But the pubs were open and used hand-pull beer pumps to fill our pint glass. We sat by candle light enjoying a drink discussing the miners’ strike.
I use ChatGPT to help with my work on elec markets. Before doing so, it went through a rather painful education exercise. The problem is that for each and every initial use of AI, by somebody asking it questions about elec markets and marginal pricing, the result will be stock answers because all AIs base their response on what the consensus looks like – even if that consensus is completely incorrect.
I exchange e-mails with people working in one of the EU’s quasi-agencies: The Florence School of Regulation. The official line is that marginal markets work and are efficient. I have e-mails from people I know in the org confirming that they agree with me and that indeed, marginal pricing fails – utterly (the same people agree with me & Dieter Helm – carbon taxes are econometrically efficient – but carbon markets rule – OK). Hypocrisy and delusion and ignorance (met with one of Ofgem’s ex-chief economists once for an hour or two of technical discussion – I came away frightened at the lack of his knowledge on energy markets in general & price formation in elec markets in particular). I dpn’t even class myself as an expert, I am just a well informed amateur at best.
Someone told me that ChatGPT said my view on the FT was wrong today.
I pointed out that it was probably because ChatGPT had been trained on the FT, which didn’t mean I was wrong. ChatGPT just cannot imagine that another world is possible, and that is its limitation.
So again, we are witnessing in a supposed ‘liberal democracy’ a huge transfer of wealth from the masses to the few.
It reminds me of what Ghandi was reported to have said when asked what he thought about Western civilisation – that ‘it would be good idea’. The same for liberal democracy it seems.
Democracy remains a good idea, still out of reach because we have allowed monopolists to take over.
What worries me is that new forms of governance structures like the EU (basically a peace making project) and the new combined local authorities (which is actually local government retrenchment project) are seen by markets as ‘rings that bind them all’ – a convenient means of getting a strangle hold of assets and power over huge geographic areas and controlling factors like prices.
It’s typical Neo-liberal DARVO isn’t it – attack the state as a monopoly but then sneak in and assume monopolistic control for your self to your advantage.
I agree, I’ve just read a Newsletter from Maurice Höfgen this morning about the same topic.
The german government does nothing at all to face this, they’re even deepening the problem now.
The most important factor for this is, that the ministry of economics is currently lead by Katherina Reiche, previously a manager and lobbyist for the gas industry.
Renewables will be put second, also building power lines to get cheap renewable energy from the northern coastal regions to the south as well as battery banks.
Instead more gas and even coal power plants will be built and delivery contracts of about 15 years will be made with mostly dictatorships or autocracies (at least I only know such countries having a lot of this resource).
This is absolute madness.
No one seems to think about gas prices rising in the future, not the least because the resource gas is limited and becomes therefore scarcer and scarcer.
What bewilders me as well is that we seemingly have to hope that private investors will build the capacities we need.
Why exactly are we counting on them with something so necessary, when they have proven, again and again, that they can only provide it as much as Herman Göring’s Luftwaffe was able to destroy the BEF at Dunkirk or sufficiently supply the 6. Army at Stalingrad.
They.
Can.
Not.
I mean, if I got this correctly and the government would invest itself in these necessary energy supplies, this should be possible without inflation or such as this supply is needed and used?
Would the government not even profit from that, not the least because it defends democracy that way?
There is already considerable anger in Scotland about this. We it seems are producing more renewable energy than we can consume and yet are still paying exorbitant prices.
Furthermore wind turbines are being paid to not produce energy when there is a surplus!
Much to agree with
Thanks Richard. I am writing a short paper on the same.
Problem 1: we have been here before: mid 2021 to end 2022 – gas prices rose massively (Euro340/MWh by August 2022) with attendant rises in elec prices.
Problem 2: EU institutions following these developments claimed to have “reformed” markets. They haven’t.
Problem 3: the events in 2021 came out of the blue (sort of) but gas problems now have been developing for 6 months. Institutional reaction?
The events of 2021/2022 saw a painfully slow institutional reaction & caused people I know in various EU institutions to question the future of the EU (do think director and director general level)
If gas prices continue to rise (gas storage in EU sits @ 65% of capacity- it need to be north of 75% for winter) then there are going to be significant political consequences.
And all this to keep bankster prop desks in business (amount of elec consumed in EU: 3000TWh, amount traded circa 8000TWh. – tells you all you need to know about lobbying and marginal markets as a quasi religious belief system))
Thanks, Mike
Thanks for this interesting info.
That sounds very disgusting and unfortunately to be expected indeed.
So, most probably a bunch of very amateurish question from my part but:
How is it possible to trade more than actually is there?
Isn’t that electricity then consumed after the trade?
Or what exactly do they trade there?
How could this be stopped to happen?
Most commodities are traded at much greater volumes than actually exist, because the future supply is traded many times before it is actually consumed. That’s what futures markets do. They play make-believe.
Ok, thanks for giving it a name.
That reminded me of one of the sketches Mitchell and Webb made with the “Old Lady Job Justification Hearings” where a Futures Trader had to justify himself…..
Then tried for 2 hours to understand how future trading actually works and more importantly helps.
Came to no better conclusion than the sketch itself (“it’s like betting on which horses go up and which go down on a carousel”) about it’s sense.
I may just not get it, but I really don’t understand why people are doing this.
Sometimes they make money, and they are stupid enough to keep thinking they will
But the gain comes at a considerable cost, which they usually dump on someone else
Good questions.
For traders to make money requires volatile markets. Electricity markets are extremely volatile. Yesterday, northwest Euurope @ 1500hrs wholesale price Euro29/MWh, 1800hrs Euro180/MWh. This volatility is a feature/function of how elec is priced (at the margin). It has no relationship to what the elec at that hour really costs. Why is it that way: historical reasons. Why has it remained that way? lobbying by traders (= banks) who make money.
The Dutch high court recently ruled that since 2017, utilities companies have been unfairly raising prices and passing these rises directly onto their customers.
We’re now waiting a massive super-claim, where those duped have been signing up online and can expect repayments when the super-claim goes to court.
I don’t claim anywhere near Mike’s knowledge of this market but 20 years ago I worked for Western Power, the then state owned power generation and distribution authority in Western Australia. The big issue then was the rapid uptake of refrigerative air-conditioning which shifted the peak power demand in Perth from winter mornings to summer afternoons. Pole-top transformers were literally bursting due to the high temperatures, and the “Summer-Ready” programmes around 2005-8 were a massive investment in the ability to cope with a peak in demand that lasted only a couple of hours each day. No batteries back then to level out the generation requirement, nor large-scale local rooftop solar to ease the network capacity requirements. What we did have was a state owned system that could decide for itself what the reasonable cost of electricity should be and where network investment was required, which was obvious to anybody who drove around the city and saw the huge amount of work being done to upgrade the overhead HV and LV infrastructure. for no obvious reason to the likes of me at the time, that soon changed to the inevitable neo-liberal privatized set of separate companies owning generation, distribution and retail sales in 2007/8, by which time we had moved further north where electricity was only available from small ‘islanded’ generation plants serving one small town each.
Also Australia with its big push into renewables and storage is now seeing lower cost batteries pushing out high marginal cost gas.
Similar will happen in the UK though offshore wind needs tight cost control.
See Australia Killed the Duck Curve (With Batteries) – Engineering with Rosie
https://www.youtube.com/watch?v=jltRq_KlGH4
“ChatGPT just cannot imagine that another world is possible, and that is its limitation.”
So, just like most Westminster, orthodox economists and MSM “journalists” then?
Yes…..
Then we look at the absurd combination of price gaps that aim to make the price rises not completely bankrupting for too many, and windfall taxes on oil and gas companies. Plus more tax revenues from petrol and diesel sales. It may make government finances temporarily look better rather than worse, at the expense of consumers.
There may end up being a sort of perverse incentive here, because what’s most beneficial is clearly to encourage progression towards renewable energy sources with the cheapest levelised cost of electricity, but marginal energy pricing may represent a net transfer from consumers to both energy companies and indirectly to government revenues.
My investment in a renewable energy plant is currently losing money because it was ‘curtailed’ – meaning it was not allowed to run and sell the energy it could produce, all while we pay for polluting plants and import electricity daily.
Meanwhile, plug-in solar just launched, and once companies like Lidl release their package it may make sense for many to reduce their grid electricity consumption a bit, although even here the rules are worse than other countries like Germany and mean battery-included systems aren’t currently compliant for plug-in.
Unfortunately, while there are discussions, most of the change is moving far too slowly for if there is a price spike this winter. National Grid knew they had issues with network capacity in the area for years and did nothing, leaving the renewable energy companies paying the price of their ineptitude. Any change now would arrive too late for this winter. Hopefully they’re warming up the price cap again to limit the harm they’ve missed the chance to avoid.
Richard writes:
“Electricity prices need to reflect the costs of the electricity actually being produced rather than allowing the most expensive marginal producer to determine the price paid across the market.”
Agreed. I was researching alternative pricing models today. One option is to create a government monopsony (single buyer) to negotiate contracts with the individual electricity producers (i.e. buy based on their actual production costs) and then sell on electricity to its consumers based on the production costs averaged across all the producers. That model could significantly lower electricity bills. Apparently Canada (them again!) have some working examples of this model in their provinces (Quebec’s Hydro-Quebec and Ontario’s IESO). Maybe we can implement something similar in the UK? (if we have the political will to move away from the neoliberal market dogmas). Common Wealth have a UK specific proposal for it: https://www.common-wealth.org/publications/fixing-the-price. Other suggestions welcome too!
Thank you
Hello Richard.
I always find comments from Mike Parr, about this subject, to be really interesting. I think I could easily read them as longer format, guest posts.
It wouldn’t be cynical to think that the EU/energy markets/UK would keep electricity generation from natural gas going, even if it amounted to less than 1% of total generating capacity, simply to allow marginal pricing to be set against its expense.
The current situation is indefensible. The silence from msm to actually try and explain WHY our electricity costs a fortune, WHY it’s a government failure to address this, WHY the situation is a policy choice, and HOW it could be restructured to provide fair priced electricity for all, speaks loudly as to the captured nature of ‘Western European democracies.
Noted, as I am sure Mike will also note.
Blushing.
Will let Richard know when the paper is finished – which is focused on EU, but could equally apply to UK.
Reform is fairly simple – split the market. Even the generators claim not to care (wrt market reform – hmm they could be lying)
what keeps the show on the road? traders/cross-border traders.
I read an article today that was interesting, but like most online news designed to grab attention, entirely missed the point. It was listing things that middle class people would be unable to afford within five years do you inflation, cost of living, energy etc. Due to rent extraction essentially. It drew no conclusions, it was just a list, but what it showed beneath the surface was complete economic collapse. One persons spend is another person’s income. If governments continue to allow choke point capitalists to extract wealth from our economy, through energy, water, land rent, needless inflation, then they are sleepwalking into economic oblivion and fascism. It’s almost like it’s by design.
Design or stupidity?
If the marginal price of electricity is ended, will the price of gas rocket: what impact will this have on consumers who rely on GCH this winter, especially the poor and elderly?
Why should it change gas prices? I cannot see the link?
The price of gas is set on a European basis, most gas is not used for elec gen – but as a chem feedstock.
There are various proposals to reform elec markets. Generation splits into two broad types: capital intensive (capex) and operational intensive (opex). Capex systems include all renewables, hydro and nuclear. Opex mostly fossil. i.e. nat gas powered. The cost of elec for capex gen’ is defined (mostly) by the capex & cost of money (how long the asset lasts and its elec output). The cost of elec for opex is defined by. cost of nat gas. Split the market into CAPEX (which has +/- fixed costs) and OPEX (variable). The capex mob get the price they need (in the Uk this is +/- defined by the auction/CfD/strike price) and the opex mob stay in their own marginal market. I have modelled what happens, wholesale elec prices drop (mostly) and there is great price stability day to day.
It is hard to believe that we have had a cost of living crisis for four or five years – since prices started rising when disrupted supply chains could not react quickly enough after Covid and then from January 2022 when Russia invaded Ukraine. And we are still taking about the obscene pricing mechanism for electricity which mean every generator – however efficient and cheap their production – is paid as if they used expensive gas. Five years of excess profits for wind and solar and nuclear. There is no good reason to do it this way. The power of vested financial interests. It is scandalous.
Much to agree with
I can’t understand why this country hasn’t already built an offshore HVDC cable going from Scotland along the coastline down to the London area. If the cable ran down the eastern seaboard it could connect to multiple off shore wind farms along the way. Scotland is a renewable powerhouse and London is the nations biggest energy market/user. We already know that people hate the sight of huge overhead power lines, so why not avoid many of the objections of the NIMBYS by using available offshore cabling technology. We already have interconnectors to Norway, Denmark, Holland and France, but can’t be bothered to create interconnectivity in our own national energy market. It’s absurd.