Saturday, May 18, 2024
 
 

Spain’s solution to the current high energy prices may end up costing it dearly

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The announcement in mid-May by the Spanish Minister of Ecological Transition, Teresa Ribera, that Spain and Portugal have reached a “political agreement” with the European Commission to place a temporary cap on prices for natural gas and coal used by power plants may seem to offer a solution to the current high energy prices. A deeper analysis, however, shows the opposite. It’s likely to have unintended consequences for consumers, renewables, and green hydrogen on the Iberian peninsula.

Capping prices at 50€/MWh is well below the current market prices of around 80-90€/MWh, and subsidizing this measure would not come from the state budget, as has happened in other major EU countries. The proposal instead suggests the creation of a mechanism that would evenly distribute the cost of the measure across all consumers.

The initial proposal suggested that, in order to avoid cross-border distortions, a two-bidding system would replace the existing one-bid market mechanism, decoupling the Iberian market from the European. But, according to Ribera, the market mechanism is not expected to be modified for the 12 months the measure is expected to be in place. As a result, France will purchase electricity subsidized by Spanish and Portuguese consumers, with an estimated cost of around €1-2bn. In addition, consumers are likely to pay around €4-6bn over the next 12 months. Then there are at least three big disadvantages.

Power Purchase Agreements or PPAs have been identified as the cornerstone of the rapid expansion of the renewable energy sector for the coming years. These contracts provide price stability, supply certainty, and green certification in exchange for a long-term commitment with the developer. Thus, PPAs attract customers and investments that are much needed for the green energy transition.

The premium that the governments propose to add to PPAs would deter customers from signing these contracts and since the premium price would fluctuate on an hourly basis, costs would become significantly higher. The lack of attractive PPAs would risk the development of renewable energy projects. This is especially striking when looking at the hydrogen recovery funds.

In Spain, these funds can only be granted if the owners of electrolyzers – the system that creates hydrogen gas by breaking water into hydrogen and oxygen through electricity – are developing a renewable plant or have signed a PPA to certify 100% green energy consumption. Increasing PPA prices and adding volatility might mean that 210M€ of European funds set aside for hydrogen are at risk and with them the additional associated 1B€ private investment.

Cutting the price of natural gas will reduce the price customers with market-indexed contracts pay for electricity with variable prices but will increase costs for customers on fixed-price contracts. Indeed, risk-averse customers would effectively end up subsidizing risk-prone customers to the tune of €30/MWh to €45/MWh, meaning that the measure would set a rent transfer scheme in the Spanish electricity market. This seems counterintuitive since most risk-averse customers paid a premium to secure the price they would need to pay in the future.

The proposed measure would impact industrial companies in a similar manner. Companies with fixed-price contracts will see their bills drastically increase (even double in some cases), which may trigger operational risks. Companies purchasing power in the market will become more competitive and will actually become more competitive than their European peers, which would inevitably raise questions about fair competition.

Negative consequences for the energy transition and emissions reduction targets are also likely. Alongside a price reduction, demand is likely to increase by 2-4 GWh, leading to increased electricity consumption that would inevitably need to be fueled by adding more natural gas and generate more than 800 tons of CO2 per hour. In addition, hydropower plants might lose their access to the market, since they would be displaced by subsidized power plants. Therefore, clean energy would be substituted by natural gas generation, further increasing emissions. The knock-on effect of this increased consumption could then indirectly drive up natural gas prices. This will be quite an unexpected effect at a time when natural gas has been identified as a key resource and there are already fears of scarcity.

In conclusion, this isn’t quite the deal it first appears to be. Customers with fixed-price contracts will see their energy bills increase and the speed of the energy transition will be negatively impacted because no PPAs will be signed this year. For the long-term prospects of Spain and the wider region, delaying the development of renewable projects means Spain might also lose the European funds available for hydrogen deployment.

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Madrid-ased Principal and Energy Practice Leader for international management consulting firm, Arthur D. Little

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