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By G. Uth – 03. October 2021 – 

Why are electricity prices exploding? 

In recent months, electricity prices in Spain have risen to unprecedented levels, but why are prices rising so much and why are the wrong actions being taken in an attempt to slow down the soaring price of electricity? 

Let’s try to take a look at it, but it’s a little complex, so grab a cup of coffee, tea, water or a “vino”, because it takes some time to get to the bottom of “the why”.  

The graph below gives a good (and frightening) picture of the development of the day-ahead price which is the daily price we pay for the electricity in the electricity spot market, OMIE 

Even the not-too-attentive reader can see that, right in this moment, there is only one direction that electricity prices are going and it’s up-up-up… and it goes fast. A fine example of this fact, just last week we paid 288€ for 1 MW/h. 

By comparison, on the same date last year we paid a cut price of 41€/MWh and in February this year around 17€/MWh 

Before this, the highest daily price ever recorded was 98€/MWh, and that was in December 2013, when Iberdrola was fined €20 million for manipulating the market with their hydro- energy production (energy from water). 

This has been a “wild” development, and the futures market has also totally underestimated how the market would develop. Even at the end of June, when we started to see the writing on the wall. The table below shows a slight snip of futures (pre purchased electricity) developments from the end of June, to the real prices paid and then futures from yesterday, to the final months of the year.  

The table should be read in such a way that, left we have the month the futures apply to, price/pool is what we have actually paid per month, and the last two are the future prices on the same months, but taken on different dates.   

Developments over the past three months have seen the prices for the futures each month rise and for the coming months, rise until the last day you can buy a future for the same month. This means that even though futures are 135.23€, it is more realistic to assume that we will hit €140-150 respectively, because the last two quarters next year, which are €84 and €87.25/MWh respectively, are not yet heavily affected by today’s prices, while Jan, Feb and Mar are up to €213 to €216 and 180,9 – and we will experience that  all the months come to fruition  with higher prices if the trend continues. 

It’s the yellow prices we’re going to pay in the next few months, so the bills are going to be higher – again. 

One of the tools normally used in the industry to calculate fixed prices is an average consideration of future prices 12 months ahead.  

Below we can see how the price has evolved since January and until today, where it peaks at 157.70€. However, even though it is a peak,  it is most likely that we will come close to  €140-150 for the 12 months leading up to the end of the year, unless Europe’s governments intervene and regulate the way electricity prices are calculated.  

Because, the daily prices do not reflect the real average price on the market. I’ll get into that later… 

But why are prices rising this way?

This time, the extreme price increase is not an isolated Spanish phenomenon, even in the Nordic countries (normally the cheapest electricity in Europe) they have been up touching 100€/MWh and the market for Nordic futures looks almost like the Spanish one, albeit with somewhat lower figures – but the Nordics have also, these days – experienced the most expensive prices ever and we have not seen the top yet, either in Scandinavia,  Spain or the rest of Europe, but like always, Spain is the place where the market is most hysterical and most “manipulated”.

CO2 

The very high prices are mainly due to the EU’s new decisions on the reduction of CO2 emissions combined with weather conditions and a sudden shortage of gas in Europe. The high demands on reducing CO2 emissions have led to a significant increase in CO2 allowances, which can be purchased to “reduce” co2 emissions. As can be seen below, quotas have increased by over 100% since the New Year, and here in October it seems to rise even more. 

The CO2 price influences energy production methods that cause C02 to be released, but not all energy productions result in CO2 emissions. It is typically fossil energy (oil, gas, coal) and co-generation, which also uses natural gas in its production, while solar, wind, biomass and nuclear power do not cause CO2 emissions.  

Natural gas

It seems that natural gas, which has now become in short supply, is going completely havoc, partly because of a somewhat smaller Norwegian production and stockpile than expected, 

partly because of a huge purchase of natural gas in China, partly due to changing weather conditions and that Russia also has much less gas in stock than first thought (they claim) … and then it has been hard to find common ground on the Nordstream2– the new Russian gas pipeline. 

Many factors come into play, and all of them have meant that natural gas has increased by more than 100%- just this year and, after all, a lot of gas is being used to produce electricity. 

In fact, the gas price has increased by over 500% since last year, as can be seen in the graph below: 

—->>

But to get even more confused, let’s just try to take a look at the Spanish energy mix in the “cheese” below: 

As we can see, only 42.5% of the energy produced in Spain is “renewable “, i.e. “green” (the cut for the year is 48%), while, for example, the worst CO2 culprits, respectively, “combined cycle” and “co-generation” with natural gas make up 28.7%, and the worst of them all,  oil and coal make up 1.5% of the “cheese”. 

The joker, nuclear power, which is not renewable energy by definition, but unlike all other non-renewable forms of energy, nuclear power does not emit any CO2.  

So, in the Spanish market, 66.2% of the energy produced is CO2 neutral… while “the bad boys in the class” who really sped off some CO2 make up 30.2% of total energy production. 

So why does a 100% increase in the price of CO2 and gas lead to a 300% increase in the price of electricity? 

At the first glance, it doesn’t really make any sense. And those who call themselves experts – both English and Spanish – say that the extraordinary shortage of gas has the greatest impact on price developments, but if we take a look at how much gas is actually used for energy production in Spain, then it is only about 27% of the total energy produced. And even if we combine high gas prices with high CO2 prices and take a relative view, we are a long way from justifying a 300-400% increase in the price of electricity.  

So what is the explanation for the extreme price increases?  

The explanation is, that a large part of the European spot markets use the same algorithm (Euphemia) to calculate the price, making the settlement price being the marginal price of the last provider on the market. It’s complicated, and even when you ask people at OMIE or other spot markets, they’re not quite sure how the algorithm actually works in detail.  

Try to imagine that every day we have to fill up a bucket of energy, so there’s enough power at hand to supply the whole country. We begin with the energies that cannot be switched on and off as needed such as nuclear power, solar and wind energy. But that’s not enough, so we’re also filling up with some hydro energy and a a slump of co-generation energy – if that’s not enough, then we have to turn on the coal power plants, and if that’s not enough, then we need to open up some more to hydro energy – if available.  

It is the price of the last energy type used to get to the 100% that determines the day-ahead price, and it is that price that is settled for all the providers.  

This means that even if nuclear energy only costs 13-14€ perMWh to produce, the nuclear plants is settled with 288€ per MWh on a good day (some 4-6000% profit)… since the two major culprits account for 30% of energy production, it will typically be the daily price of their production that will be the one everyone has to pay, regardless of the average price the market actually has.  

With the large increases in the price of CO2 and gas (because gas is lacking), prices have therefore risen so dramatically and in Spain even more mostly because the price of hydroelectric power has been so attractive that one electricity company in particular, Iberdrola, in northern Spain has emptied several domesticated lakes of water, with disastrous consequences for both nature and pricing, as there is a very small amount of water,  and the “energy bucket” must therefore be filled with even more co-generation and fossil electricity production, which is therefore the most expensive. 

Unfortunately there will be no dramatic change in the prices unless the EU intervenes and changes the EUPHEMIA algorithm. Or, of course, if gas prices and CO2 prices drop to the same level as before, which is not likely to happen in the next half year. 

We should also not forget that no government is that interested in lower electricity prices, since electricity taxes are not calculated per consumption, but on the amount paid for the energy. In other words, here in Spain, electricity tax revenues have tripled and VAT revenues even more, as the electricity tax is part of the VAT base. 

It must be said, however, in defense of the Spanish Government, that VAT has been lowered to 10% in the private sector and the electricity tax to 0.5% in general, but the State still makes a great deal of money more than normal in the business sector, which more than compensates for the “lost” revenues of private end-users. 

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