Correct Europe’s energy mistakes

When nearly half of France’s nuclear reactors went offline, more than 50 terawatt hours of nuclear power was lost

BRUSSELS – Europeans are finally taking a breather from skyrocketing gasoline prices. Thanks to declining demand from industry and households, driven by energy conservation efforts and a milder-than-usual winter, coupled with rising alternative energy sources such as wind and nuclear, prices Gas prices have fallen to levels not seen since before Russia invaded Ukraine in February last year. But prices could rise again, and governments should let it happen.

Throughout the European Union, electricity generation and gas are closely linked. Gas is the most flexible fuel for thermal power plants, which is why it is essential at peak times. But it’s not particularly efficient. In fact, gas requires at least two megawatt hours of heat content to produce one MWh of electricity.

Last year, when nearly half of France’s nuclear reactors went offline, more than 50 terawatt hours of nuclear power was lost. To make up the shortfall, it would have been necessary to import some 100 TWh of additional natural gas. With gas prices averaging more than 100 euros ($106) per MWh, due in part to the loss of nuclear power, the implicit cost was more than 10 billion euros. A key reason for the recent drop in gas prices is that some French nuclear reactors have been restarted.

More fundamentally, however, electricity prices are now falling due to Europe’s so-called merit order system, whereby the price of electricity is determined by the most expensive source. Of course, marginal cost pricing was also the reason why wholesale electricity prices rose sharply in Europe after the war started, while they remained constant in the United States. But those high prices weren’t bad: they encouraged users to consume less, thus reducing the need to import gas. The problem is that only wholesale prices, those paid by industry and public services, are determined by the merit order system. Retail rates are often heavily regulated, leading to large price discrepancies between countries.

In Germany and Italy, where electricity costs have been less regulated, retail prices have nearly doubled since the war began, according to data from the Home Energy Price Index. In France, by contrast, the government has decreed that retail prices must remain essentially constant, and in Spain, subsidies have caused the prices paid by households to fall, despite rising costs caused by the war.

Efforts by governments to shield households and businesses from the impact of higher costs have obvious benefits, including mitigation of inflationary pressures, with headline inflation much lower in France and Spain than in Germany and Italy. . But the indirect economic costs are much higher, starting with removing the incentive to save energy. (Gas price caps are based on similar logic and have the same undesirable effect.)

In addition, the subsidies raise public debt, something that neither France nor Spain can afford, since both already face record levels of debt. Efforts to ease price pressures also contributed to France’s recent nuclear problems. State nuclear producer Electricité de France suffered massive losses last year after the government forced it to sell a significant part of its output below cost.

But France and Spain are not content to keep retail prices low; they are now pushing to abolish the merit order system at the European Union level. They complain that marginal cost pricing keeps electricity prices high as long as gas prices are high, even if the share of low-cost renewables increases. Consumers, they argue, should reap the benefits of investing in renewable energy.

The problem with this populist-minded stance, which has also been taken by the European Commission, is that it ignores the important role that high energy prices play in reducing gas demand and boosting investment in renewable energy, and that there are other ways to support the purchasing power of households.

Yes, Europe’s merit order system will need to be rethought as zero marginal cost renewables displace all fossil fuels. But it is the ideal system for the transition to net zero emissions. That transition will take too long for countries to be able to afford to continue providing subsidies, especially if prices are not allowed to rise enough to stimulate the necessary investment.

Unfortunately, that could happen, because the quality of policy making in the European Union is declining. The Commission used to be a bulwark against attempts by member states to launch politically motivated interventions in the economy. Now it seems to have abandoned this role, not only with regard to energy policy, but also with regard to the limitation of state aid.

This fits with the commission’s self-perception as a “geopolitical” body. But even from a geopolitical perspective, efforts to control gas and electricity prices are pointless. As the costs of state intervention in the energy market increase, the geopolitical position of the EU will decrease.

The author

He is a board member and distinguished fellow at the Center for European Policy Studies.

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