How to tackle energy prices?

For around a decade now, the strategy to tackle climate change has become an integral part of European Union (EU) policy, as an inseparable means of ensuring sustainable development, competitiveness and security of energy supply.

The Communication from the Commission to the European Parliament, the European Council, the European Economic and Social Committee and the Committee of the Regions of 11 December 2019 established a European Green Deal for the European Union and its citizens, redefining the Commission's commitment to tackling climate and environmental challenges, and setting out a new growth strategy aimed at transforming the EU into a fair and prosperous society, with a modern, resource-efficient and competitive economy, achieving net-zero greenhouse gas emissions by 2050 and decoupling economic growth from resource use.

Regulation (EU) 2021/1119 of the European Parliament and of the Council of 30 June 2021, known as the «European Climate Law» gave binding legal force to this target, establishing the framework for achieving climate neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999.

Article 4, No. 1, of Regulation (EU) 2021/1119 provides that, in order to achieve the climate neutrality objective by 2050, the Union's 2030 climate target shall consist of a domestic reduction of net greenhouse gas emissions (emissions after deduction of removals) of at least 55% compared to 1990 levels.

However, energy prices in the EU have been rising exponentially in recent months, jeopardising the planned path towards the energy transition. Following a period in which fuel became cheaper, during 2019 and 2020, due to reduced demand during the COVID-19 pandemic and the rapid expansion of renewable energy production, electricity and natural gas prices rose sharply throughout 2021, and this trend is feared to continue into 2022.

The current spike in energy prices appears to stem from rising global demand for gas as the post-pandemic economic recovery gathered pace, but political instability arising from the latent military conflict between Russia and Ukraine, together with the deadlock over the commissioning of the Nord Stream 2 pipeline, has prevented Russia from increasing its natural gas supply, prolonging this price surge in both the European and global energy markets.

As natural gas prices are a key determinant of electricity prices in most European Union countries, the price increase has spread to electricity as well, but the rise in electricity prices also stems from seasonal weather conditions seen across Europe since last summer, with low rainfall (widespread drought) and low wind levels, resulting in lower renewable energy production.

Meanwhile, global electricity demand is expected to continue growing in 2022, at a pace close to the 5% growth rate recorded in 2021.

Furthermore, the European price of carbon dioxide emissions doubled in 2021, rising from €30 to €60 per tonne of CO2, driven by increased demand for emission allowances as economic activity accelerated after the pandemic and expectations grew around the ambition of the EU's 2030 climate target. Between January and September 2021, the rise in the price of carbon dioxide emission allowances translated into an increase of around €10/MWh in the cost of electricity produced from natural gas (50% efficiency), and an increase of around €25/MWh in the cost of electricity produced from coal (40% efficiency). Natural gas currently accounts for around a quarter of the EU's total energy consumption, with 26% used in electricity production and 23% in industry, the remainder being used for heating and cooling.

In recent years, fuel has increasingly been replaced by natural gas and renewable energy sources, while the share of nuclear energy has remained at around 25% of the electricity mix, but the recent rise in gas prices has reversed this trend in favour of coal in some Member States, despite coal burning generating a higher CO2 intensity per MWh. Counter to this trend seen in some stronger European economies, Portugal decided to accelerate the closure of its coal-fired power plants.

Consequently, the current high prices of natural gas and electricity affect most Member States to varying degrees. The relationship between wholesale and retail prices varies by Member State and depends on the regulation and structure of retail prices and the energy mix, but Member States with more baseload energy production alternatives and where long-term contracting is more common (which is not the case in Portugal) have seen a slower pace of price increases.