Extreme price fluctuations in the electricity market seem to have become the new normal. From sharply negative prices during periods of oversupply to spikes during shortages: the system is buckling under its own dynamics. Yet the solution does not lie in more market intervention or in splitting the market into one for renewable electricity and one for natural gas. The solution lies primarily in smart choices, because the government already holds the key levers for controlling costs.
It happened again at the end of last month. Electricity prices dropped to a record low of minus 550 euros across virtually all of Northwestern Europe. A combination of wind, plenty of sunshine, and lower demand meant that all the electricity needed could be generated from renewable energy sources for several hours straight.
In fact, there was so much of it that it led to a significant oversupply of electricity. After all, negative prices are always the result of an imbalance between supply and demand. Too much supply leads to the need for load shedding to keep the grid in balance. And that is why the grid operator has to dig deep into its pockets to entice parties to use more and, if that does not fully succeed, to shed load.
It’s the new normal. Not just negative prices, but above all an increasingly frequent imbalance between supply and demand. Price fluctuations in the electricity market are now many times more volatile than, for example, in the oil and gas market. After all, the electricity market must always—that is, every second—remain stable at 50 Hertz. That requires a great deal of balancing. For commodity markets such as oil and gas, the situation is slightly different. There, too, markets seek a supply-demand balance based on the most cost-efficient mix, resulting in significant price fluctuations. Yet, the requirements there are just a bit less strict.
Recently, in the UK, the national grid operator NESO (essentially the UK’s equivalent of TenneT) issued a call to households to use more electricity this coming summer. Not only to take advantage of low electricity prices and balance the grid, but also to save producers from having to pay substantial curtailment fees. Higher consumption would then lead to lower costs. This stands in contrast to the call from Brussels and the International Energy Agency to consumers of gas, oil, and petroleum products. There, we are seeing shortages as a result of the war in Iran, and lower consumption would help balance the market.
At the same time, policymakers sometimes tend to go too far in this regard. Just as during the energy crisis of 2021–22, there are renewed calls to decouple the electricity and gas markets. In fact, in the UK, they are actually going to try it—against all advice. After all, gas prices are high as a result of the U.S.-Israeli war against Iran. And when the wind blows less and the sun shines less or not at all, it is mainly the gas-fired power plants that keep our electricity grid in balance. And those cost money. Not only because the price of gas is higher now, but because they have to make their business case work in fewer and fewer hours. If they can’t do that, there would no longer be an incentive to keep the plants available at all in case they are needed.
And that is where policymakers’ reasoning goes wrong. The idea behind decoupling the electricity and gas markets is that the price of electricity can sometimes be too high when gas is needed in the mix. After all, all electricity prices are then calculated based on the cost of the highest bidder—which is usually gas. This would lead to excessively high prices for consumers.
It remains a strange principle that we apparently have no problem with negative prices during times of oversupply, yet struggle with higher prices during times of shortage. Regardless of the scenario, there are winners and losers in the market. When prices are negative, investors in solar and wind energy earn nothing, and policymakers even feel compelled to use subsidies to coax out even more investment. When prices are high, parties that are making a profit at that moment are almost treated like criminals, whereas you should actually be grateful that they are solving “the problem of shortages” at a higher price.
Selective intervention—or the lack thereof—in markets not only leads to uncertainty in financial markets and misaligned incentives regarding demand management and investments in energy sources. Above all, it leads to a less efficient market. Decoupling gas and electricity will result in the creation of two separate markets. Each with its own supply-and-demand balance, its own backup systems to ensure security of supply, and its own rules and oversight. And this at a time when liquidity in those markets will be lower.
The fact that consumers sometimes pay more for gas as a backup or for curtailing renewable energy sources during periods of oversupply is a result of the current electricity mix. Do you want to eliminate gas from the mix entirely? Then you’ll need to install even more renewable electricity sources. In many cases, this leads to more frequent negative prices, making the business case unsustainable without corresponding growth in electricity demand. On the other hand, if you still want a fixed price, sign a fixed-rate contract as a household, or, as a business, enter into a Power Purchase Agreement (fixed price) or a Contract for Difference(variable price within a range).
Fragmenting markets and thereby making them even more complex is a recipe for uncertainty, resulting in even greater volatility with much higher and much lower prices. And this is despite the fact that energy bills are primarily determined by energy taxes, grid fees, transmission costs, and VAT. So if the government actually wants to do something about high prices, it already has the most important tools at its disposal.
Hans van Cleef is Head of Energy Research at EqoLibrium (this column was written in a personal capacity and previously published on Studio Energie Opinie)
