Why does the price of electricity depend on gas?

On Thursday, February 10, 2022, the President, Emmanuel Macron, announced in Belfort an ambitious program to renew the French nuclear industry. Following in the footsteps of his elder, General de Gaulle, he declared:

”To produce energy, especially electricity, we have a chance, it is our historical model. The installed park, the nuclear power plant.”

Today, The war in Ukraine, which reminds us more than ever of the risk of the atom, both through the half-veiled threats of the Russian President, Vladimir Putin, and through the deliberate attack by his military forces on the largest nuclear power plant in Europe, Zaporizhia, both through the half-veiled threats of the Russian President, Vladimir Putin, and through the deliberate attack of his military forces on the largest nuclear power plant in Europe, Zaporizhia, the French are facing a dramatic rise in wholesale electricity prices and this despite the rent of the historic nuclear fleet that they have...

Why is electricity nuclear but is paid at the price of gas? This is the question that we will try to answer in this article, which will explain to you in particular the Operation of European wholesale electricity market.

Why have gas and electricity prices been rising since September 2021?

Gas and electricity market price curve for 2023 - Source: SirEnergies

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This phenomenon has increased dramatically since the beginning of 2022, gas has increased by 60%, so we can talk Rising gas prices.

This surge in gas prices is linked to international and even geostrategic reasons, since France is not a gas producer, She imports all her gas needs, especially from the North Sea, from Norway, and also, like its European neighbors, from other countries such as Russia.

Geostrategy at the origin of a surge in gas prices

These geostrategic reasons for the surge in gas prices are due to:

• the very significant increase in global demand, especially in Asia,
• the necessary maintenance of installations in Norway,
• the action of Russia which is withholding its production to push for the start of production of Nord Stream 2 gas pipeline,
• the low filling of European gas storages this summer at the end of winter 2019-2020 due to poor expectations of gas price increases,
• the very low level (one third) of stocks located in Germany and managed by Gazprom.

The market mechanisms behind a surge in electricity prices

For electricity, it is something else and much stranger for the average consumer, since there has been almost no increase in the cost of producing electricity in France in recent months.

The share of gas and oil in French electricity production is around 7% and in Europe it is around 20%, and part of the cost is linked to the construction of installations. So if we just look at the fuel portion, it is less than 10% of the total cost of electricity production that depends on gas in Europe.

Source: Energy Knowledge

So it is not the cost of electricity that has soared due to the increase in gas prices. In addition, The demand for electricity has not soared either, it is stable. The price of electricity on the market has soared only due to market mechanism himself.

Comparatively, if France had remained in the system of regulated tariffs that existed during the time of the public company, the price would have changed little or hardly at all since the costs did not change overall. Especially since today ARENH allows market players to Cover part of their cost at a regulated fixed price.

A European market mechanism erasing regional energy mixes

Les wholesale price on the energy markets are based on marginal costs.

That is to say that at every moment The market price is equal to the cost of producing the The most expensive power plant of the entire interconnected European network, even if the production share of this power plant represents a tiny part of total production, because this mechanism for the formation of wholesale prices is independent of the quantities produced.

Principle of economic precedence

It is the principle of the economic precedence (Merit Order) which consists in starting the production plants from the cheapest to the most expensive as demand increases and in remunerating the electricity produced at an instant T at the price of the last power plant called to operate for Ensuring a balance between electricity supply and demand and balance the tension on the network at 50 Hz.

Economic precedence: the price is established at the intersection of supply and demand curves - Source: Ministry of Ecological Transition

Marginal cost of production: the master standard for wholesale electricity prices

This price, which depends not on the average price of the electricity produced but on the price of last marginal power plant called to operate, is applicable to all power plants in production at that time, regardless of their relative share in the production of the installed fleet.

So there is a market alignment on the marginal production price of the last power plant called by the network operator (RTE for France).

In other words, if a gas power plant provides 1% of the electricity in the interconnected network, the cost of producing this power plant will be applied to 100% of this electricity on the wholesale market.

And so in the event of a strong tension in Europe on electricity demand, that is to say in the event of mobilization of state-of-the-art production plants, the resulting price on the wholesale market will be Much higher to the average value of production at the same time.

So, If the price of gas soars upon gas markets, as a ricochet effect: as soon as a gas-fired power plant is called into production, its production cost will automatically apply to all the electricity produced on the European interconnected network, even if this electricity is generally produced from hydraulic dam Or of nuclear power plants whose costs are much lower and almost stable.

As a result, the wholesale energy price does not reflect The energy mix of each country and therefore the structural political choices of the production park.

CO2 enters the equation for the marginal cost of production of gas power plants

And that's without forgetting The price of CO2 which applies to the electricity production of fossil power plants, and therefore gas power plants, which increases the production price of gas-fired power plants and, by mechanical effect of the principle explained above of economic precedence, that of all electrical production, whether of nuclear, hydraulic or wind origin.

Why does electricity increase when gas increases?

From this point of view, according to their energy mix, Not all European countries are equal, some being more virtuous than others. Consumers are suffering from the mechanical effect of the European wholesale market and the choices of their neighbor's energy policy, as evidenced by This card.

Wholesale electricity prices correlated in part to gas prices

With this market mechanism, wholesale prices are correlated to gas prices and become uncontrollable by public authorities and extremely volatile.

This penalizes producers who have to make very significant investments and who face a very volatile price that they cannot anticipate and therefore with a significant financial risk.

A market mechanism that impacts consumers

And this also obviously penalizes consumers, first of all individuals since their bills are going to go up to reflect the increase in prices in wholesale markets.
And then French and electro-intensive companies, SMEs/SMIs, who need to ensure the electrical supply of their productive equipment and who would like to have visibility on prices, in other words a stable price linked to production costs, in order to be able to control the selling price of their products and remain competitive.

In the current situation this is a problem for everyone, even if there are some consumers who suffer from rising energy bills and not others.

On the markets, operators exchange electricity at wholesale prices and then To pass on the change in prices on their customers.

Some consumers have supply contracts with guaranteed fixed prices over several years, so for now they are not suffering from price increases in wholesale markets. They will experience these increases later when their contract is renewed, but in a very smooth way.

Other consumers have contracts indexed to market prices and therefore they are already experiencing these increases on electricity markets.

Is the tariff shield an effective measure to protect French consumers?

As you will have understood, The increase in gas prices has a direct impact on the wholesale price of electricity reaching new heights and putting Europe under pressure.

That's why Tuesday 1^Er March 2022, Bruno Le Maire, Minister of the Economy, Finance and Recovery declared on FranceInfo: “I want us to extend the tariff shield”.

A shield put in place in September 2021 to limit the increase to 4%

The tariff shield was announced by the Prime Minister, Jean Castex, on September 30, 2021 for Dealing with the exceptional Rising energy prices observed since mid-2021. The implementation of this rate shield by the government then aimed to limit to 4% the average increase in TRV (regulated sales rates) applicable to residential customers.

Tariff shield: the war in Ukraine is perpetuating the energy crisis

Today, in the face of the war in Ukraine, electricity prices are soaring again in Europe. The tariff shield, originally designed to deal with an exceptional situation, Will last under the combined action of the war and the presidential election in France.

The public authorities say that the tariff shield will resist and make it possible to contain the rise in prices with the target of 4% announced in September 2021. Price increase that should have reached nearly 40% according to the estimates presented on 10 January by Bercy.

All these measures to contain the price of energy already represented a cost for the State of 14 billion euros in 2021-2022, front the war in Ukraine.

What about the ARENH nuclear pension promised to the French?

To respond to the current crisis situation, the government has also increased the ARENH level by 20 TWh (initially 100 TWh) (initially 100 TWh), which will be delivered in 2022, and at the same time revised its price upward to €46.20/MWh (initially to €42/MWh).

Thanks to this measure concerning ARENH, suppliers will therefore be able to benefit from 20% more nuclear energy to meet the needs of their customers. However, this price has increased by 10%.

What energy policy should France pursue?

In the light of the current crisis, we therefore observe the limits of the market mechanism model built on The principle of economic precedence And of marginal cost of the last power plant called which leads to a dramatic increase in prices for the end consumer.

At the same time, the government is obliged to take palliative measures in order to allow French consumers to benefit from Nuclear rent without drawing the wrath of Brussels.

Energy has already been widely used in The presidential campaign, some advocating the revival of nuclear power, such as the current president-candidate, Emmanuel Macron, and others, like Yannick Jadot, being totally opposed to it and wishing on the contrary to increase the existing wind farm, which already has 9,000, by 3,000 additional wind turbines.

As everyone knows, the increase in renewables raises the problem of their intermittency. However, in order to deal with their intermittency, advanced CCGT power plants (gas-fired power plants) are highly stressed, which, with current European market mechanisms, would tend to artificially maintain a high wholesale electricity price.

Undoubtedly, the geostrategic component, i.e. dependence on gas and therefore on Russia, will become an increasingly important criterion in the energy policy choices of the 27.

To climate change, to the revival of the French nuclear industry, to the dependence on Chinese photovoltaic panels, to the transformation of our countryside and coastlines by wind turbines, etc., our French policies must now deal more and more with gas geostrategy, unless they try to get out of European market mechanisms!

This is an unlikely hypothesis, as it is true that, in the current period when the 27 are calling for more Europe, cohesion and solidarity have never been so severely tested, first by Brexit, then by the war in Ukraine, then by the war in Ukraine.

Do not hesitate to read our recent article:” War in Ukraine - What dependence on Russian gas for EU countries? ”

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