gas cap questions and answers

gas cap questions and answers

The so-called Iberian solution arrives this Thursday at the Congress of Deputies, which must validate the Royal Decree-Law that includes the mechanism agreed with Spain and Portugal, a day later of the final green light from the European Commissionwhich has taken longer than expected to approve it, after the clarifications published a few days ago by the Portuguese energy regulator.

Brussels forces Spain to change the regulated electricity rate as a condition to approve the gas cap

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Here we summarize the keys to this measure, described as "historic" by the Government and which aims to be a kind of shield to protect consumers from what may happen in the coming months with the price of natural gas, as a consequence of the war in Ukraine.

How does it work?

The mechanism aims to prevent, for a period of one year (until May 31, 2023) that the price of gas continues to contaminate the prices of the wholesale electricity market. By imperative of the EU (which already openly acknowledges the shortcomings of this design), the so-called pool works based on the so-called marginal model: the latest technology is what sets the price every hour. And this is usually determined by the price of natural gas, which has skyrocketed in the last year.

With the cap on gas, the price at which combined cycle, cogeneration and coal plants (already very residual in Spain) can offer will be limited. Initially (in the first six months), the cap will be 40 euros per megawatt hour (MWh), with which the wholesale market price will be around 130 euros/MWh, compared to 182 euros this year. Thursday, the more than 200 of the last weeks or the 700 euros that he punctually reached in March.

That limit will then gradually rise, at a rate of 5 euros per month, so that the effect of the measure will be diluted from next January. In the average of the twelve months in which it will be in force, the cap on gas will be 48.8 euros, compared to the 71 euros at which this raw material is now listed on the Mibgas Iberian market.

This does not mean that gas plants have to operate at a loss: the difference between the real price of the raw material and the Iberian cap will be charged against the electricity system. The compensation will be paid by consumers, who will however notice a net saving on their bill. Brussels calculates that the measure will cost 8.4 billion euros, of which 6.3 billion will correspond to Spain and 2.1 billion to Portugal.

What will the savings be?

It will depend on the price of natural gas in the coming months and other factors such as the contribution of renewables, which make the wholesale market cheaper. But the Government affirms that the reduction for Spanish consumers will be between 15% and 20% with respect to current prices, less than 30% initially calculated. The reason is that, in the negotiations with Portugal and Brussels, it was agreed that contracts not linked to the wholesale market did not have to finance the compensation in the first place to the electricity companies for the cost of gas, and that they do so as these contracts expire.

When will it be reflected in the invoice?

The mechanism will begin to be applied in the daily auction next Tuesday, given that next Monday is a holiday in Portugal. With this, it will begin to have an effect on the price of the so-called pool from Wednesday. And, already in the bills that consumers receive in July, it will be reflected first in domestic customers and SMEs that are covered by the regulated rate, the so-called PVPC, in which the price of energy is directly linked to the wholesale market: the “fools”, in the unfortunate expression of the president of Iberdrola. A little less than 10 million supplies had been received in this modality in December. And industrial customers, who cover 70% of their electricity demand by going directly to the pool, will also benefit directly from the outset. Subsequently, it will be extended to clients in the free market, who have contracts valid for one year, as they expire.

Will it have an effect on inflation?

Yes, and immediately, because the National Institute of Statistics (INE) is it leaves out in the measurement of the consumer price index (CPI) the electricity contracts that are in the free market, although it is preparing changes in its methodology. And that way of measuring the CPI explains why Spain has been at the forefront of the rampant rise in inflation in Europe, with a peak of 9.8% in March, after the invasion of Ukraine. Now, by affecting contracts in PVPC first, the effect on the IPC will be immediate. The third vice president and minister for the Ecological Transition and the Demographic Challenge, Teresa Ribera, estimated this Thursday that the cap will help reduce inflation in Spain "around eight tenths or one point" in the coming months.

Will it imply changes for consumers?

Yes, for an important part of households. Spain has promised Brussels (and this is reflected in the Royal Decree-Law that will be submitted for validation this Thursday) change the regulated electricity tariff and make it less volatilean old request from the electricity companies: "One of the conditions for the approval of the mechanism by the European Commission is the reform of the current voluntary price for small consumers (PVPC)", indicates the text.

Thus, from 2023, the way of calculating this rate will be changed to reduce its link to the hourly price of the wholesale market and link it to more stable references, as is done in Portugal, including term references: annual, quarterly and monthly.

How is the mechanism going to affect interconnections with France?

Predictably, it will spur exports north of the Pyrenees. Initially, Spain and Portugal planned a double auction to avoid subsidizing the energy that is exported to France. But, after the negotiation with the community authorities, both countries will have to sell the electricity at the price resulting from that cap, which implies that the Iberian consumers will subsidize the French.

The decree establishes a safeguard, a mechanism to partially correct this effect called congestion rent, which will help finance compensation to power companies. But it is foreseeable that electricity exports will skyrocket, given the technical problems that drag about half of the powerful French nuclear park. However, we must remember the limited interconnection of the Peninsula with France, which does not reach 3% and which is the main argument that Madrid and Lisbon have put on the table for the European Commission to give its arm to twist and accept this mechanism exceptional.

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