Energy Inflation is Caused by too High Dependency of Gas

The price of energy has gone sky high thus causing broad-based inflation and financial problems for many – this inflation is due to two things:

    1. Russian mindless war, and 
    2. Companies are passing on huge increases in energy prices to consumers.

The European Central Bank (ECA) has been trying to chase this inflation caused by Russia’s invasion of Ukraine by increasing interest rates, another inflationary cause! 

The President of the ECA and its other board members office appear not to understand that increasing interest rates will not reduce the price of gas or the rest of the energy prices.

They seem not to understand that price of electricity moves with the the price of natural gas, even though electricity produced by natural gas is the most expensive way to produce gas and is only used when demand is very high!  

So the big question is “Can Electricity Prices Be Decoupled From Natural Gas Prices?”

Although electricity prices are not officially pegged to natural gas prices, it is clear that many big European countries that depend heavily on gas are definitely coupling the prices of these two commodities. 

The only direct way to decouple the social costs of electricity production from natural gas is to completely stop using natural gas to produce electricity, but this may cause some energy blackouts in some places – then the question to be asked is “how many?”. The probable answer to that question is probably not much, if any at all, because governments will probably step in to support price differentials to avoid prolonged blackouts.

The European Union could choose to change the electricity market model. 

There have been rumours of an overhaul plan for some time, and this year, Ms. von der Leyen announced that the European Commission is indeed preparing to ‘end the link between gas and electricity prices.’ 

What this plan will entail remains to be seen. The EC could, for example, choose to design the wholesale markets in such a way that electricity prices are no longer determined by the marginal cost of the most expensive power plant in operation, or to introduce a price cap on either electricity or gas prices. 

Some bank economists talk about the challenges in changing the above pricing system. They say that hasty changes in the pricing models could lead to problems for the security of supply.

However, many big countries are heavily dependent on gas and other fossil fuels whereas others are not, and that is what we need to consider. Why should countries that depend on gas demand that those countries that have not exposed themselves to gas be forced to contribute! 

The Nordic countries, for example, are not that dependent on fossil fuels, but get exposure through high electricity prices from being part of the European energy network where big countries are highly dependent on fossil fuels.

This means that there is no consensus yet on what the best alternative to the current market model is and whether there is a better alternative at all. But given the current energy crisis, Ursula von der Leyen has suggested a fast-tracked approach, in line with other recent regulatory changes related to energy supply and pricing.

An alternative to decoupling wholesale electricity prices from natural gas prices is to decouple retail electricity prices from wholesale prices, for example, by capping them. Obviously, this would most likely mean that in this case energy suppliers would need financial support to overcome the gap between the costs they face and the prices they can charge retail consumers. But this argument is weakened when looking at many of the big power utilities in Europe that are reaping huge profits just now… Claiming that they could go bankrupt is most probably a gross exaggeration.

At the end of the day, the costs of electricity production will need to be covered, but that should be handled at the national level. This also means that as long as natural gas remains a significant source of electricity production in Europe, and natural gas prices stay high, average electricity production costs will also remain high, and that does not seem equitable for the Nordics that have taken action to reduce their risks by investing heavily in renewables and nuclear power sources.

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