Your browser is not supported. Please update it.

14 September 2022

EU targets low-carbon profits to solve energy crisis

The European Commission will carve out the profits of Europe’s clean energy firms, as part of long-awaited plans that aims to offset the skyrocketing energy prices for its citizens.

The windfall tax, as presented on Wednesday, will apply to the ‘surplus’ profits of low-carbon energy companies. With fears of supply shortfalls this winter, following Russia’s invasion of Ukraine, many of these companies have benefited excessively as wholesale gas prices have soared and driven profit margins for retail electricity to record levels.

Under EU energy regulations, the price of electricity to consumers is dictated by the cost of the most expensive fuel, allowing greater profits for those generating electricity at a lower cost. Even prior to the current energy crisis, gas-fired power generation dominated market pricing, but with wholesale prices for natural gas up 2,000% in just two years, cheaper renewables and nuclear power have seen profits that “they never imagined,” according to European Commission president Ursula von der Leyen.

As such, coal and gas plants – both of which have faced extreme increases in fuel cost – will not be hit by the windfall tax.

In announcing the levy, von der Leyen said that “in our social market economy, profits are good. But in these times, it is wrong to receive extraordinary record profits benefiting from war and on the back of consumers.” Brussels expects to raise more than €140 billion from the tax, which can be “shared and channeled to those who need it the most.”

The Commission will continue to debate the detail, with finalization of the technicalities expected by the end of the month. The measure is likely to put a price limit on each megawatt hour of electricity that low-cost generators can achieve. Draft proposals suggest a limit of €180 per MWh, lower than the €200 per MWh included in a previous draft, and still leaving room for margins of over 250% for generators of wind and solar power.

It will, however, cap generators’ revenue at less than half the levels seen in current markets. In Germany front-year prices have pushed beyond €1,000 per MWh in recent months; they sit close to €500 per MWh.

The limit will also only be applied post-trading, so will not directly affect prices in Europe’s exchange-traded electricity market. It’s impact on alleviating record-high inflation – which has largely been caused by rising energy prices – will depend on how revenues from the tax can be allocated towards government subsidy schemes.

There are some questions, though, over how much the Commission can raise through the scheme. Renewable generators often sell their electricity under fixed-price contracts, protected from market volatility, meaning they won’t have any excess profits to be taxed.

The Commission has identified that the cause of this problem is the design of Europe’s energy markets. These must now be redesigned such that low-carbon generation – and energy storage – can be incentivized to benefit from participation in a broader range of market mechanisms.

It seems bizarre that the EU would look to discriminately tax the generators of clean energy that it has been so keen to promote. But for fossil fuels, it is not power generators that are benefiting from the price hike. TotalEnergies reported a record-high profit of $11.5 billion for Q2 2022, while Shell posted a profit of $9.8 billion.

The European Commission will impose a second, temporary windfall for EU-based fossil fuel companies, which could take 33% of their “taxable surplus profits made in the fiscal year 2022.” Brussels is likely to implement a minimum rate for this ‘solitary contribution’ for all EU countries, given that countries like Italy and Germany have already announced their own domestic schemes.

 

Taking this route, it appears that the EU has decided not to implement the controversial gas price cap, that had been suggested by several member states. Many had debated whether the cap should apply to all imported gas, pipeline flows, or wholesale gas trading, and how logistically feasible it would be to distinguish between the three. Italy and Poland were among those in support, citing reduced inflationary pressure, while Germany, the Netherlands and Denmark, warned it may simply divert global supplies – including dwindling supplies from Russia – away from Europe, threatening winter energy security. It is worth noting that the EU has spent nearly €100 billion on Russian fossil fuels since start of its attack in February.

 

The draft proposal also detailed a mandatory target for EU nations to reduce their electricity demand this winter. The measure aims to save 4% of gas use in the power sector by decreasing power consumption by 5% in the 10% of hours that electricity demand is expected to be highest in each month.

As things stand, Europe is in a much better position than many expected ahead of winter – even despite Russia continuing to weaponize its supplies; it recently said that it would not reopen the Nord Stream 1 gas pipeline unless Western sanctions were lifted. The bloc’s gas storage is now 84% full, surpassing the pre-winter target of 80% for November 1st. Analysts at Goldman Sachs have suggested that the long-overdue energy union that Vladimir Putin has forced the EU into, may have already successfully solved the issues related to supply. The bank now expects the price of gas to more than half over the coming months, to below €100 per MWh.