June 23, 2024
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Europe: The role of government in setting electricity prices

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The subsidy race triggered by the energy crisis in 2022 showed how electricity policy is central to industrial policy. Addressing this at the EU level will become even more important in the coming years as Europe moves to electrify transport and other sectors, argue Ben McWilliams, Giovanni Sgaravatti, Simone Tagliapietra, and Georg Zachmann.

Ben McWilliams is an affiliate fellow in energy and climate policy at the Bruegel economic think tank in Brussels. Giovanni Sgaravatti is energy and climate research analyst, while Simone Tagliapietra and Georg Zachmann are both senior fellows at Bruegel.

The role of government in setting final electricity prices is becoming a main arena of industrial policy debate. The allocation of taxes and tariffs creates a huge discrepancy between the prices paid by different consumers in the same market.

At the same time, Europe’s energy transition depends upon increasing electrification of the economy and increasing the share of that electricity produced by renewable sources. Both factors will raise the relevance of electricity taxes set by governments.

The energy crisis drew attention to this: as electricity prices soared, European industries were confronted with higher and more volatile prices than their overseas competitors. Governments responded with billions of euros in subsidies to reduce prices.

While the acute phase of the energy crisis has now passed, growing concerns of industrial competitiveness create political pressures for governments to continue with such subsidies or tax exemptions.

Two high profile examples have been the French reform on how state-owned utility EDF sells nuclear-power generated electricity and a political debate in Germany over how aggressively to subsidise the electricity price of energy intensive firms.

These came amid a wider European discussion on reforming the rules governing the EU electricity market design. These developments deserve particular attention also because in the coming years governments will have to spend billions of euros to transform their electricity grids.

As we see it, the debate should revolve around five key distributional questions that are currently not adequately discussed in the EU energy and industrial policy debates.

The first question is whether funding for electrifying the economy should be raised through electricity tariffs or general taxation.

Historically, governments have recovered the costs for subsidising renewables and expanding the grid through electricity tariffs, however in the last two years they shifted large shares of these expenses to the general budget to shield consumers from high energy prices.

This dynamic might be beneficial to encourage the electrification of the economy. However, lowering electricity costs also decreases the incentive for energy efficiency, which should instead be ramped-up quickly.

The second question concerns how taxation should be split between households and companies. The standard decision of European governments is to impose a larger share of taxes on households to subsidise the electricity consumption of companies.

As governments push households to install heat pumps and adopt electric vehicles, pressure will grow to reverse this policy. Conversely, industrial competitiveness concerns will press governments to reduce taxation on energy-intensive and exporting firms.

The third question relates to whether energy-intensive industries should benefit from lower taxation compared to non-energy-intensive industries. The economic logic of subsidising energy-intensive firms is controversial.

Some level of support is justified as compensation for the higher carbon cost in the EU compared to international competitors. Governments consider certain energy-intensive firms to provide economic security benefits, for example, the manufacture of steel.

However, companies that are energy intensive typically produce lower value added per unit of electricity consumption and they also employ fewer people.

The fourth question relates to the possible trade-offs in attracting new clean technology manufacturing factories.

The production of many clean technologies involves electricity-intensive manufacturing stages, for example, the refining of polysilicon for solar panels, or the production of battery cells. Just like legacy energy-intensive production, this new wave of cleantech will face the same dynamics in competing for electricity generation.

The huge energy consumption of these facilities implies an important role for policy and industry in sensibly locating them.

Finally, an important question is whether EU coordination of energy subsidies should be preferred to individual national actions. Any increase in one country’s consumption means that other countries in the internal electricity market can consume less and will face higher electricity prices.

Therefore, national subsidies have cross-border effects. For example, during the energy crisis, European governments competed in a subsidy race, which ultimately raised the price of a limited supply of natural gas.

The good news from Germany and France is that these countries have so far resisted temptations to generously subsidise energy-intensive industries. This would have had consequences for the integrity of the European single market and non-energy-intensive domestic consumers.

However, their debates highlight that electricity policy is central to industrial policy. This will become even more the case in the coming years. Firstly, electricity will grow its share of final energy demand with transport and demand sectors particularly shifting consumption to electricity. Secondly, because the share of renewables will grow.

This implies that the unit price of wholesale electricity will decrease; however, as volumes grow there will be a growing share of taxes and tax revenues for governments to distribute between consumers.

Our five distributional questions need to be made central to the current EU industrial policy debate, as their answer will define the future integrity of the EU single market and the trajectory of EU economic competitiveness.

Source: Euractiv

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