Analysis: for bills to start coming down rather than going up, we need stability in the market and this depends on three conditions - Dr. Paul Deane, Senior Research Fellow, Energy Policy & Modelling Group, MaREI Centre/ERI/UCC
The word 'unprecedented' has become a familiar term to describe the many extraordinary global events since the pandemic, but when it comes to the current energy crisis and its impact on electricity markets, the word ‘mayhem’ is a better fit. At times last year the daily price of generating electricity in Ireland was over 12 times higher than normal as electricity prices surged in lockstep with European natural gas prices to never before seen levels in response to the war in Ukraine and Russia’s reduced gas flows to Europe.
These exceptional prices were seen, felt, and paid by us all. Annual household electricity bills doubled from a typical €1,000 per year in 2020 to now over €2,000 per year and while the Government did a good job in shielding many homes via a €600 credit, bills are still high and unfortunately will remain elevated for the foreseeable future.
Recently in response to lower international gas prices, driven primarily by warm weather across Europe, the cost of generating electricity or what is also known as the wholesale cost of electricity has reduced. But while wholesale prices have come down, they are still very high. This year's average winter prices were slightly lower (6%) than the same period last year but are still 350% higher than the long-term average for the same months.
Because we generate most of our electricity from gas in Ireland, it is still the dominant driver of costs and while wind energy and renewables put downward pressure on prices, they are a secondary rather than a primary driver of prices. When it comes to our household electricity bills, the cost of generating electricity represents a little less than half of the full bill with the remainder relating to taxes and charges for the delivery of electricity to our homes.
Because of this relationship between wholesale costs and our bills, a rule of thumb is when wholesale prices go up by a factor of four then bills will double, and this is essentially what happened since 2021 when EU gas prices started to rise in what we now know was strategic manipulation of gas storages by Russia’s Gazprom in advance of the war.
While it is important that wholesale prices are coming down, it takes time for these reductions to translate into lower bills. This is because electricity supply companies take long-term perspectives on electricity prices to households, typically over a 12 to 30-month period, rather than a short-term monthly or quarterly view when it comes to retail price setting.
This approach or hedging strategy cuts both ways. It shields us from extraordinary high prices such as last summer when prices were 6 times higher than normal, but also means it delays the benefit of accessing reduced prices when they do drop (such as this winter) because the higher prices are still working their way through the market and to our pockets.
This means short-term impacts, be they good or bad, take time to translate into market outcomes. Looking to the next three to six months it is unlikely that residential retail prices will reduce in a significant way, however, we may see small reductions as EU gas supply is currently in a healthy position but the outlook across the full year is still very volatile, and volatility keeps upward pressure on prices.
For bills to come down we need stability to return to the market and for volatility to dissolve. This is a big ask, but if current wholesale prices stabilise for a longer period, then we can expect to see a moderate reduction in our final electricity bills. But this stability is contingent on three conditions:
If the weather in Europe stays mild and windy throughout this spring this will lower the demand for gas and push prices down.
European power and gas infrastructure must remain reliable and robust to avoid power shortages and price spikes.
A reliable and adequate supply of shipped gas (LNG) to the EU and the UK is necessary to make sure we have enough gas to meet demand across Europe.
Each of these elements is required for stability to return to markets but if one is absent then volatility will prevail, and any potential reductions will take longer.
At the core of this energy crisis is the problem of natural gas supply. The energy crisis will be resolved if there are structural changes to global gas supply and more gas becomes available to push down energy prices, or if more renewables and other sources come online quickly to push down the need for natural gas. Unfortunately, both options take years not months to deliver and while hopefully the worst of the crisis is behind us, the likelihood is that prices may come down but will remain high across 2023.