Decoupling electricity prices from natural gas: a key to unlocking renewables’ potential

Introduction

The EU is a global leader in renewable energy adoption, with wind and solar providing an increasing share of electricity. Yet, despite their declining costs, electricity prices across Europe remain tied to natural gas prices, a disconnect that frustrates consumers and hinders the transition to a sustainable energy future. The Draghi report on industrial policy calls for a rethinking of this pricing structure to ensure Europe’s energy market supports its climate goals and industrial competitiveness.

The problem with marginal pricing

At the heart of the issue is the EU’s marginal pricing mechanism, where the most expensive source of electricity, often natural gas, sets the price for all electricity traded on the market. This system worked well when fossil fuels dominated the energy mix, but as renewables grow, it creates distortions:

1. Unfair costs for consumers: Even though renewables are cheaper to produce, electricity prices remain high during periods of high gas prices, as seen during the energy crisis following the Russian invasion of Ukraine. This mismatch burdens consumers and industries, undermining public support for the energy transition

2. Missed opportunities: The low operating costs of wind and solar are not reflected in electricity prices, reducing incentives for further investment in these technologies. This slows the pace of renewable energy deployment, which is critical to meeting EU climate targets

3. Industrial competitiveness: High electricity prices impact Europe’s industries, particularly energy-intensive sectors like steel and chemicals, making them less competitive globally. Draghi’s report emphasizes that reforming the electricity pricing system is essential to safeguard Europe’s industrial base

A call for reform

Reforming the EU’s electricity pricing mechanism is not just a technical adjustment but a necessary step to align energy markets with the realities of a renewable-dominated system. The EU is in the process of doing this and several approaches could help achieve this:

• Decoupling electricity and gas prices: Introducing a pricing system that reflects the true cost of electricity production, rather than relying on the marginal pricing model, would ensure that the benefits of cheap renewables reach consumers. One option is to establish separate markets for renewables and fossil fuels, allowing renewable energy to set its own prices

• Contracts for Difference (CfDs): Long-term contracts for renewable energy producers could stabilize prices and provide predictable revenues, making renewables more attractive for investors while shielding consumers from price volatility

• Strengthening grid integration: Expanding cross-border electricity trading and storage capacity can reduce the reliance on natural gas by better balancing supply and demand across the EU. This would allow regions with abundant renewables to export cheap electricity during periods of surplus

Aligning policy with climate goals

The current pricing model is increasingly at odds with the EU’s climate objectives. By maintaining a system that benefits fossil fuel producers at the expense of renewables, the EU risks slowing its energy transition, drawing investment away from other aspects of the transition like storage , heat networks and grid reinforcement. Reforming electricity pricing is therefore critical to achieving the twin goals of decarbonization and affordability.

Draghi’s report highlights the urgency of this issue, stating: “Europe must transition to an energy market where renewable energy, rather than fossil fuels, drives price setting. Without this shift, the economic and social benefits of renewables will remain unrealized.”

Challenges and considerations

While reform is essential, it must be implemented carefully to avoid unintended consequences. For instance, overhauling the pricing system could disrupt existing energy contracts and markets, requiring coordinated action at both EU and member-state levels. Additionally, reforms must consider the role of natural gas as a transitional fuel, ensuring that changes do not jeopardize energy security during the transition.

Conclusion

Decoupling electricity prices from natural gas is not just a technical fix, it is a strategic necessity for Europe’s energy transition. By aligning electricity pricing with the realities of a renewable energy system, the EU can lower costs for consumers, accelerate the deployment of clean energy, and strengthen its industrial competitiveness. As Draghi’s report rightly notes, this reform is key to unlocking the full potential of Europe’s renewable revolution and securing a sustainable, affordable energy future.

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