By lowering the price cap
Beginning in 2022, the EU set an electricity wholesale price cap of €3,000/MWh, as well as an automated rule stipulating the ceiling to increase by €1,000/MWh five weeks after each time the realized market price, at any hour in any market area within the EU, was above 60% of the current price limit. The rule was triggered in April and August 2022. But a high and increasing price cap, argue Gerlagh et al. substantially increases the average costs of electricity especially during the current energy crisis. They therefore suggest a reduction in the price cap at least for as long as the current crisis lasts:
The ceiling price is a social contract that defines what can be charged for electricity if there is a shortage. Its level should be such that producers are compensated and thus have an incentive to invest and keep capacity for disruptive situations. The high price is acceptable when it is rarely paid, and only over short periods. The crisis caused by the Russian invasion is different because the disturbance is persistent. The ceiling price must be lowered when the frequency and length of disturbances increases, and can be lowered while keeping the same overall compensation promised to reserve suppliers. We believe a price cap of €1,000/MWh is more reasonable under the current circumstances, and it will substantially reduce the risk premium.
A common concern is that lowering maximum prices may lead to reduced supply, increasing the need for quantity rationing. The data, however, tell us this problem is insignificant. There is virtually no additional supply above €1,000 /MWh.
Stabilizing the EU Electricity Market: Mandatory Demand Reduction and a Lower Price Cap
By: Reyer Gerlagh, Matti Liski, Iivo Vehviläinen – Tilburg University, Aalto University
