Thursday 15 December marked six months since the introduction of a mechanism to cap wholesale gas prices in Spain and Portugal. The two countries introduced the ‘Iberian exception’, an Iberian gas price cap, in June in a bid to rein in soaring power prices and increased risks of energy poverty.

Madrid and Lisbon fought hard to push this measure through, largely due to the scepticism of northern EU countries that warned of possible market distortions. However, the measure gained traction in Brussels after the summer – with France coming out in favour and the European Commission suggesting it deserved study.

“It really merits to be considered at EU level,” said Commission President Ursula von der Leyen during a debate at the European Parliament ahead of an EU summit on 20 October. “There are still questions to be answered, but I want to leave no stone unturned.”

For the past year, Brussels has had a hard time finding its way out of the energy price crisis. The European Commission has been tasked in several instances with addressing gas price hikes while pursuing its net-zero goals, but the energy and climate crisis cannot be addressed with ‘one-size-fits-all’ measures, when we are talking about 27 different energy mixes.

Finally, in a display of unity, the EU’s 27 energy ministers agreed to the introduction of an EU-wide gas price cap on 19 December after months of wrangling.

The so-called ‘market correction mechanism’ will only be triggered under certain circumstances: the month-ahead price on the TTF gas hub must exceed €180 per megawatt-hour for three working days and it must be €35 higher than the reference price for LNG on global markets for the same three working days. The objective is to limit volatile price spikes in the European gas benchmark – regardless of its end use.

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The Iberian gas price cap explained

In contrast, the Spanish and Portuguese price cap applies exclusively to gas for power generation. The Iberian model – known in Spanish as ‘tope al gas’ or ceiling on gas – subsidises gas and coal-fired power plants above a certain wholesale electricity price with the objective of reducing electricity prices in wholesale power markets.

This is financed through a cap on so-called ‘windfall profits’ that infra-marginal technologies such as solar, hydro, wind or nuclear obtain from selling their power generation with lower costs than fossil fuel plants.

With the gas price cap, Spanish households under the ‘tarifa regulada’ – a type of energy contract where consumer prices fluctuate every hour depending on demand – have shaved an average 24% off their electricity bills compared with a scenario without the cap, according to a paper by Madrid-based research institute EsadeEcPol.

EsadeEcPol estimates that the average Spanish household, which would consume some eight kilowatt-hours per day, has saved €69 since 15 June, when the Iberian gas price cap was introduced. Considering that around ten million households have tarifa regulada contracts in place, the total savings could amount to €690m across Spain.

Renewable powerhouses

If such a mechanism has had success in Spain and Portugal, it is largely due to the fact that both countries have a high share of renewables and are part of a rather isolated power system, with limited interconnections.

“The mechanism was effective in reducing bills for consumers because it allowed electricity prices to better reflect the lower costs of renewables in a context of very high gas prices,” says Artur Patuleia, senior associate at the think tank E3G. “In power systems with higher shares of coal and gas it would have not provided the same savings for consumers.

“It proves that high levels of investment in renewables are already yielding considerable benefits to consumers,” he adds.

However, the gas price cap may have had an unintended side effect: since the measure was put in place, gas-fired power generation has increased by 42% in Spain. This brought it to about 139 gigawatt-hours of generation per day between June and August 2022, according to the EsadeEcPol paper – and that in turn led to a surge in Spain’s gas imports via LNG

The increase in gas consumption is largely because Spain became a net electricity exporter after the price cap was introduced (because its electricity was suddenly much cheaper than neighbouring France's). The EsadeEcPol paper suggests that power exports to France rose by as much as 80% between June and July 2022. It could mean that this year, Spain will export twice as much electricity as in 2021. The increase in gas-fired power production was exacerbated by droughts in the Iberian Peninsula and much of Europe, which saw hydropower production at record-low levels.

“At first glance, the Iberian mechanism seems to be attractive: it managed to bring down consumer prices, it keeps competition distortion at a minimum, it does not interfere with the functioning of the spot and forward electricity market, and it is not messing with the merit order mechanism,” says Bernd Weber, CEO at the Germany-based think tank EPICO.

“But then, if you look at the adverse effects after the cap was introduced, there has been more gas-fired power generation, and that has allowed France to import cheap electricity. So this largely means that Spain is paying for lower electricity prices in France,” he adds.

Gas demand is up

The concomitant increase in gas demand is critical in the current context, where the ongoing energy crisis has forced governments to take several measures to reduce gas consumption for energy security reasons. REPowerEU, the Commission’s response to the energy crisis, includes an EU-wide target to save 15% of gas consumption this winter.

“We must analyse the discussion of an Iberian mechanism at the EU-level by understanding the trade-off it represents,” says E3G’s Patuleia. “[We must] assess if we can risk increasing gas demand in the current context for the sake of unclear expected savings in consumer prices.”

Spain and Portugal have the infrastructure to import a large share of gas from a wide variety of suppliers – with Portugal’s Sines LNG terminals and seven of them in Spain, as well as gas pipeline interconnections with North Africa – but not every EU member state is in this position.

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“[A mechanism like the Iberian model] might make some sense for countries that can increase their gas supply, but it is not useful for countries that have bottlenecks to import gas, as it could exacerbate the scarcity [of gas supply],” says EPICO's Weber.

According to data from Cores, an agency within Spain’s energy and environment ministry, Spain’s LNG imports rose to more than 26 billion cubic metres (bcm) between January and October this year. In contrast, LNG imports in 2021 amounted to some 23bcm for the year. Pipeline gas exports from Spain to France also rose to some 2.80bcm between January and October 2022 – compared with just under 1.50bcm for the whole of 2021.

The Iberian gas price cap at EU level

The increase in electricity exports from Spain to France shows what could happen if the 'Iberian exception’ were introduced at EU level. It could not only lead to an increase of gas-fired power generation within the bloc, but much of this electricity could be exported to countries outside of the EU, who would benefit from the subsidies and lower prices at no extra cost.

Such a mechanism would also expose divisions within the EU, as countries that have less capacity to import gas and lower shares of renewables in their power mix would struggle to pay for the ‘cap’ and compensate gas-fired generation.

“[The Iberian model at EU level] could create all sorts of distortions: across countries, but also across sectors,” says Weber. “For instance, if gas demand is subsidised for power but not for other sectors, such as energy-intensive industries, this creates the risk of higher gas prices for our industries.”

Similarly, the EU-wide gas price cap has raised concerns in terms of security of supply, with some EU countries such as the Netherlands fearing it could dissuade gas producers from exporting to Europe and divert their cargoes to other world markets.

The EU mechanism can be deactivated or suspended in case security of supply or intra-EU gas flows are jeopardised, the agreement reached at the Council on Monday said. These ‘safeguards’ convinced nations sceptical of the price cap to change their minds and support the measure.

Ultimately, neither the EU-wide price cap nor the Iberian mechanism can provide a way out of the energy price crisis in the long term, since both mechanisms fail to introduce structural changes in the form of energy savings and a switch away from fossil fuels. “Gas markets will continue to be tight in the next few years, so it is crucial to have a clean energy action plan for the next two to five years that addresses gas demand reduction and investment in renewables and energy efficiency,” says Patuleia.