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21 February 2022

Will rising gas prices hasten the switch to renewables?

The soaring cost of energy is top of mind for consumers worldwide. How will the increase affect climate and energy policy?

By Dave Keating

Energy prices are soaring, chiefly driven by a sharp increase in the price of natural gas. Few places are feeling this more acutely than Europe, which is heavily reliant on gas imports for both heat and electricity. Natural gas in Europe now costs as much as €150 per megawatt hour (MWh), compared with an average of €49/MWh last year. During a visit to Washington, D.C. earlier this month, German Chancellor Olaf Scholz said one way to ride out the storm is to accelerate the energy transition toward renewables – but is there any evidence this is happening in the short term?

The good news, according to a recent report by climate think tank Ember, is gas power generation is being replaced with renewable energy because renewables have become the cheapest form of electricity by far. Last year saw a decline in fossil fuels’ share of electricity production in the EU, from 39% in 2019 to 37% in 2021. Renewable electricity has had an average annual growth of 44 terawatt-hours over the past two years, and more than half of that new wind and solar power replaced gas plants.

Consumers are increasingly worried about high energy bills. (Photo by coldsnowstorm via Getty Images)

The bad news is those renewables were until now going to replace coal instead of gas. From 2011 to 2019, more than 80% of new renewables came at the expense of coal, according to the Ember report. Because there are not yet enough renewables online to replace both, that means the decline in coal is slowing because there are less renewables available to replace it – they are busy replacing gas – and yet coal is much more emissions-intensive than gas.

“The gas crisis has really demonstrated that Europe needs to get serious about renewables deployment,” says Charles Moore from Ember. “Europe has been focused on coal, but not gas. The gas crisis is a big wake-up call. We need to get off both coal and gas by 2035.”

“We need action to keep the EU coal phase-out on track,” he adds. “It is clear you will need legislation to guarantee that coal plants will be off-grid by 2030.”

Meanwhile, on heating, the rise in gas prices has not yet spurred a widespread switch to renewable heat such as heat pumps, although their share is growing. Because it is difficult or impossible for most homeowners to change their heating source, price signals are not enough to motivate switching.

Market flaws

Europe finds itself in a situation where gas prices are at record highs, while renewables prices are at record lows. Yet this is not spurring a big increase in renewables; it is only moving renewables from replacing coal to replacing gas. The culprit, say experts, is the “merit order” in which the most expensive power stations set the overall price.

The price on the electricity exchange varies based on how much power is available from different kinds of sources and at what cost. This means that at times of high input from low-priced renewables (such as sunny or windy days), coal and gas become so expensive by comparison that they are pushed out of the market – but the price is still set by these most expensive plants. That takes away the price incentive of switching to renewables – by making the price remain artificially high even after the switch.

“There has been a sense that you can let the market do its work with carbon pricing and coal will finish itself off,” says Moore. However, right now market flaws are stifling renewables growth even when renewables are priced so low.

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EU member states are split about how to address the energy price problem. A meeting of EU energy ministers in December became tense when a proposal by Spain, France and Italy to end the merit order system was rejected by countries opposed to market intervention, such as Germany, Austria, Denmark and the Netherlands.

Governments across Europe are bailing out citizens to help them with higher energy costs. Spain was one of the earliest countries to take that decision, and Germany reluctantly came around to it last month. There have been debates about what is and isn’t allowed under EU law. In October 2021, the European Commission put forward a “toolbox” outlining how member states could help citizens through short-term income support measures, state aid and tax reductions – but it says in the long term countries need to strengthen their resilience against future volatility. The Commission committed to further support investments in renewables and energy efficiency, and increase energy storage.

Germany already last year reduced its renewables levy on consumers to €0.65/kWh, and last month it was reduced further to €0.37/kWh – an amount that would lower the annual power bill of an average German household by €100. Some politicians in the Social Democrats, the largest party in government, have now started calling for the tariff’s complete abolishment to be brought forward from 2023 to now. This is supported by German industry association BDI, which says all fees and levies on energy need to be abolished or at least revisited. The German government is currently considering a “climate payment” to all citizens to compensate them for high energy prices.

However, this money has to come from somewhere, and there are concerns that funding streams for renewable energy are being withdrawn faster than the market can cover on its own. The German government plans to use income from the sale of emission allowances in the EU Emissions Trading System, where the price of carbon is at record highs close to €100 per tonne of CO2, to support renewable installations instead of the levy.

Green backlash

The degree to which the high ETS price is to blame for consumers’ high energy prices has been a matter of debate. At the contentious EU energy ministers’ meeting in December, Poland, Hungary and the Czech Republic vocally singled out the ETS and said it needs to be reigned in. German centre-right MEP Peter Liese has proposed that the EU gives member states a partial opt-out from a planned ETS for transport and heating, exempting private housing and transport for two years after it is set to come into force in 2026.

Yet experts say the high carbon price is only playing a minimal role in the energy price rise. “Unfortunately, we are once again seeing claims that volatility in gas and electricity markets is the result of the clean energy transition,” said Fatih Birol, executive director of the International Energy Agency, last month. “These assertions are misleading to say the least. This is not a renewables or a clean energy crisis, this is a natural gas market crisis.”

This is a dangerous time for those who want concerted climate action. Eastern European governments have already started telling their citizens EU climate policy is to blame for their rising energy bills. Further price increases will also likely erode public support for climate measures in western Europe if there is an impression they lead to higher prices. This has frustrated experts, because the energy transition to cheaper renewables is in fact what would solve the price crisis.

There is also a risk of the flagship tools for fighting climate change being knocked off course by the extreme price volatility. Too much government relief, especially for companies, would dampen the pricing signals the EU ETS is supposed to create to spur investment in clean energy. The effect is seen in smaller ways as well, such as if high electricity prices make the benefit of driving an electric car less obvious.

Climate change policies may not have caused the current energy price crisis, but they are at great risk of being encumbered by it if the problem is not addressed soon. That is why the Commission is anxious to address the problem, and why it released the toolbox – but Europe’s changing energy sourcing and energy efficiency remain a long-term project. Meanwhile, as Europe faces the prospect of a war to its east that could turn off the gas tap, the gravity of the situation may increase significantly in the short term.

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