Europe’s Upcoming Energy Affordability Crisis – September 2022

Electricity prices are set to soar in Europe over the upcoming months. It is expected to hit lower-income families hardest with utility bills going up steeply. Europe uses the merit order principle, a mechanism designed to determine the price of electricity. The price is linked with demand, starting with low cost power sources such as renewable energy. As demand increases, the price is determined by its costliest energy source such as coal-fired plants.

So on an average day, if the costliest source is wind energy at say 2$/KwH, that is the price you will pay for electricity. But if demand is high and the costliest source is natural gas at say 10$/KwH, you will pay that amount even if you are drawing energy from other sources.

This mechanism may not reflect the true cost of electricity. Nevertheless, the merit order principle has been the standard in many rich countries. In the United States, which uses the same system, 1 out of 6 households are behind on energy bills (20 million families). As long as the war in Ukraine drags on, the outlook for commodities like oil and gas are unclear and expensive. Colder temperatures mean higher demand for such energy.

I believe over the coming months, electricity prices will squeeze European households as well as stoke inflation further. Attempts to mitigate price increases such as energy price caps, subsidies, tax credits are not going to solve the problem and may make it worse. It will either gobble up government spending or create widespread blackouts.

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