Is Spain heading for European power prices?

By Benedict De Meulemeester

By Benedict De Meulemeester on 27/06/2009

In the past five years, Spanish power consumers enjoyed lower prices then their competitors in many other countries of Europe like Germany, the Benelux, France, UK or Italy. Only Scandinavian countries had lower wholesale power prices most of the time. There is some rationale for Nordic power prices to be lower. Hydropower is so abundant that it produces the marginal megawatthour that sets the price for all energy. And as the fuel cost of hydropower is zero, it is logic that this produces low overall energy prices. But how about Spain? It produces around 50% of its electricity from fossil fuels. Hence, it should be expected that marginal MWh's are produced with coal-fired power plants during off-peak hours and gas-fired power plants during peak hours. Hence, the prices of coal and gas should set the prices of respectively baseload and peakload power. Spain should therefore have power prices that are similar to those of Germany.

Then why were Spanish power prices systematically lower than German in the past years? I can think of two reasons:

1. Like the French government, the Spanish rulers never embraced power market liberalisation wholeheartedly. Regulated tariffs continued to co-exist along open market prices for a long period. As regulated tariffs are based on the average total cost of power, they remain lower in times that the fossil fuel costs run up. Open market prices had to adapt to these lower regulated tariffs. We see a similar phenomenon in France, where the regulated market prices are also lower than the open market tariffs in periods - like the past five years - when coal and gas prices rise.

2. We have seen gas contracts in the Spanish market with pricing formulas that resulted in prices that were much lower than what gas costs in other countries. I wouldn't be surprised if Spanish power producers have old long-term contracts for coal and gas which allows them to pay prices that are far below the international market benchmarks used by producers elsewhere in Europe to set power prices.

Both advantages are dissapearing. Coming under intense pressure from the EU, the Spanish government had to abandon the regulated tariffs last year. We see how the market is starting to function like a full-scale open market. During a discussion that we had with an important Spanish power producer, we heard them say that internally more and more questions are being asked why they should sell power from a coal- or gas-fired plant if the price they get for the power is insufficient for buying the fuel. This means, Spanish power suppliers are wondering why they are not applying marginal cost economics like their colleagues in other European countries. From their perspective, this is perfectly understandable. Moreover, all over the world old long-term commodity contracts resulting in prices that are below world market levels, are being put into question by the producers of those commodities. The most famous example of that is the gas price row between Russia and Ukraine. I can imagine that similar discussions are going on between Spanish power producers and their suppliers.

We always expected that the Spanish power market would have a price level and development similar to what happens in the German- French - Benelux market. And as you can see from the graph below: the Spanish wholesale power price is indeed moving closer to wholesale power prices in those countries. For the Spanish power consumers, this will have the following consequences:

1. In times of high coal and/or natural gas prices, higher power prices will be noticed,

2. The volatility will increase, marginal pricing results in larger price differentials than average total cost pricing,

3. Power prices will be more unpredictable, as they depend on what happens in the international coal, oil and natural gas markets.

As the retail power markets in Spain stand today, the Spanish power consumers will be hardly shielded from the risks of these new markets. We find many Spanish power suppliers reluctant to supply the products and services to deal effectively with this increased risk. A multi-click contract, common in most European countries, is regarded as an exotic product. Those suppliers argue that they are not asked for such contracts by clients. Until now, this was probably the case. But as market volatility and unpredictability increase, many Spanish clients will learn the hard way how risky it is to fix power prices in one moment. Moreover, we can see how our Spanish client base is rapidly expanding. This means that Spanish companies feel the need for energy market risk management so hard that they hire us as consultants despite the severe economic downturn that they are currently subject to (together with Ireland, Spain is extremely hard hit). Which makes me happy that we decided one year ago to do business in that country. We will most certainly be extremely helpful to our clients there.


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