Does the price cap for electricity endanger the energy transition?

The German Government has put together extensive relief packages worth a total of €300 billion since spring. In our previous blog post, we already outlined one of the relief packages associated with the economic defence shield, which included a proposal for price caps for electricity, gas and heat. The German Cabinet has now created the framework conditions for the price caps bill via what is known as a circulation procedure (a procedure in which resolutions are agreed on exclusively in written form without convening). This was done on 25 November 2022. The framework conditions are expected to take effect as of March 2023, apply retroactively for January and February 2023 and expire in April 2024. The draft law on introducing a price cap for electricity, which is intended to help reduce electricity costs overall, is something new.

How exactly does the price cap for electricity work?

The electricity price for private consumers and small businesses is capped at 40 cents per kilowatt hour. This applies to the baseline demand of 80 per cent of past consumption rates – usually measured against the previous year. The current regular market price must continue to be paid for consumption exceeding the 80 per cent requirement.

For context: according to the comparison portal Verivox, consumers pay a monthly average electricity price of 48.16 cents per kilowatt hour (November 2022). It was just 34.79 cents in November 2021, and in November 2020, it was even less (28.77 cents). The cap on electricity prices applies to the baseline demand of 80 per cent of past consumption rates – usually measured against the previous year. The regular market price must then be paid for consumption in excess of this. For medium-sized and large companies with more than 30,000 kilowatt hours of annual consumption, the cap is set at 13 cents per kilowatt hour (net energy price) for 70 per cent of past consumption rates – usually measured against the previous year. They also pay the regular market price for consumption in excess of this. According to the electricity price analysis by the German Association of Energy and Water Industries (Bundesverband der Energie- und Wasserwirtschaft, BDEW) from July 2022, the electricity price for industry rose to 40.05 cents per kilowatt hour. This was just 17.76 cents per kilowatt hour in 2020.

Who is supposed to finance the whole thing anyway?

The relief for households and industry that the price cap for electricity provides is refinanced by taxing windfall profits (unexpected spike in earnings) in the electricity market. The currently high electricity prices, which are leading to very high windfall profits, are a result of how the electricity market is structured. According to this structure, the price for all types of electricity generation is determined based on the power plant with the highest marginal costs that is needed to generate electricity to meet current needs (‘merit order effect’). At the moment, these are gas-fired power plants, the marginal costs of which depend on the sharp rise in gas prices, whereas for all other types of electricity generation, the production costs have not increased. This means that, for the most part, unexpected additional revenues (‘windfall profits’) are currently being generated. With the price cap for electricity, such exceptionally high windfall profits will be taxed for a limited time and redistributed to households and companies. Renewable energy producers in particular have most recently profited from the high prices on the stock market.

The tax began on 1 December 2022. The duration of the tax will initially be limited to 30 June 2023 but may be extended at a later date by legislative decree, but not beyond 30 April 2024.

What are the reactions?

Even though the German Association of the Automotive Industry (Verband der Deutschen Automobilindustrie, VDA) and the Central Association of German Handicrafts (Zentralverband des Deutschen Handwerks, ZDH) praise the price cap for electricity, as it will also benefit smaller energy-intensive trade firms. However, the environmental organisation Greenpeace criticises the plan, as it sees the decisions as artificially cheapening energy and a failure to ensure that dependence on fossil fuels decreases in future.

Wind, solar and bioenergy producers see their livelihoods being threatened and fear that urgently needed investments in the energy transition will be withheld since the price cap for electricity is supposed to be financed by taxing windfall profits. This is because the tax is supposed to be calculated on the basis of prices on the spot market (among other things), where electricity that can be delivered at short notice is traded. However, spot market prices are often significantly higher than the prices that operators and sellers have agreed on. This results in the German Government taxing more revenues than are actually generated. The tax deprives the affected companies of a large portion of their liquidity, which is needed for the required investments in expanding renewable energies.

The president of the German Renewable Energy Association (Bundesverbands Erneuerbare Energie, BEE) sees the error-prone mechanisms for taxing windfall profits as a risk that could cause severe upheavals in the renewables sector. This is because the planned interventions in existing marketing and business models are already causing incredible uncertainty as well as project cancellations. According to the president of the BEE, 92 per cent of project developers working on solar power systems also expect that their projects will become unprofitable due to the announced tax.

Conclusion

The German Government is using the price cap for electricity as part of the €300 billion economic ‘defence shield’ in an attempt to cushion the rising costs for consumers in Germany. Even though, according to Germany’s Federal Minister of Justice, the price cap for electricity will reduce the burden on singles and family households by several hundred euros a year, the renewables sector has criticised it extensively. This is because if this tax mechanism is introduced as described, it is to be expected that the further expansion of renewables could grind to a halt.

Furthermore, according to an expert report by the Hamburg-based energy supplier Lichtblick, it remains to be seen whether the price cap for electricity will actually be implemented, as it could be unconstitutional. The bill violates EU law and infringes on the German property guarantee (Eigentumsgarantie) according to their report. Many experts expect a wave of lawsuits against the price cap for electricity. We will keep you posted with all the latest updates.

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