Why is delaying electrification both a risk for the green transition and a financial concern?

Over the next decade, the EU and its member states plan to substantially increase wind and solar capacities. By 2030, the planned installation of roughly 1000 GW of new renewables capacity will cost in the order of a trillion Euros. ?

According to the reformed electricity market design that will enter into force next week, much of this investment should happen under ‘Contracts for Difference’ (CfD), to ensure that consumers still get access to low-cost renewables power, even if wholesale electricity prices rise.

But what happens if electricity demand fails to keep up with new renewables investments? If prices drop, a scenario may occur where producers, instead of consumers, need to be compensated for a shortfall in market revenues. Sluggish electricity demand growth in past years has indicated that this is not unconceivable. If supply investment proceeds according to plan while demand turns out 20% lower than expected, the cost to be covered could easily reach dozens of billions of Euros per year.

The European rules do not specify how to cover potential costs. If costs should only be recovered from households’ electricity tariffs, this might not only be unpopular, but would also delay the rollout of electric heat pumps and electric vehicles. If cost is put on all electricity consumers equally, some energy-intensive industries might decide to dislocate or delay electrification. If household and/or industry electricity demand declines, oversupply would become an even bigger problem – leading to even higher CfD cost. Alternatively, taxpayers could burden the cost of financing CfDs, but this would add to the exposure of public budgets. Hence, sharing the risk of deficient demand is a challenging distributional question.

Better synchronisation of supply and demand investments could mitigate this issue somewhat. As the underlying wholesale market is for good reasons European, this would call for better foresight on European supply and demand projects, ideally in the form of a European Energy Agency. Moreover, it might be fiscally cheaper and more efficient to complement renewables deployment policies with policies to stimulate adequate electrification of demand, especially when market signals are muted due to CfDs.

Read the full policy brief 'The changing dynamics of European electricity markets and the supply-demand mismatch risk' by Conall Heussaff and Georg Zachmann. ?