-- Increases in price on Europe's benchmark Title Transfer Facility, or TTF, gas trading hub have sharply increased day-ahead prices for electricity in Italy and Germany, an economic vulnerability of continued reliance on gas, the Institute for Energy Economics and Financial Analysis said on Monday.
This reflects how frequently gas sets the marginal price in these markets and thereby amplifies the transmission of gas price shocks into power prices, IEEFA said, in a market where marginal prices determine prices overall.
In simpler terms, it is the price of the last units of gas to be contracted, beyond base load, that sets the price for all contributors to the power supply. When this is gas and gas has surged in price, the impact ripples across the price of power from the other sources, amplifying power price increases overall.
This happens even when gas is not the dominant source of power generation in a grid.
TTF front-month gas prices have fluctuated in recent months between 20-30 euros ($23.55-$35.33) per megawatt hour (MWh) to 60-70 euros per MWh during times of geopolitical tension such as the Middle East conflict now.
That has translated into day-ahead electricity prices of 120-150 euros or more in Italy and Germany while they remain between 60 and 80 euros per MWh in France.
IEEFA said that gas-fired generation now produces about one fifth of all EU electricity, falling from about 25% before the 2022 energy crisis. While gas now has a smaller role, its influence over power prices has not diminished.
IEEFA explained that under the "merit order system", the lowest marginal cost generation sources, nuclear, hydro, wind and solar are contracted for supply first and gas is deprioritized over its higher cost.
Usually in the EU, gas only sets the marginal price for several hundred hours per year, usually when renewables output is lower. In Italy and Germany, there is a much stronger connection between gas and electricity prices than in France or Iberia, IEEFA said, and power prices tend to be much higher as a result.
This happens despite interconnection between European power markets. In France, gas sets the overall price of power less frequently given its large nuclear fleet. In Spain and Portugal, renewables now produce more than half of their power, limiting the influence of gas on power prices.
Gas accounts for about half of all power generated in Italy while gas and coal have a balancing role in Germany, compensating for dips in renewables output.
IEEFA said that this market design is generally efficient and is not necessarily flawed but said the issue lies in structural reliance on gas, which it concludes only renewables and the necessary upgrades to transmission and distribution, including through battery storage and pumped hydro, can resolve.