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The clash with gas: Should it stay or should it go?

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Europe’s stated goal of achieving a net-zero power system by 2050 is inherently replete with enormous opportunities and challenges. High energy prices and Russia’s invasion of Ukraine have now ratcheted up the urgent need for action to emergency levels. Policymakers are facing the challenge of a lifetime to secure the supply of energy and protect disadvantaged consumers while maintaining momentum towards long-term climate goals. The events of 2022 have made evident to many experts that the transition away from fossil gas will figure prominently in all of these objectives.

To support policymakers and the numerous stakeholders in planning for a deliberate reduction in the use of fossil gas in the coming years, RAP has developed five fundamental guiding principles. The principles are general in nature due to the breadth of this gas transition and the various policy instruments that governments will need to reform such a large part of our energy economy. In light of the current crises, the authors have also applied these best practices specifically to the European Commission’s proposed Hydrogen and Decarbonised Gas Market package and Hydrogen Strategy, as well as to the hydrogen strategies of selected Member States.

To achieve an efficient and cost-effective transition away from fossil gas, we offer policymakers the following recommendations:

Graphic with five principles for transitioning away from fossil gas

 

Levelling the playing field: Aligning heating energy taxes and levies in Europe with climate goals

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Taxing energy in line with its environmental harm aligns the prices facing consumers with policy objectives. Energy taxes and levies encourage energy efficiency and raise revenues for governments, which can then dedicate them to energy transition projects. Not all energy sources are equal, however, when it comes to their environmental-damage costs. Adding taxes and levies disproportionately to electricity encourages the continuation of an emissions-intensive status quo and discourages investments in key decarbonisation technologies, such as heat pumps. This paper shines a light on the imbalance in energy taxation across almost all European markets and makes the case for reform.

The authors explain the current structure of energy taxes and levies in five key European countries where reform would be beneficial: Italy, Spain, the United Kingdom, Belgium and Germany. All five countries overtax electricity — in three cases by more than 200% — and undertax oil and fossil gas while not taxing wood use at all. Only in Italy is the tax rate on heating oil close to the value of the environmental costs caused by its use.

The European Commission’s proposals in the Fit for 55 Package would go a long way towards addressing the taxation issue. But these proposals would need to be implemented and there’s no guarantee they’ll survive the upcoming negotiation process. Member States wishing to align their tax and levy policies with their climate targets can act now to begin the process of rebalancing.

The authors detail four approaches to rebalance energy taxes and levies, drawing on examples from around the continent.

  • Option 1: Lower tax on electricity for heating
  • Option 2: Environmental taxation
  • Options 3 and 4: Shift levies to public budget or fossil fuels

Price shock absorber: Temporary electricity price relief during times of gas market crisis

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European policymakers are weighing possible responses to the extraordinary surge in energy prices and the consequences for citizens and industry. The European Commission expects to issue additional guidance in May, following analysis due in April from the Agency for the Cooperation of Energy Regulators. Targeted relief to vulnerable consumers should be undertaken in any case. Whilst RAP would urge caution in considering possible broader interventions in the electricity markets, if such a course of action is under serious consideration, we offer this proposal of a ‘price shock absorber’ for reflection as a measure best fit for purpose, designed to acknowledge and address the essential aspects of the current crisis:

  • This is a gas market crisis — it is an extraordinary event that is adversely affecting all sectors of Europe’s economy. The priority for the electricity sector must be measures that allow the electricity market to ride through this shock to the system, and similar future shocks, preserving its functionality whilst avoiding undue harm to consumers.
  • The midst of a crisis is the wrong time to take decisions with long-term implications that will be difficult to walk back once the crisis has passed. Our proposal acknowledges that the fundamental design of the electricity market is sound; whilst improvements are certainly needed, they have no direct bearing on the causes of or remedies for this crisis.
  • This crisis has revealed in stark terms the true cost of dependence on a volatile fossil gas market, including the risks inherent in the prominent position Russia will continue to occupy in global supply.
  • Consumers and industry have the power to contribute to the response to these risks, by procuring the energy services they need more efficiently and flexibly.

When responding to the crisis, policymakers should preserve and even intensify the electricity market’s role in mobilising and empowering consumers rather than concealing the true cost of ‘business as usual.’ The value of the only durable response — an accelerated transition away from fossil fuels — must remain visible to consumers in an equitable fashion.

The authors outline this price shock absorber mechanism as an additional market feature to bring consumers some measure of relief whilst preserving the market’s essential functions. These include valuing energy efficiency, rewarding beneficial demand and resource flexibility and ensuring a ‘normal’ level of expected inframarginal rent to incentivise and compensate investors in the energy transition for the value of their investments. If a decision is taken to intervene broadly in the electricity market, we suggest this approach offers a significant measure of relief whilst doing the least harm.

 

Ensuring the EED energy savings obligation is Fit for 55

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In late 2020, we recommended that the European Commission align the Energy Efficiency Directive’s energy savings obligation with the 2050 climate goal. It took a first step towards achieving this objective in summer 2021. In its proposal, energy savings derived from the installation of technologies that directly combust fossil fuels are excluded for the purposes of compliance with the Directive. From 2024, energy savings from new coal, gas and oil boilers will no longer be eligible.

This policy brief explains why this provision is so important. We also lay out how Member States can benefit under the Energy Efficiency Directive by ramping up policy measures that support the beneficial electrification of heating in buildings.

 

 

 

 

 

 

 

 

Responses to fossil gas price volatility

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The first ten months of 2021 have seen dramatic increases in energy prices in Europe and elsewhere. Experts now agree that the surging international demand for liquified natural gas and the rise in gas prices are driving electricity prices to seldom-seen heights. The fact that fossil gas accounts for 45% of household energy for heating is real reason for concern, with winter just around the corner.

Governments around Europe are scrambling to find ways to help families struggling to pay their energy bills this winter. The European Commission has now issued a toolbox of short-term recommendations to mitigate the effects of this crisis. RAP also offers guidance on this dynamic situation, with a focus on the current circumstances. Authors Bram Claeys, Michael Hogan and Dominic Scott explore near-term relief measures for Europe’s most vulnerable consumers as well as long-term solutions to ensure this crisis does not repeat.

Analysis of the root causes of the electricity price ‘roller coaster’ shows that the best and most durable solution to alleviate the social and economic impact of volatile fossil fuel prices is tackling the demand for fossil gas. Reducing Europe’s appetite for this fuel requires prioritising energy efficiency, ensuring a massive rollout of solar and wind, electrifying end uses currently served by natural gas, and limiting the use of hydrogen to green hydrogen solutions devoted strictly to hard-to-reach applications.