High electricity prices can be a major cause for concern for both consumers and utilities around the world. The Russia-Ukraine conflict has created turmoil in energy markets by disrupting supplies of natural gas to Europe and tightening commodities markets. While European countries experienced soaring electricity prices first, other nations are now feeling the effects of a heavy reliance on natural-gas-fired generation, supply chain disruptions, and rising interest rates—all of which have conspired to help drive electricity prices to record levels in some jurisdictions. Despite recent declines in inflation rates and in natural gas prices, it seems the struggle for electricity utilities and their customers is far from over. In major developed economies, electricity prices are largely expected to rise even further this year, raising the question of how consumers and utilities could react.
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As suggested in Deloitte Global’s Facing the electricity crisis in Europe, most, if not all, electricity consumers will likely try to lower their exposure to market prices, given the current situation. This holds for residential and commercial consumers as well as energy-intensive industries and retailers that purchase electricity from producers and sell it to end customers.
The impact for energy-intensive industries and power retailers
For energy-intensive industries, such as iron and steel, and power retailers, the current crisis will likely propel two related trends: first, a revised approach to hedging to protect retailers from financial loss, which includes more hedging to guarantee physical deliveries and adjustments to the hedging corridor for future years; and second, greater use of power purchase agreements (PPA), which could enable buyers to secure prices for the next 10-to-20 years.
The better hedged retailers and heavy consumers are, the better they can weather the crisis, either by minimizing expensive purchases on the spot market or by having the opportunity to resell a portion of their hedged electricity if they had taken long positions. Ideally, companies would manage to align market price changes with the ability to pass those through to their customers – either through adjusting the electricity rates to customers or through reconciling contract life spans on a case-by-case bases. A further option is to reduce price volatility by engaging in long-term PPAs. These can give producers and consumers visibility into power prices well into the future, typically 10–20 years. While energy retailers and energy-intensive industries alike can profit from a more stable product calculation, there is a risk to price oneself out of the market in case of significant drops in energy prices. Which is something that has been seen before. For example, when power prices hit low levels in Europe during the beginning of the pandemic. This is why many companies typically prefer making PPA pricing more flexible when contract durations exceed five years.
Residential and commercial consumers could also drive industry trends
The current crisis will likely prompt residential and commercial consumers to take action to help manage higher costs, which in turn could drive the following trends:
- Supplier switching: This may increase in the coming months as many end-users face rising electricity bills. Once the market corrects the energy price spikes and a drop in retail prices occurs, switching is likely to soar. The risk-averse consumers will likely favor fixed tariffs compared to market offers, which are typically more volatile since prices are not necessarily set for a whole year.
- Demand-side response: Regulations on average costs rarely end up making much of a difference with consumer demand. This stands against the growing need to develop peak-load reduction levers - a long-standing missing piece of the power-market puzzle. In the future, the demand side will likely need to participate more in increasing load flexibility as a result of the current crisis. Accordingly, some utilities are experimenting with flexible tariffs that adjust end-user power prices daily depending on the tension in the power markets.
- Electrification incentives: Despite soaring electricity prices, electrification incentives are still effective, and might be even more so now, due to high natural gas prices. For instance, Germany’s heat pump market grew by 53% in 2022, marking a strikingly large switch away from fossil-fuel-based household heating sources. Moreover, in the US, the Inflation Reduction Act of 2022 offered new electric vehicle tax credits. Such electrification trends should not be curtailed but rather encouraged amid soaring power prices because they can reduce reliance on natural gas and are aligned with long-term decarbonization objectives.
- Local energy procurement: This represents an emerging trend that could accelerate in the near future. The current power price crisis may incentivize consumers to source their energy locally. This could pique interest in community energy projects and in self-sufficiency for industries that can deploy their own distributed energy resources, such as solar and wind generation, clean hydrogen, and batteries.
Keeping long-term goals in sight
Taking these implications into account, there is much debate about whether the current electricity price shock warrants emergency policy intervention or a full revamp of power markets. In deciding how to respond, policymakers should bear in mind that short-term measures carry a risk: they often focus on mitigating the consequences of the crisis, rather than on addressing the root causes of the problem. Decades of delayed investments in new clean energy sources or grid reinforcements have worsened the current crisis. Governments should, therefore, make sure that crisis response measures align with the long-term goals of accelerating the energy transition, reducing energy and raw material dependencies, and improving energy security for national economies.
