#Extended Finance

Analysis: dynamic electricity pricing tested by the crisis

The principle of dynamic electricity pricing appears difficult to sustain in a context of tension on the energy markets.

Benoit Ravel
6 minutes

On July 9, 2020, the Commission de Régulation de l'Energie (CRE) launched a consultation on dynamic pricing electricity contracts. This was in response to Article 11 of the European Directive 2019/944 requiring Member States to offer any consumer equipped with a smart meter the possibility of subscribing to a dynamic pricing electricity contract. Dynamic pricing is defined as "an electricity supply contract between a supplier and an end customer that reflects price changes on spot markets, including daily and intraday markets, at intervals at least equivalent to the frequency of market settlement."

At the time, we decided with Professor Stéphane Auray, from the Center for Economic and Statistical Research, and Benoît Thieurmel, Managing Partner in charge of Quadratic's Extended Finance activity and then Director of Operations at Datastorm, to make a contribution to this reflection.

Our analysis, both qualitative based on reference articles and quantitative using the various market data available, focused on the impact that this type of pricing could have on the various market players: consumers, producers and network operators.

By impact, we tried to measure whether this type of pricing was likely to meet the objectives of the directive, i.e., to offer a flexible, more readable pricing system and to contribute to the need to smooth consumption and therefore prices.

What would be the impact of a fully spot-indexed tariff on a residential customer?

Today, with the disruptions (the meteorological parallel would be more apt to speak of a storm) that the market has been undergoing since the beginning of autumn 2021 - disruptions due to multiple factors: post-Covid economic recovery, decrease in Russian gas flows as of summer 2021, nuclear production fleet with major unavailability, war in Ukraine - it seems to us that it would be interesting to complete our work with an analysis of the impact this type of pricing would have had on consumers. Indeed, if many mechanisms, including a particularly strong tariff shield, have been put in place from autumn 2021 to limit the impact of price increases on consumers (mainly residential), we observe today that many consumers (residential or professional, not to mention companies and communities) are offered contractual renewals with very high increases to anticipate on their bill.

For residential customers, for example, the mechanisms have limited the increase in the regulated tariff to 4% in February 2022, whereas the normal mechanism would have led to an increase of nearly 45% (in fact only about 41.8% on the supply side, but we will keep 45% for the rest of the analysis).

Using market data, we sought to measure the impact of a fully spot indexed tariff on a residential customer.

To do this, let's compare the period from February to August 2022 with the same period in 2021 (sources ENTSOE-E Transparency Platform for prices, RTE for consumption levels):

Figure 1: Comparison between 2021 and 2022 of electricity prices and consumption (February-August period).

The April 4 market peak (following a late cold snap in late March 2021) overwhelms the outlook, but the scale on the left highlights that market prices over the period generally range between €150 and €600/MWh (unweighted average price at about €295/MWh), compared to prices between €50 and €150/MWh in 2021 (unweighted average price at about €64/MWh). The increase is therefore particularly strong. This can be seen for example in the months of July and August where the increase is even more obvious:

Figure 2: Comparison between 2021 and 2022 of electricity price and consumption (focus July and August).

If we now weight these prices over the period by the average residential consumption profile (source RTE), we obtain an average price of €62.05/MWh in 2021 and €280.13/MWh in 2022, i.e. an increase of 351%.

To obtain this projection, we have weighted the black curve by the blue curve of the graph below, which provides the level of consumption of the residential sector over the period (source RTE):

Figure 3: Residential sector consumption levels over the period February - August 2021.

It should be noted that over this period, price levels have been increasing overall, while consumption was naturally decreasing at the end of the winter (we note a correlation coefficient of -0.2 for this period in 2021).

A bill multiplied by 4.5

The first observation is that a dynamic spot indexed tariff (considering the supplier's risk premium identical over the two years) would have led the bill of a consumer not changing his consumption behavior to be multiplied by 4.5. This is a far cry from the 45% increase in the regulated sales tariff (even if the two figures are not entirely comparable, since the increase in the TRV includes variations in several components, but the increase linked to the post ARENH energy share was of the same order of magnitude, at 42%).

Now let's imagine that this consumer manages to shift 50% of his consumption from peak hours to off-peak hours (a very optimistic assumption as we pointed out in our study in 2020), we can then distort the consumption profile that applies in 2022 and we find an average price of €278.95/MWh.

Even if the incentive mechanism of postponement of consumption is effective (very effective in the hypothesis taken!), the bill of the consumer would have in fact increased by 349% compared to 2021.

We have redone these calculations month by month, in order to measure the impact of each period. It is clear that it is the summer period that has seen the biggest price increases due to the particularly chaotic situation of the markets.

Figure 4: Change in electricity prices between 2021 and 2022 (February-August period).

Dynamic pricing is unsustainable in a context of international crisis

Also, and this was not the purpose of the Commission's consultation in 2020, which was primarily seeking answers about the mechanism itself, it appears that consumers who have subscribed to a dynamic pricing offer would have experienced a very significant increase in their bill, of the order of 6 times the increase in the regulated tariff.

Of course, this is not sustainable for the final consumer who, if he has to accept to pay more for his electricity in the future, must also be able to arrive gradually at a higher rate and not be directly affected by the brutal variations of the market.

One could legitimately question the relevance of the regulated tariff in a market economy, and this is undoubtedly the main argument that advocates of dynamic pricing would use.

But the fact that we are talking about a regulated price does not change the analysis too much: in a market logic and on the basis of indexed offers whose coverage would be made progressively upstream of delivery, we would find a mechanism for forming the final sales price that is quite similar, in its evolution, to the regulated tariff.

Indeed, the regulated electricity sales tariff is indexed, for its "supply" part, mainly on market prices (more precisely on forward prices), through a mechanism of smoothing the coverage over the two years preceding delivery. This mechanism is similar in every respect to that used by a supplier who would establish an indexed price by gradually obtaining supplies on the markets beforehand.

Conversely, if prices were to fall sharply in the coming months, a consumer with a dynamic pricing contract would see his bill drop much faster than others, provided that he had been able to pay his energy bills by then!


Links and references :

Deliberation of the Energy Regulatory Commission of January 18, 2022 on the proposal of regulated electricity sales tariffs

Methodology for the construction of regulated electricity sales tariffs

The consumption data used in the graphs:

Market data used in the charts:


Photo by Khara Woods on Unsplash

Contact us
Analysis: dynamic electricity pricing tested by the crisis
#Extended Finance
Cookie management

By clicking "Accept", you consent to the placement of cookies to improve the performance of the site and to allow us to analyze usage. You can access the full list of cookies used via our Privacy Policy.