Last week, the European Commission granted approval for the Iberian exception, a gas-price mechanism negotiated by Spain and Portugal to cap electricity costs. After two months of review and three weeks since council approval, the measure moves forward. On Thursday, the Congress of Deputies discussed it, with implementation expected to begin on Wednesday, June 15, and a potential end date of May 31 of the following year, pending any shocks to the market.
How does the mechanism work?
The system pauses the use of gas for electricity generation when the market price is driven by actual gas costs. Electricity producers that rely on gas-based plants, such as combined-cycle facilities and some coal plants, will be compensated for the disparity between the real gas price and the capped price. Estimates from the Spanish and Portuguese governments show that in the first month of operation, the real gas price would average about 96 euro per MWh, while wholesale electricity would average around 110.63 euro per MWh, compared with about 213 euro per MWh under a no-cap scenario. The shortfall is covered by a compensation mechanism that considers the gap between the real gas price and the cap, plus payments linked to certain electricity exports, including a sale of electricity to France. In total, consumers are expected to see a reduction close to 176.60 euro per MWh, roughly 40 euros less per MWh than without a cap. [European Commission briefing, 2023]
When will the savings start showing?
The first auction with a cap of 40 euro per MWh is scheduled for Tuesday, June 14, with the resulting price limit becoming effective on Wednesday, June 15. Teresa Ribera, the third vice-president and minister for Ecological Transition, explained that Monday was a holiday in Portugal, so operations begin on Tuesday at the border. The measure is planned to run for about a year, concluding on May 31, 2023, with the 40 euro cap applying for the initial six months. Starting in December, the cap will increase by five euros each month, ending at 70 euro per MWh at the close of the period. The government’s 2022-2025 Stabilization Plan estimates the raw gas price for 2023 at roughly 81.9 euro per MWh on average.
How low will the bill go?
Consumers are expected to see an average reduction in the electricity bill of around 15 percent, while industrial users should see discounts between 18 and 20 percent. Initially, the regulator proposed a larger 30 percent discount to match compensation for all consumers in both free and regulated markets from the outset. In the final design, some regulated-rate contracts may become more competitive than many free-market offers as the market adjusts.
Who will benefit from the discount?
About 37 percent of Spanish households are on the PVPC rate, and roughly 70 percent of industrial customers buy energy directly on the market. These groups will benefit most immediately, as they bear the brunt of recent price spikes. Companies with fixed-price contracts in the free market or regulated markets will receive compensation during the cap period if prices are updated; new fixed-price contracts will need to reflect the compensation. Over the entire period, compensation is projected to total around 5.5 billion euros, with an additional 800 million euros from electricity sales to France, bringing the European Commission’s total estimate to approximately 6.3 billion euros. Officials remain optimistic that the lower market reference price will eventually press fixed-contract prices downward. [European Commission assessment, 2023]
Why one year?
The measure is designed to provide temporary relief through the summer and winter, while allowing the PVPC ratio to adjust and reduce exposure for households and small businesses facing market prices. The royal decree outlining the gas cap is intended to take effect at the start of 2023, with a goal to align the rate with daily price movements and futures-market baskets. The plan notes that low market liquidity and price volatility delayed full implementation, but improvements in supply and demand liquidity are expected in the coming months. The cap will be held for six months initially, with the remaining six months used to gradually raise it toward 70 euro per MWh, guiding prices toward convergence within a year.
Why does gas set the price of electricity?
Spain and Portugal, like much of Europe, operate a marginal pricing system where the most expensive generating technology sets the price at any given moment. Generators with lower costs, such as renewables or nuclear plants, are scheduled to run first, but the market price is determined by the most expensive unit online at that moment. When demand is high or supply from cheaper sources declines, gas-fired plants and coal plants often set the price. OMIE, the Iberian energy market operator, notes the historical mix: hydroelectric power led prices for about 54.9 percent of hours in 2021, followed by renewables, cogeneration, and waste-to-energy at 23.6 percent; gas facilities at 15.9 percent; pumped storage at 10.2 percent; and coal at 1.5 percent. Gas has a significant influence on prices because hydro plants have zero marginal cost but can choose when to generate, while gas-fired stations contribute more during peak periods. As coal’s role diminishes and hydro and renewable outputs change with weather, gas remains the main determinant of daily price levels in the Iberian market.