Overview of the Iberian Gas Price Cap and Its Impact on Electricity Costs
The mechanism developed by Spain and Portugal in collaboration with the European Union sets a cap on the price of natural gas used for electricity production. The goal is to reduce the cost of electricity for consumers and, at the same time, help curb inflation. Inflation reached 8.9 percent in May and has been a major issue since the onset of the Ukrainian conflict. The gas price ceiling is expected to shave about half a percentage point off inflation this year, according to officials from the Bank of Spain who noted a range of eight tenths to one point as a target for government projections this week.
Bank of Spain projections suggest that the Iberian mechanism will cap gas prices observed between June 2022 and May 2023 at roughly 70 to 80 euros per megawatt hour for gas generation. The combination of gas and coal generation is projected to stay at similar levels to the previous year, with demand from consumers rising. The difference in price with France is tied to the capacity of the mechanism, which is designed to recover about 300 million euros. The result anticipated from implementing the Iberian mechanism is a reduction of wholesale electricity prices by about 30 percent and a decrease in the final PVPC bills by around 17 percent. The mechanism is expected to reduce the contribution of electricity to the Harmonized Consumer Price Index by roughly 0.5 percentage points on the annual inflation figure for 2022.
In terms of its inflationary effect for 2023, authorities expect a modest positive impact, around 0.1 percentage points, as the measure loses some influence over time during the first half of 2023. Since December, the base price limit began at 40 euros per megawatt hour and rose by five euros each month through May. By the second half of 2023, the measure aims to keep electricity prices lower than the levels seen in the same period of 2022, providing relief against rising costs.
The impact of the policy could be influenced by other price development factors, including the cost of running gas-fired plants and the volume of generation affected by the cap. There is also potential for revenue changes if gas prices move toward the Dutch TTF benchmark, which would affect the average inflation outcome. If the price gap between Spain and France exceeds expectations, there could be substantial revenue implications, potentially reaching around two billion euros in certain scenarios. In total, Spain would compensate the mechanism with about six thousand three hundred million euros, with the bulk allocated to electricity customers and a portion allocated to revenues from sales to France. The net effect on average inflation would remain negative, around minus six tenths of a percentage point.
If generation levels rise by more than the baseline, for instance due to a less renewable mix, the estimated impact could be closer to minus four tenths of a percentage point in 2022. Conversely, if electricity demand on the peninsula were to increase sharply by June, the costs of the mechanism could be higher, producing a similar negative effect on inflation of around minus four tenths of a point.
When considering government calculations, the vice president did not specify all input variables. However, European Commission forecasts indicate that the bill for households could drop by a notable portion, and for industrial users the reduction could be even larger. To reach these figures, estimates assume an electricity price around 96 euros per megawatt hour and substantial sales to France, while keeping generation and demand at near-previous-year levels. The Bank of Spain baseline scenario implies a rise in generation from 46 percent to near full capacity by the end of the period, underpinning the overall inflation impact.