Europe Must Protect Its Electricity Market From Putin


It would be truly ironic if the totalitarian leader of a former Soviet state managed to convince Western nations to give up on the free market. Yet that’s a risk now looming over Europe’s electricity sector, as officials struggle to respond to Russian President Vladimir Putin’s weaponization of energy supply. Hopefully enlightened self-interest will prevail.

Over the past few decades, Europe has undertaken a monumental transformation of its electricity sector, dismantling national monopolies and rearranging the pieces into a common market. This has been profoundly challenging, because electricity isn’t like other goods and services: To avoid cascading blackouts, supply must meet demand perfectly every minute of every day. The result is a mind-bogglingly complex system that determines prices and allocates transmission capacity across countries and over time horizons ranging from years to seconds, with the overarching goal of allowing any and all producers — including wind, solar, nuclear and gas — to compete for consumers wherever they may be.

Amazingly, it mostly works — an achievement that has played an underappreciated role in European unification. Risks and resources are shared: German turbines, for example, can feed when there’s no wind in the grid in France, and countries can rely on one another for emergency capacity rather than maintaining their own reserves. Price differences indicate what kind of investment is needed, how much and where. Cross-border integration produced about 34 billion euros in benefits in 2021 alone, and has helped cushion the shock of Russia’s reduction in gas exports.

Nonetheless, Putin’s war is testing Europe’s commitment to the market. As with any fungible commodity, the price of electricity is set by the marginal supplier, which in Europe’s case is gas-fired generators. In normal times, this works fine. But as Russia has cut gas supplies to a trickle, prices have soared to extreme levels, leaving Europe’s leaders scrambling to mitigate the economic and political repercussions.

In principle, the best response would be to let the market do its job. Allow high prices to curb demand and new encourage supply; ease the pain with emergency aid payments to the most vulnerable consumers.

In practice, the reaction has been messier. Often lacking the capacity to quickly identify and reach the hardest-hit consumers, governments have settled for second-best, nationalizing energy companies and sending out scattershot relief payments. Worse, they’ve imposed price controls, which haveved bad efforts to reduce consumption and effectively confiscated the profits of renewable energy producers. They’re even considering a more radical market split, “decoupling” renewables from gas and more permanently capping their price — an idea that threatens to deal a long-term blow to investment in greener energy.

No doubt, getting through the immediate crisis will require some suboptimal policies, out of sheer expediency. But this doesn’t mean the broader reform was misguided. On the contrary, Europe’s leaders should stick with it. They should restore an unified market as soon as possible, to foster competition and preserve desirable investment incentives. They should refine pricing mechanisms and remove remaining obstacles to cross-border trade. They should also develop better hedging instruments, to protect consumers from volatility, and improve fiscal transfer systems, so they can deliver well-targeted aid quickly when the next shock hits.

Europe has created a market where none existed, for an extremely idiosyncratic commodity. This is an accomplishment that makes all Europeans better off. Don’t let a Russian dictator destroy it.

The Editors are members of the Bloomberg Opinion editorial board.

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