The Commission and others have identified renewable electricity as the main lever to reduce gas imports and reduce industrial carbon emissions. Yet electricity prices are often significantly higher than fossil fuel prices, so the business case does not always stack up.

EU industrial energy prices are higher than in China and the U.S., primarily due to rising gas costs. Reforming network tariffs is essential to enhance competitiveness and support electrification.

As highlighted by the recent Draghi report, persistent high EU energy prices are undermining the competitiveness of European industry.

Proper regulation can address this.

The European Commission and many others have identified the use of renewable-based electricity as the main lever to reduce gas imports and reduce industrial carbon emissions. Yet electricity prices are often significantly higher than fossil fuel prices, meaning the business case does not always stack up.

Lowering the electricity costs for industry would both improve the competitiveness of European industry and provide an incentive for industrial electrification. But how to do it in a way that is beneficial for the energy system overall and the industry sector in particular?

Options

One option could be to subsidise electricity prices, which some countries in Europe have recently considered. Financing electricity through state budgets does not provide investor confidence, however, and may not provide adequate long-term security.

Cost exemptions or subsidies for specific industry sectors would also undermine fairness and put the costs on other consumers, including low-income households. Instead, the way forward is through reforms that are in sync with the changes in Europe’s energy system.

One of the cost elements ripe for reform is network charges. At the moment, the costs of power networks account for on average 8%-12% of industrial electricity prices (for large to small industrial consumers across the EU). Official estimates point to rising future network costs, given the grid build-out required to meet the ambitious renewable energy and electrification targets.

The required investment may translate into additional network costs of 1.5-2.0 euro cents/kWh on average. At 2023 prices, this would increase the share of network charges from 8% to 16% of bills for large industrial consumers and from 12% to 19% for small industrial firms.

But there are ways to lower the cost burden: better and smarter regulation can reduce network costs, in turn reducing electricity prices for industrial end-users and encouraging them to electrify.

Why we need to reform network tariffs for industry

This can be done in different ways. Currently, grid companies recover a significant part of network costs through fixed charges, based on the capacity of a grid connection, rather than the volume of electricity consumed.

The rationale is that network costs primarily stem from capital investments and therefore fixed or peak-demand fees better reflect these costs.

Fixed network fees are often based on the maximum capacity of the connection and an implicit assumption that the capacity of the grid connection will be used to the maximum 24/7.

In reality, industrial electricity customers will not always use the same amount of electricity and will not always consume close to the maximum capacity of their connection.

Historically, large industrial consumers even received discounts, for example in Germany, for maintaining constant demand for electricity.

This regulation originated at a time when power generation was centralised, with electricity supplied primarily by large power plants. The goal was to maintain a steady load on the grid to optimise efficiency and minimise fluctuations.

With today’s increasing reliance on variable renewable energy sources such as wind and solar, this traditional model is quickly going out of date.

Smarter network tariffs

Smarter tariffs will lead to better use of Europe’s power network. But what would smarter network tariffs actually look like?

When and where electricity is used will increasingly become more important than how much electricity is used. If industrial customers are to be incentivised to offer flexibility to the grid, network tariffs need to be reformed.

As airlines charge more during high-demand periods, smart regulation can and should send the right price signals to industrial facilities to invest in flexibility. In fact, EU regulations already mandate that network fees must be cost-reflective and non-discriminatory.

As the energy mix shifts to more variable renewable sources, this cost reflectivity requires time-varying network fees, which have not yet been universally adopted across Europe.

Industrial consumers that shift their electricity use to low-cost times save money.

Industrial customers with a flat consumption profile could also see indirect cost savings, if this demand-side flexibility drives down wholesale electricity prices and network costs.

It is clear that current approaches such as flat network fees or annual demand charges fail to address grid constraints at peak times, and disincentivise electrification in the long run. More cost-reflective network tariffs can not only lower the costs to industrial consumers, but also reduce total system cost.

Regulators across Europe have the ability to fix this misalignment. With the challenges of high electricity prices, rising grid costs and the pressing need to electrify, regulatory reform is clearly needed.

A version of this article was originally published on Euractiv.

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