Energy prices coming down – is Europe on the right track?

For Europe, good news has been in short supply. The war in Ukraine shows no sign of ending, trade tensions remain elevated, economic growth is sluggish and the Iberian Peninsula recently suffered an unprecedented blackout. Yet, amid this turbulent backdrop, there is a glimmer of optimism: energy prices for consumers are falling. According to a recent survey by the comparison portal Verivox, energy costs in Germany have significantly decreased since the start of the year. A typical three-person household now spends €269 less annually on electricity, heating and fuel than it did in January – dropping from €5,442 to €5,173. Similar downward trends are being observed across other EU countries. This is certainly a step in the right direction. However, prices remain over 25% higher than pre-crisis levels in 2022, and the volatility in global energy markets leaves the door open for new price shocks.

Energy prices have been at the heart of European policymaking since the onset of the energy crisis triggered by Russia’s invasion of Ukraine. The crisis laid bare Europe’s dependency on fossil fuel imports and its vulnerability to price surges. Into this discussion, the Draghi report has introduced a critical new dimension by underlining that high energy costs are undermining Europe’s economic growth and widening its competitiveness gap compared to other global regions. Moreover, growing price volatility is raising hedging costs and clouding investment decisions. The report argues that without decisive action, this competitiveness gap could widen further. However, it also presents an opportunity: by accelerating the decarbonisation of its energy system, the EU can reduce fossil fuel dependency and simultaneously enhance competitiveness, affordability and supply security.

The new European Commission has embraced these recommendations, and one of its flagship initiatives has been the Action Plan on Affordable Energy. This comprehensive eight-point plan marks a promising shift, aiming to gradually narrow the cost gap between low-carbon and fossil-based energy sources. Among its priorities is reducing electricity bills through lower network charges and energy taxes. While such measures do shift costs from households to public budgets, they offer short-term relief and can be implemented swiftly. For example, Germany’s new government has identified electricity prices as a crucial lever to boost competitiveness while advancing the green transition. A lower electricity tax and reduced levies are intended to ease the burden on consumers without dulling price signals that encourage more efficient consumption. However, the fiscal burden of these subsidies is substantial and will need to be addressed in parallel with long-term reforms.

The Action Plan also includes more structural measures, such as lowering the cost of electricity supply, promoting tripartite contracts between governments, producers and consumers, and enhancing the functioning of gas markets. Other components – like boosting energy efficiency, integrating a resilient EU-wide energy market and strengthening governance – will require sustained effort, legislative support and coordination across member states.

Yet, even a plan this ambitious falls short in one critical area: improving the overall efficiency and capability of the European electricity system. The EU needs more renewable energy sources, more storage capacity and more flexible, controllable power generation. Crucially, the pace of this expansion must align with growing demand. The recently published Clean Industrial Deal communicates this more effectively than the Action Plan, with two of its six key performance indicators (KPIs) directly addressing electrification. One targets an increase in the economy-wide electrification rate from 21.3% today to 32% by 2030. The other aims for 100GW of renewable electricity installation annually through the end of the decade.

The net-zero transition by 2050 hinges primarily on electrification. Adequate access to clean, low-carbon electricity is essential for deep decarbonisation and for preserving industrial competitiveness. By 2035, direct electrification technologies could potentially meet 90% of the energy demand that remains unelectrified today, with current technologies covering about 60% of this. Low-temperature heat (up to 150°C), crucial in many industrial processes, can already be economically generated via electrification, especially when efficiency gains and carbon pricing are factored in. However, electrifying industry at this scale implies tripling electricity demand, and that demands substantial new investment. Given tight margins and high market volatility, industry will need a well-designed state aid framework to support this transition and manage risk.

Crucially, Europe’s future also depends on increasing electricity demand in a sustainable and system-friendly way. A scenario in which renewable electricity supply grows rapidly while demand stagnates could backfire, leading to electricity market imbalances and rising redispatching costs. These occur when electricity cannot be transmitted due to grid constraints or localised oversupply, requiring financial compensation to producers. Without targeted interventions, redispatching costs could soar to €50-100bn annually by 2040.

Three interlinked issues deserve urgent policy focus:

1. Electrification and structural demand growth: demand for electricity must grow in a way that reflects the structural shift from gas and other fossil fuels. Electrification across industry, heating and transport is central to achieving this.
2. Grid infrastructure: permitting delays and infrastructure gaps are major bottlenecks. The EU’s grid must be upgraded and expanded to accommodate decentralised renewable generation, long-distance transmission and flexible loads. The Commission’s forthcoming grid package must tackle these challenges head-on.
3. Functioning of the Single Electricity Market: the market’s current structure is under pressure. A prime example is the controversial rejection of the European Network of Transmission System Operators for Electricity (ENTSO-E)’s proposal to split the joint Germany-Luxembourg bidding zone. This proposal, based on a comprehensive bidding zone review aligned with the Agency for the Cooperation of Energy Regulators (ACER), recommended dividing the zone into five separate bidding zones. The aim was to improve market efficiency and reduce redispatch costs with estimated savings of €339mn annually, largely from a 50% cut in redispatching. Yet, the proposal appears to have been politically dismissed in favour of grid expansion, which, while necessary, may ultimately be more costly for consumers if not paired with market reform.

In conclusion, while the recent drop in consumer energy prices is welcome, it does not signal that Europe has solved its energy challenges. The European Commission has taken several encouraging first steps in the right direction, particularly with the Affordable Energy Action Plan and Clean Industrial Deal. But the road ahead will require deeper, more concrete commitments – particularly on electrification, grid readiness and the continued integration and reform of the single electricity market. Without decisive follow-through, today’s progress may prove fragile in the face of future shocks. Europe is on the right track, but it must now pick up the pace.