Despite a decline in natural gas consumption across the EU, the fossil fuel remains a critical determinant of electricity prices, according to a recent report by the EU’s energy watchdog, ACER.
As coal-fired power plants are phased out and renewable energy capacity grows, natural gas has solidified its role as the backbone of Europe’s power grid, particularly during peak demand periods.
Key findings from ACER’s report
In 2023, the EU consumed 24 TWh less natural gas than the previous year, and the share of electricity generated from gas dropped to 14%, down from 18% in 2020. However, natural gas prices still set electricity prices 40% of the time, highlighting its outsized influence on the market.
While gas-fired power plants operate at just 20% of their capacity on average annually, this figure jumps to 52% during peak demand hours. Gas is increasingly the go-to source for meeting high electricity demand, especially in the evenings when renewable energy production wanes.
The cost of electricity from gas turbines has more than doubled in recent years, rising from an average of €49 per MWh in 2019 to €104 per MWh in 2023. The surge reflects gas’s growing dominance in setting power prices.
ACER identifies two major trends contributing to natural gas’s central role in Europe’s power markets: renewable energy growth and coal plant retirements.
The phase-out of coal-fired power plants has reduced competition among conventional energy sources, leaving gas as the primary option for meeting peak demand. The lack of alternatives has made the market more vulnerable to fluctuations in gas prices.
Market implications
With gas prices heavily influencing electricity prices, markets are becoming more exposed to fluctuations in gas markets, particularly during periods of high demand. Meanwhile, the disparity between midday solar oversupply and evening demand is widening, further entrenching gas’s role in balancing the grid.
On month-ahead markets, the correlation between gas and electricity prices has risen from 0.82 to 0.86 within a year, indicating a stronger link between the two. In contrast, short-term correlations are declining, reflecting the growing complexity of the energy mix.
As Europe continues its transition to renewable energy, natural gas is likely to remain a critical component of the power grid for the foreseeable future. While the EU’s green energy ambitions are reducing overall fossil fuel consumption, the intermittent nature of renewables and the retirement of coal plants have reinforced gas’s position as the dominant backup source.
To mitigate the risks of price volatility and over-reliance on gas, policymakers and market participants will need to focus on expanding energy storage solutions, investing in grid flexibility and demand-side management, and diversifying energy sources to reduce dependence on gas and enhance energy security.
For now, natural gas remains the undisputed king of Europe’s power markets, but its reign will depend on how effectively the region addresses the challenges of its energy transition.
