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Why is electricity so expensive in Spain?

Find out why Spain has one of the most expensive electricity services in Europe. This happens because of taxes, tolls and production.

Why is electricity so expensive in Spain?

To understand why this happens we need to start from the MWh pricing system that exists in Spain. Wholesale electricity markets, also called pools, match the supply from electricity generating companies with the demand from the distribution companies.

Power can be generated from a number of sources: gas-fired thermal power plants, hydroelectric power plants, nuclear power plants and renewable energies (such as solar, wind and tidal). There is a price for each way of generating energy, which can also vary at different times of the year or day. This means that the MWh that the generators add to the pool is a reflection of production costs.

With regard to the distribution companies, those that buy the energy, it should be noted that demand is not very elastic, in other words, there is no way to replace electricity, so prices will rise the moment demand increases and supply does not do so to the same extent.

It should also be taken into account that not all ways of generating energy can be activated at will to adjust production to demand. On days when there is no sun or wind, we will not be able to obtain electricity from solar or wind plants, which are also those that usually generate the cheapest kWh on the market. In these cases, it is necessary to resort to other forms of production (gas, hydroelectric or nuclear power plants), where the cost per MWh is higher.

To all this we need to add the European Union (EU) auction system for wholesale markets. The price is established by time band: the cost of the last MWh contracted to meet demand sets the market equilibrium price that is paid to the production companies for each MWh generated. However, this does mean that the first MWh to enter the auction are the cheapest, until demand is matched. In Europe, it is common for most energy to be traded between retailers and generators, using the daily market as a tool to make final adjustments.

This market is based on the marginal system, and this has a number of advantages, including the following: It secures the highest positions for low-emission energy, it encourages investment in renewable technologies, it ensures fairness between large and small electricity generators and protection from possible abuses by generators.

However it certainly has one great disadvantage: this system is very sensitive to fluctuations in the prices of energy sources. If it is possible to cover demand only with renewable energies the price will be minimal, however, if it is necessary to use gas, the price will increase significantly. This is why there is widespread criticism of the wholesale market at times like the one we are experiencing, in which prices escalate rapidly.

To summarise, we get MWh from nuclear power plants, with constant production and low prices; MWh from renewables, which are by far the cheapest but their generation is very irregular. This makes it necessary to resort to more expensive kWh, such as that produced by gas or hydroelectric combined cycles, in order to meet demand.

 

Why gas and hydraulic?

Because they are easy to store. Electricity cannot be stored in large quantities (at the moment, because accumulators are already being developed that in the future could be very useful). However, gas and water can be stored in tanks and reservoirs, respectively. When a peak in demand is expected, electricity generation can be released and increased, which is not possible with other types of energy.

If we continue with the particularities of Spain, we should highlight its renewable generation capacity, which accounts for almost half of the energy mix. However, we know that variables such as weather sometimes cause that percentage to fall and then we need to resort to gas.

 

Historically, the most expensive electricity in Spain

Historically, the most expensive price per MWh in Spain was recorded on the afternoon of 8 March 2022. In the 8pm time band that day, the price per MWh reached 700 euros, due to the high gas prices as a result of the Ukrainian War. The average price per MWh that day was 544 euros.

 

Taxes, tolls and production costs

So far we have spoken about the price per MWh on the wholesale market, which obviously has an impact on the electricity bill. But there are other costs that appear in your invoice, and here is a breakdown:

Taxes:

  • VAT: the Value Added Tax is 21%, however, the Government approved a temporary reduction of this percentage (up to 10%) to alleviate the rise in the price of electricity.
  • IVPEE: this stands for Electricity Production Tax, it is usually 7% but it has been temporarily suspended.
  • IEE: this stands for "Special Tax on Electricity", also known as the electricity tax, which is 5.113%, but which has temporarily been reduced to 0.5%.

Tolls or access tariffs: this is to pay for transmission and distribution networks, the promotion of renewable energies, the higher cost of production in non-mainland systems, and annuities to recover the tariff deficit. They vary each year and are established by the Spanish Markets and Competition Commission (CNMC).

Retailer's margin: this corresponds to the services provided by the company. If your contract is governed by the PVPC market, it consists of a fixed amount for contracted power and a variable for your consumption. If your contract is governed by the deregulated market, it is reflected in the cost of energy.

Metering equipment rental: this is charged to customers who do not own a meter.

What is the future for electricity prices in Spain?

In the EU, the wholesale price per kWh is determined by the price of natural gas and the price of CO₂ emissions. Europe's dependence on imported gas is the reason why the increase in the price of gas has had such a notable impact on the price per kWh.

This is why the governments of Spain and Portugal, which share a wholesale market, have obtained recognition from Brussels that their situation with regard to energy is unique and they have provided a temporary solution to reduce the electricity bill. It consists of limiting in the energy pool the price per kWh generated by the combined gas cycle: We have already seen that the first units of kWh to enter the auction are the cheapest, but that the price at which all the kWh for a time band are paid at the cost of the last ones to enter, that is, those that are more expensive. This limit on the price helps to control the increases in the final price of electricity.

There has also been progress in the implementation of renewable generation, included in the Integrated National Energy and Climate Plan (PNIEC) for 2021-2030, and the arrival of European funds for the Strategic Project for Economic Recovery and Transformation (PERTE) of Renewable Energies, Renewable Hydrogen and Storage (ERHA) provide a promising future for renewable energies, which as we have seen, have lower production costs and could lower the price per kWh, and, therefore, the electricity bill.

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