Explainer: Will Germany’s energy cap point the way for Ireland and rest of EU?

Extraordinary times bring extraordinary measures. As energy prices for consumers and businesses soar, governments across the European Union have been trying to figure out what to do. A new plan announced over the weekend in Germany – which appears to mirror emerging proposals from the European Commission – may point the way to what happens here.

What is the issue?

The electricity market works in a way which means that gas is vital in setting electricity prices. Under the so-called marginal pricing model, electricity prices are set by the most expensive plant that is required to meet demand. As gas prices have been soaring, this means electricity prices have been based on the soaring cost of gas. But energy coming from other sources – wind, nuclear and so on – costs the same to produce, so excess profits are being made somewhere in the supply chain for these energy sources.

[ Germany announces €65bn package to help manage soaring energy prices ]

[ Surging energy prices raise concerns over ‘self-disconnections’ ]

[ Energy prices to climb higher if windfall tax imposed, warn suppliers ]

How will Germany tackle it?

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Germany is proposing to tackle this by putting a cap on the profits of energy producers which generate electricity from non-gas sources like wind, solar, coal and nuclear. The price set for the energy will be the same, but the excess over the cap will be handed over to the German government and used to support consumers, partly through a cap on electricity prices for households up to a certain amount of usage. This is similar to a windfall tax – though taxes are normally paid on profits reported by a company, while this is a direct intervention in the market and is probably a bit easier to implement. Germany hopes that the EU will agree a similar plan, or if not says it will push ahead on a national basis. EU energy ministers will discuss the issue this week but initial plans are unlikely to be announced until the middle of the month.

What would this mean for Ireland?

Ireland is reliant on gas for about half its electricity production. If a similar cap was in place here, the profits coming from other sources, notably wind energy, would be capped. There are significant excess profits being earned at the moment from wind energy due to the soaring gas price.

Where these profits currently accrue to depends on the contracts between wind farm operators and energy supply companies – wind farm operators say that in many cases the price they receive is capped and the benefits accrue to the suppliers, some of whom in turn warn that any windfall tax could be counterproductive. How much revenue might be raised for the exchequer would depend on where the cap was set.

The Irish Government is committed to some form of windfall charge and if this is way the rest of the EU goes, then it may well be followed here. Key issues still be to discussed are the impact on the supply of energy of this scheme and what it would mean for longer-term investment, particularly in renewables. There are also fears of financial pressure on energy companies in many EU countries due to the volatility of the market – and policymakers will not want to make this worse. And whether the idea of some kind of electricity price cap for consumers as part of this wider strategy gains traction across Europe will be closely watched here.