Electricity price and electricity exchange: How does the electricity market work?
Rising energy costs are an issue that is of great concern to both the economy and private households. The energy transition plays a key role in this. Above all, the forced expansion of renewable energies and the associated expenditure have a significant influence on the development of electricity prices. But what other factors play a role in the pricing of electricity
How is the electricity price composed?
The price of electricity in Germany is made up of various components that essentially determine the costs for you as a consumer:
- Procurement and sales: This share accounts for about 52 percent of the electricity price. It is influenced by competition between electricity suppliers. It can therefore vary depending on the provider.
- Grid fees and meters: Fees for grid use account for around 21 percent of the electricity price. They cover the operation, maintenance and expansion of the power grid. The amount of the grid fees is determined by the network operators and must be approved by the Federal Network Agency. Due to the different population density and the expansion of renewable energies, the amount differs regionally. The fees for meters (operation, maintenance, metering) are also included in this item.
- Taxes, levies and levies: These state-imposed price components contribute about 27 percent to the electricity price. These include grid usage fees, concession fees (to cities and municipalities to be allowed to lay lines in public spaces), the EEG levy (Renewable Energy Sources Act), the CHP levy (combined heat and power plants), the offshore grid levy, the §19 StromNEV levy as well as electricity and VAT.
Every supplier who is active on the electricity market is obliged to pay the aforementioned taxes, levies and levies. These costs are levied and passed on as part of the electricity price. Consequently, competition is limited to those cost areas that can be directly controlled by the companies – namely electricity procurement and sales.
What is the electricity exchange?
The procurement is carried out via the electricity exchange in Leipzig. In general, like other stock exchanges (e.g. for shares), it represents an organized marketplace on which electricity is traded. It allows all actors (in particular the larger consumers and energy supply companies) to buy and sell electricity. Prices on the electricity exchange are determined by supply and demand and reflect current market conditions.
In Germany, there is a main electricity exchange, the European Energy Exchange (EEX), based in Leipzig. EEX is not only the central electricity exchange for Germany, but also acts as an important trading platform for energy and energy-related products in Europe. It offers trading opportunities for electricity, natural gas, emission rights and other energy products. Several factors influence pricing on the electricity exchange:
- Power plant availability: The availability and production costs of power plants are crucial. Power plants that can produce cheaply (e.g. wind and solar power plants) are preferred. The availability of power plants can be affected by maintenance work, outages or fuel shortages.
- Emission allowances: The cost of emission allowances under the EU Emissions Trading Scheme affects the production costs of power plants that use fossil fuels. Higher costs for emission allowances can lead to higher electricity prices.
- Commodities: The prices for coal, natural gas and heating oil have a direct influence on the production costs of power plants that use these fuels. If the prices for these energy sources rise, electricity prices usually also rise.
On the EEX electricity exchange, electricity is primarily traded on the futures market. The spot market is represented at EPEX SPOT, which is based in Paris. The spot market allows for the trading of electricity that is delivered within a short period of time (typically the next day), while the futures market trades contracts for the supply of electricity at a much later date.
Spot | Futures market |
On the spot market, the price of electricity is determined based on the current supply and demand situation. This market is particularly important for short-term price discovery. The availability of green electricity has an influence on the price and can fluctuate greatly depending on weather conditions (e.g. sunshine and wind strength). | The futures market is used to trade electricity for future delivery periods. Here, buyers and sellers can hedge against price fluctuations by concluding long-term contracts at fixed prices. Electricity suppliers can thus purchase their needs in partial quantities over two to three years. Sometimes contracts can be concluded up to six years in advance. This offers planning security for both sides. |
Spot market products are traded on EPEX SPOT, based in Paris. The availability of EE has an influence on pricing.
OTC Trading
In addition to trading on the electricity exchange, there is so-called OTC trading. Transactions take place directly between two parties without the intermediation of an exchange. OTC stands for "over the counter". However, electricity is also often traded through special brokers. OTC trading allows for more individual contract terms and is often used for larger volumes or special products.
Participants in the OTC market are usually large energy suppliers, industrial companies and energy traders. Direct trade is now also largely standardized. Nevertheless, it always requires a high degree of trust between trading partners, as there is a risk of counterparty risk. There is also a spot and a futures market for OTC transactions.
How does trading on the electricity exchange work?
Trading in electricity has a special feature. Because here the order is determined as to who is allowed to sell electricity first - and how much money can be earned. The procedure is also known as the "merit order principle" and works as follows:
- Listing of power plants: First, all available power plants are sorted according to their marginal costs, starting with the lowest to the highest. Marginal costs are the costs incurred for the production of each additional megawatt hour. Typically, renewable energy sources such as wind and solar power have the lowest marginal cost because they have no fuel costs and are therefore often in first place. This is usually followed by nuclear power, lignite, hard coal and finally gas-fired power plants and oil-fired power plants with the highest marginal costs.
- Meeting demand: In order to meet the current electricity demand, the power plants are switched on in order of their marginal costs until the demand is fully covered. The last power plant needed that can still meet demand determines the market price for all power plants that supply electricity at that time.
- Pricing: The price set by the last connected power plant is called the "system price" or "market clearing price". All power plants that supply electricity at that time receive this price for the amount of energy they produce, regardless of their actual production costs. This mechanism ensures that the most cost-effective energy sources are used first.
The development of electricity prices is not only a concern for private households, but also for the economy.
How is the electricity price developing?
For many years, the procurement costs for energy remained largely constant. Since 2021, however, energy prices have repeatedly experienced strong fluctuations. This development was first exacerbated by the COVID-19 pandemic and then in 2022 by Russia's war of aggression on Ukraine. The resulting gas crisis led to a record increase in the price of electricity on the stock exchange in Germany in the months of August and September 2022, doubling in 2022 compared to 2021.
After a further price increase in December 2022, the electricity market in Germany was somewhat more relaxed at the beginning of 2023: prices on the spot market fell from an average of €251.62 per megawatt hour in December 2022 to an average of €117.83 in January 2023. Throughout 2023, trading prices for electricity remained relatively stable, falling to an average of €68.52 per megawatt hour by the end of the year.
The general development of electricity prices is influenced by various factors: These include geopolitical events such as the war in Ukraine or the decision of the German government to fill German gas storage facilities in view of an impending gas shortage. Failures or planned maintenance of power plants, for example for safety inspections, also have an impact on pricing, such as seasonal fluctuations in electricity consumption. In winter, electricity consumption usually increases, while in summer, solar systems provide more energy. Political measures, such as the electricity price brake, which has since ended, also influence the price of electricity.
Currently, the increasing costs of operating the electricity distribution grids are leading to a renewed increase in electricity prices. At the end of 2023, the German government cancelled a planned subsidy of billions of euros to the transmission system operators. As a result, they announced that they would pass on the costs to the electricity suppliers and increase the grid fees from 3.1 to 6.4 cents per kilowatt hour. At the turn of the year 2023/2024, fees for electricity grid use have consequently risen by about 25 percent on average nationwide.
Result
A permanent reduction in electricity prices isnot in sight in the medium term. The energy companies assume that electricity prices will be about twice as high in the medium term compared to the times before the energy crisis in 2022. In particular, the trend towards rising grid fees due to the expansion of the infrastructure for large wind turbines and photovoltaic plants makes a further reduction in electricity prices seem rather unlikely. In addition, the energy transition continues to progress, which means that our world is becoming more and more electric, be it in mobility (electric cars) or in heating (heat pumps).