Column Spain & Portugal tackling Europe’s industrial power cost crisis

Column Spain & Portugal tackling Europe's industrial power cost crisis

The Iberian Exception: Why Spain and Portugal Offer Relief from High Power Costs in Europe

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Industrial sectors across Europe have been facing significant challenges due to high power costs over the past year. The combination of Russia’s invasion of Ukraine, which disrupted natural gas flows to the region, as well as high inflation and interest rates causing a decline in global consumer demand, has taken a toll on European output in chemicals, paper, crude steel, and aluminum. The International Energy Agency’s latest electricity market report warns that many energy-intensive operations are at risk of permanent closure unless power costs decrease significantly.

While the future power costs in major manufacturing hubs like Germany, France, and Poland are expected to remain high, power costs in Spain and Portugal are relatively stable and substantially lower than the average across Western Europe. This is thanks to price caps that are expected to continue for the foreseeable future. The presence of price caps in these countries could result in widening power price discounts for consumers in Spain and Portugal compared to Western European consumers, offering potential relief for industries facing high power costs.

The Iberian Exception, a policy that allows Spain and Portugal to create their own price-setting power rules, has played a significant role in ensuring lower power costs in these countries. This exception was granted because Iberia historically relied less on Russian gas imports than the rest of Europe. As a result, Spain and Portugal were able to strip out the price of natural gas in their electricity price-setting system and implement a new pricing method from mid-2022.

The impact of the Iberian Exception is evident in the significant power price differences between consumers in Iberia and Germany, Europe’s largest power consumer. Power prices in Spain for the second half of 2022 averaged less than half of those in Germany. While German and Spanish power prices have been relatively close in 2023, forward power markets anticipate that German prices will rise again later in the year.

The high power costs resulting from the disruption in gas flows and the expectation of long-term high power prices have led many energy-intensive businesses to scale back or halt operations until energy costs decrease and a clearer energy price outlook emerges. Some businesses may consider relocating their operations to lower-cost locations, such as Asia or Africa, where operating costs are more competitive. However, others may choose to remain within the Eurozone to take advantage of favorable tax treatments for businesses manufacturing products in Europe.

For businesses opting to stay within the Eurozone, Spain and Portugal emerge as potential locations for production processes and operations due to their lower energy costs. Although even with the Iberian Exception, Spain has experienced some power cost inflation in 2023, it remains significantly lower than Germany, where power prices have averaged 165% more than the 2018-2020 average. Industries, especially those in Germany’s chemicals and fertilizer sectors, may face mounting financial losses if they do not find low-cost operating bases or risk being overtaken by overseas competitors.

However, the shift of operations from Northern to Southern Europe may pose challenges for industries tightly integrated into manufacturing supply chains that rely on just-in-time inventory management and other closely-knit industrial systems. Despite these challenges, some sector reshaping is inevitable considering the extensive damage caused by high power costs to Europe’s industry. Spain and Portugal offer favorable locations within Europe, where costs may be lower compared to regions outside of Europe, but with limited access to Europe’s consumers.

In conclusion, the Iberian Exception granted to Spain and Portugal has provided relief from high power costs experienced by many European countries. The price caps implemented in these countries have ensured relatively stable and lower power costs, making Spain and Portugal potentially attractive locations for industries seeking to reduce operating expenses. However, businesses must carefully consider the challenges associated with relocating operations and the potential disruption to supply chains. Ultimately, the need for sector reshaping is undeniable, and Spain and Portugal may be viewed as favorable alternatives within Europe to mitigate the impact of high power costs.

The opinions expressed here are those of the author, a columnist for Reuters.

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