The Iberian Exception Mechanism

The policy contributed to alleviate inflation in Spain, whereas the effect in Portugal in minimal.

Miguel Haro Ruiz | September 15, 2023

Before 2021, electricity prices in Europe had remained relatively constant around 100€/MWh. As the region’s economy reopened following the COVID-19 pandemic, the global supply of natural gas was unable to keep up with the increasing demand, which began pushing prices up. Russia’s invasion of Ukraine in February 2022 made an already delicate situation worse by adding uncertainty to Europe’s supply of natural gas. By the spring of 2022, European electricity markets had experienced several price spikes, which can be traced back to volatily episodes in international gas markets.

EU average wholesale electricity prices

Under these circumstances, Spain and Portugal —who operate under a single electricity market, MIBEL— were allowed to temporarily amend the EU-wide guidelines that regulate wholesale energy markets. The policy that resulted become known as the Iberian exception mechanism, due to it being the only measure across the EU that directly intervenes in the wholesale of electricity.

The Iberian exception came into effect on June 15, 2022 with the goal of decoupling the spot price of electricity from international gas prices by setting a cap to the price that gas-firing generators of electricity can sell their product for. On days when international gas prices sit above electricity prices, gas generators are entitled to adjustment payments which prevent them from operating at a loss. These adjustment payments are calculated based on the cap, as well as a daily gas market price, which results from a weighted average of different gas spot contracts at the Iberian gas market.

I employed synthetic control methods to estimate the effect of the Iberian exception on wholesale electricity prices as well as inflation for both Spain and Portugal. For details on this methodology, please refer to the technical appendix at the end of this article.

Over the 12 months following the entrance into force of the Iberian exception, the policy managed to reduce the wholesale price of electricity by more than 60€/MWh, equivalent to a 40% reduction.

Wholesale prices in the Iberian electricity market

with, without^☨ the Iberian exception

Despite Spain and Portugal having identical wholesale electricity prices, the effect of the Iberian exception on inflation varies substantially across the two countries; In Spain, the intervention reduced the inflation rate by 3.5 percentage points; By contrast, the effect of the policy on Portugal's overall price level is considerably weaker.

Overall inflation rate in Spain and Portugal

with, without^☨ the Iberian exception

The explanation for this difference lies in the retail market structure in each country. On one hand, Spain’s regulated PVPC tariff, which serves about 40% of households and small firms, is indexed by MIBEL wholesale prices. This creates a direct link between the intervened wholesale price and Spain's inflation. On the other, there is no short-term link between wholesale and retail prices in Portugal.

This analysis shows that Spanish consumers are highly exposed to fluctuations in wholesale electricity prices, and while the policy is responsible for bringing inflation down, it may not have been necessary with a different price-setting mechanism of the PVPC tariff.

Spanish policymakers have taken note and will modify the regulated tariff to reflect longer-term contracts in order to reduce volatily. The new PVPC tariff will enter into force at the beging of 2024, coinciding with the end of the Iberian exception mechanism.

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Technical appendix

We estimate the effect of the Iberian exception mechanism on different price outcomes via synthetic control methods, which estimate a counterfactual unit as the weighted average from a pool of untreated units.

The treatment effect is estimated individually for Spain and Portugal, and to construct the synthetic control unit for Spain, we exclude Portugal from our analysis and vice versa. We base our estimations on the monthly average day-ahead electricity prices and the overall Consumer Price Index (CPI).

We take into account 23 European countries for the donnor pool. In particular, all EU-27 countries plus Norway are considered, as they all operate under the EU Electricity Directives and the Guideline on Capacity Allocation and Congestion Management, as well as engage in market coupling through the Single Day-ahead Coupling mechanism. Cyprus and Malta are removed from the donor pool because they do not operate a wholesale electricity market of their own. France is also removed, as we cannot rule out the possibility that the Iberian exception affected its day-ahead electricity market. When estimating a counterfactual unit for the day-ahead price, Croatia, Hungary, and Ireland are removed from the donor pool as their data is subject to inconsistencies.

Our synthetic-control specifications included all pre-treatment outcome lags as predictors. The lenth of the pre-treatment period is 108 months for the Overall CPI, and 89 months for the day-ahead price due to lack of available data before 2015. Furthermore, the post-treatment period is 12 months. We only take into account full intervention months, for which the pre-treatment period goes up to May 2022, and the post-treatment period begins in July 2022.

A deployable tool is available to replicate the results presented in this article.