Oil rig in Esbjerg, Denmark
Photo: iStock
Photo: iStock
6. Conclusions
The Nordic electricity market has responded relatively well to the current crisis. The increased prices, together with information and awareness campaigns and other measures, resulted in significantly lower demand. Based on the current data, it is difficult to distinguish between the effects of the special measures and the effects of prices.
A revenue cap on inframarginal technologies, as implemented in Denmark and Sweden, does not distort the short-term incentives to produce to a significant degree. However, administrative costs may be high. Considering that power prices have been much lower in 2023 than they were in the second half of 2022, the actual tax revenue from the measures is relatively low. A profit tax, as implemented in Finland, is theoretically better than a revenue cap. In addition, the administrative costs of a profit tax are expected to be lower.
The main potential impacts of the emergency measures relate to incentives to invest in new production capacity. Hence, it is crucial that the authorities emphasize that the emergency measures are exceptional, targeted and time-limited.
6.1. Measures to reduce electricity demand
The core property of a well-functioning market is that it allocates resources efficiently. Efficiency implies that (1) electricity is produced at the lowest possible cost, (2) electricity is consumed by those who value it the most, and (3) the right amount of electricity is produced and consumed. Efficiency also implies that in periods of scarcity, the demand with the lowest value is reduced first. Price is the most efficient tool for allocating resources. However, efficiency does not imply that the allocation is fair or perceived as fair.
It lies at the heart of the CR that measures other than the price mechanism and the electricity market itself are to be used to manage scarcity.
A general tax on all electricity consumption would ensure that demand is reduced efficiently by allocating demand reductions according to the value of electricity for different consumers. However, such allocation is less efficient than if it were fully left to the price mechanism, as the tax creates a wedge between the consumer price and the producer price. Therefore, the market price does not fully reflect the scarcity in the market and does not give the correct signal to the supply side to increase production. Instead of the price being at a level that signals the value of increased production to producers, the tax leads to a reduced market price. The value of electricity to consumers is then higher than the cost of production, which implies a deadweight loss. If the tax applied only to some consumer groups, it would allocate demand reductions even less efficiently.
The Nordic countries have an electricity tax for most end users. However, the tax has been reduced in response to high electricity prices. Hence, the authorities have actually removed (or weakened) one potential measure to reduce consumption.
A thorough analysis of the different measures’ impacts on consumption is outside the scope of this project. We note that electricity consumption was reduced considerably in the winter months of 2022–2023. However, we cannot deduce how much of this reduction was due to the emergency measures and how much was due to increased prices or relatively mild weather. Nevertheless, we cannot rule out the impact of the information campaigns: consumers have become more aware of both prices and opportunities to adjust their consumption. The large reduction in demand that occurred in January, when prices were significantly lower than in December, may imply a time lag in demand reduction.
We also note that the reduction of demand in peak hours in Sweden was considerably larger than the 75 MW procured in the flexibility procurement scheme. Hence, the reduction in electricity consumption in the rest of the economy was significant.
6.2. Revenue cap and profit tax
We assessed the short- and long-term impacts of the revenue cap on the wholesale electricity markets. The main question was whether the revenue cap on inframarginal technologies would affect the incentives of power market participants. The short-term impacts were found to be related to incentives to produce, while the long-term impacts were found to be related to incentives to invest in new capacity.
6.2.1. Short-term impacts
Our main findings related to the revenue cap in Sweden and Denmark include the following:
- In principle, the inframarginal producers’ incentives to produce are not affected by a revenue cap; producers will produce as long as their marginal revenues are larger than their marginal costs. Furthermore, taxing only 90% of revenues exceeding 180 EUR/MWh contributes to maintaining the incentives to produce.
- Special provisions for high-cost producers (biomass- and oil-fired power plants) ensure that their incentives are preserved, thus ensuring security of supply.
- The way the tax was implemented in Sweden, with a day-ahead price as a reference price and hourly prices for settlements, did not influence the producers’ short-term incentives. The impacts of using the monthly average price, as in Denmark, are not straightforward, but the incentives were preserved in Denmark as well.
- However, the actual prices obtained by the producer form the tax base. Hence, if a producer has hedging agreements or power purchasing agreements (PPAs) and does not earn a market price exceeding 180 EUR/MWh, the tax does not apply. The share of hedging agreements in the Nordic market is relatively high. In particular, wind and solar power producers are hedged to a large degree. Therefore, a large share of production is not influenced by the tax, even when spot prices are high.
- Using the monthly average price as the tax base is likely to reduce the administrative costs of the tax. However, it also reduces tax revenue, as illustrated in Figure S.3. Recall that the tax in Sweden applied only to revenues obtained between 1 March 2023–30 June 2023.
Our main findings about the profit tax in Finland are as follows:
- A profit tax does not distort short-term production incentives. Profit-maximizing firms will still have incentives to maximize profits even if a share of profits is taxed. Thus, rational agents in the electricity sector behave as before and offer the same supply in the same markets as before.
- A profit tax is easier to implement and has lower administrative costs than a revenue cap.
- The present profit tax implies a higher tax level in Finland than the revenue tax in Denmark and Sweden, as the profit tax was calculated to be equivalent to a revenue tax for electricity prices of 280 EUR/MWh and applies to a longer period. While this does not influence short-term incentives, it may influence competitiveness and long-term investment decisions.
6.2.2. Long-term impacts
The potential long-term impacts relate to incentives to invest. Investment decisions depend on expectations about future prices and cash flows. Therefore, the main question is how such crisis measures influence expectations about the future – whether investors believe that policymakers will implement a revenue cap or profit tax (or other extraordinary measures) whenever prices are extraordinarily high. If they believe that a similar tax will be introduced in the future, the expected after-tax profitability of new investment projects will be reduced, and investments may be reduced as well. In order to maintain incentives to invest, it is important to emphasize that the measures were introduced as a response to an extraordinary crisis and not as regular taxes.
Electricity prices are much higher now than they were prior to 2021, and investments have been planned and carried out at much lower prices than those of today. However, uncertainty about market conditions in general – prices and taxes – may cause some investors to postpone making decisions.
It is also worth noting that the differences in the implementation of the measures may lead to changes in competitiveness between countries, which could have long-term impacts, such as investments being “moved” from one country to another. The negative effects on investment can be mitigated by communicating that these crisis measures are unlikely to be used again.
Hence, we conclude that if investors believe that the current emergency measures are exceptional and time-limited, long-term incentives to invest should not be affected. Therefore, it is crucial that the authorities emphasize the temporary, one-time nature of these extraordinary measures.
6.3. Solidarity contribution from fossil fuel sector
The third measure is the solidarity contribution from the fossil sector – a mandatory contribution of at least 33% of the taxable profits in fiscal years 2022 and/or 2023 that are higher than 20% of the average profits in the four preceding fiscal years. This applies to companies with activities in the crude oil, natural gas, coal and refinery sectors. This measure has appeared to be less relevant for the three countries of this report: no such companies were identified in Finland, and only a few relevant companies were identified in Sweden and Denmark.
The fossil fuel solidarity contribution is, in essence, an extraordinary tax on the profits of fossil fuel companies. A profit tax does not influence short-term incentives to produce, but it may influence long-term incentives to invest if it influences expectations about future net tax revenues. Representatives of the fossil fuel sector have argued that the solidarity contribution may reduce investments in green technologies. However, the profitability of green investments will not change because of the tax on fossil fuel companies. Other companies will invest in green technologies as long as these investments are profitable relative to other investments in the economy. Moreover, if companies are convinced that the tax is a temporary and extraordinary measure indeed, incentives to invest will not be affected.