What’s behind the electricity price increases

In early September, ElCom communicated the basic electricity supply prices for households reported by the distribution grid operators. These have increased substantially for the second time in a row, although there are significant differences between suppliers. What are the reasons for these differences? The answer can be found by looking at the current regulatory framework. One way forward would be to fully open up the Swiss electricity market.

On 5 September, ElCom announced that basic electricity supply prices for households in 2024 will rise by an average of 18 percent compared to the previous year. This is the second substantial spike after prices rose by an average of 27 percent in 2023. However, there are significant differences between the distribution grid operators – some have barely increased the tariffs while others have even increased them many times over.

The Association of Swiss Electricity Companies (VSE) recently published an article explaining how electricity price tariffs are structured, the reasons for their increases and how they are not connected to the profits of electricity companies. In order to better understand the links and differences between the suppliers, it’s worth taking a closer look at the regulatory framework.

Regulated household electricity prices

The current legal framework means that households in Switzerland cannot freely choose their electricity supplier, but instead are supplied by their local distribution grid operator. They are bound to their “basic supplier” and their electricity prices (or electricity tariffs) are strictly regulated. In order to determine the electricity tariff, the respective distribution grid operator – to put it simply – indicates its total costs and calculates the corresponding tariffs based on the amount of electricity delivered for basic supply. Which costs can be taken into account is clearly specified and reviewed by ElCom.

However, distribution grid operators usually supply not just consumers in the monopoly sector, but also major consumers in the free market. A rule is therefore needed to divide the costs between the two customer segments. To this end, ElCom specifies a regulation according to what is known as the average price method. With this method, the procurement costs and the production costs of the distribution grid operator’s production are divided proportionately for basic supply. For example, if it provides 60% of the energy for basic supply and 40% to the free market, then 60% of all procurement costs as well as all production costs for its own production are allocated to basic supply. As of 2018, however, distribution grid operators have legally had the option (but not the obligation) to include a higher proportion of renewable domestic production in basic supply; the procurement proportion is then reduced to the corresponding extent.

Drivers of differences between suppliers

In contrast, there are no provisions regarding which strategy the distribution grid operators must use to procure the amount of electricity for basic supply. With wholesale electricity prices increasing up to twenty-fold last year, the procurement strategy has come into focus as an essential aspect. If a supplier had already made a long-term purchase of electricity, they would be able to keep costs – and thus electricity tariffs – low. However, for suppliers who practice short-term supply coverage, the price increases led to correspondingly high procurement costs. This leads to a hike in electricity tariffs within the regulated area.

A second key aspect is the distribution grid operator’s own production. As described above, the production costs of in-house production are included proportionally in the costs for the end consumer. This reduces the dependence of tariffs on procurement strategies. However, production costs can also fluctuate: directly due to the costs of purchasing pump energy from hydroelectric power plants as well as due to reduced plant availability (e.g. failures or low precipitation).

Basic supply does not protect against high electricity costs

The price increases demonstrate that basic supply does not fundamentally protect end consumers from high electricity costs. Although consumers are not directly exposed to wholesale prices, the price increases still affect them depending on the supplier’s procurement strategy. The direct impact of regulated basic supply is simply a delay: since the tariffs are defined in advance and fixed for a year, higher costs only become apparent in future tariffs. In such cases, distribution grid operators create deficits that must be eliminated within three years.

A long-term procurement strategy or the supplier’s own production, in particular, provide protection against short-term electricity price peaks. However, as the market is not currently completely open, it is not possible for tied consumers to influence the distribution grid operator’s procurement strategy or to choose another supplier whose procurement strategy corresponds to their own risk profile.

The way forward

Major consumers in the free market already have access to various market tools and products to protect themselves against future price peaks. One way forward would be to fully open the Swiss electricity market so as to also give small-scale consumers a choice. Parliament, which is expected to finalise what is known as the consolidation bill during the autumn session, currently appears to want to refrain from doing this and has eliminated opening the market from the bill. Whether distribution grid operators should have to procure a minimum proportion of the electricity for basic supply via long-term contracts is up for discussion as an alternative.

Regardless of the approach, significantly accelerating the domestic expansion of renewable energies is also crucial to ensure future price stability for Swiss consumers. The approval procedures for large-scale plants in particular must be sped up to achieve this. The more the import volume increases in the future, the greater the dependence on developments in Europe, including price developments.

However, the focus should not be placed entirely on moderating price peaks. The price level is also crucial for household electricity costs. To keep this low, as efficient and cost-effective plants as possible must be developed. It is also important for household electricity prices not to be completely static or divorced from market signals. There would otherwise be no incentives to adapt the consumption profile to the production profile of renewable energies and increase consumption efficiency. Markets, market signals and competitive tools remain the best solution for coping with the energy transition as cost-effectively as possible.