The distributional effects of climate policies – Bruegel

Report on European Union Electricity Costs and Sustainable Development Goals

Introduction: Aligning EU Electricity Policy with Sustainable Development Goals

The European Union faces a critical challenge in reconciling high electricity costs with its commitments to the Sustainable Development Goals (SDGs). Elevated electricity prices undermine industrial competitiveness, impacting SDG 8 (Decent Work and Economic Growth) and SDG 9 (Industry, Innovation, and Infrastructure). Crucially, they threaten the accessibility of essential energy services for households, creating a direct conflict with SDG 7 (Affordable and Clean Energy) and SDG 10 (Reduced Inequalities). The transition to net-zero emissions, central to SDG 13 (Climate Action), depends on widespread electrification of heating and transport. However, high electricity prices disincentivize this shift, potentially delaying long-term climate targets. This report analyzes the structural and short-term policy options for managing EU electricity costs, evaluating them through the lens of the SDGs to ensure a just and sustainable energy transition.

Analysis of EU Electricity Cost Components and Governance

The final price paid by consumers is a composite of various costs, with decision-making authority fragmented across EU and national levels. This fragmentation complicates a coherent approach to achieving the SDGs.

Cost Components and SDG Implications

• Generation Costs: Variable costs from fossil fuels currently dominate, but the shift towards renewables will increase the share of fixed capital costs. This transition is vital for SDG 7 and SDG 13, but requires mechanisms to fairly distribute these new fixed costs.
• Network Costs: These fixed costs are recovered through charges on consumer bills. Current methodologies often place a greater burden on households than on industry, raising questions of equity under SDG 10.
• Support Schemes: Costs for renewables, backup generation (capacity mechanisms), and flexibility are increasingly socialized and recovered through levies, creating significant distributional challenges.
• Taxes: Non-energy taxes like excise duties and VAT form a major part of consumer bills. Misalignment of these taxes with climate goals can hinder the progress of SDG 13 by making clean electricity disproportionately expensive compared to fossil fuels.

Fragmented Governance as a Barrier to SDG 17

A multi-layered governance structure impedes a unified strategy. While the EU sets rules for wholesale markets and provides principles for retail markets and network tariffs, national governments retain significant control over cost recovery methodologies and energy taxation. This fragmentation creates policy conflicts and undermines SDG 17 (Partnerships for the Goals) by preventing a harmonized, EU-wide approach to ensuring electricity affordability and sustainability.

Policy Interventions and their Impact on Sustainable Development

Short-term policy interventions primarily involve redistributing existing costs or altering taxation. Each option presents significant trade-offs concerning various SDGs.

Taxation Reform: Balancing SDG 7 and SDG 10

Reducing excise duties and VAT on electricity can lower consumer bills, promoting electrification in line with SDG 7 and SDG 13. However, this action has consequences:

• Fiscal Impact: Lost tax revenue must be compensated, potentially by increasing taxes on fossil fuels—which could exacerbate energy poverty for households reliant on them—or by increasing public debt, impacting funds available for other SDG-related public services.
• Equity Concerns: Tax reductions may not be fully passed on to consumers and could disproportionately benefit higher-income households, failing to adequately address the energy poverty challenges central to SDG 10.

Redistributing Fixed Costs: A Trade-off Between SDG 9 and SDG 10

The fixed costs of the clean energy system (networks, renewables, backup capacity) are set to rise. How these costs are allocated presents a direct conflict between supporting industry and protecting households.

• Network Costs: Shifting a greater share of network costs from energy-intensive industries (to support SDG 9) onto households would increase the financial burden on families, potentially worsening energy poverty and inequality, thereby undermining SDG 10.
• Renewables and Backup Costs: Without clear EU-level rules for cost recovery from state-backed renewable contracts, existing exemptions for large consumers shift the burden onto households and SMEs. This practice will become more pronounced as the transition accelerates, intensifying the challenge to SDG 10.

Systemic Trade-offs: Efficiency, Sustainability, and Reliability

Policy choices involve balancing cost, efficiency, and sustainability, with direct implications for the SDGs.

• Efficiency and Flexibility: Increasing system flexibility and cross-border interconnection enhances efficiency and lowers overall costs, supporting SDG 7 and SDG 12 (Responsible Consumption and Production). However, it creates distributional effects between and within countries that must be managed to uphold SDG 10.
• Sustainability: Maintaining robust carbon pricing through the EU Emissions Trading System (ETS) is fundamental to SDG 13. While this increases costs, revenues can be redistributed to protect vulnerable households, turning a potential challenge to SDG 10 into an opportunity for a just transition.

Quantitative Assessment of Short-Term Policy Scenarios

An analysis based on data from the five largest EU economies illustrates the tangible SDG trade-offs of short-term policy choices.

Scenario 1: Shifting Costs from Industry to Households

To alleviate cost pressures on energy-intensive industries (EII) and support SDG 9, one option is to shift costs to households. Reducing EII electricity prices to 2019 levels by reallocating costs would have a significant impact on households, directly challenging SDG 7 and SDG 10.

• The EII share of total electricity costs would fall from 7% to 4%, while the household share would rise from 53% to 56%.
• This could increase household electricity prices by up to 14% in countries like Germany and Poland. For an average German household, this translates to an estimated additional annual cost of €200.

Scenario 2: Reducing Energy Taxation

Removing VAT from electricity bills offers immediate relief to all consumers, advancing SDG 7. However, it creates a substantial fiscal gap that could compromise public spending on other SDGs.

• Removing VAT could reduce consumer electricity bills by up to 21%, with a German household saving nearly €350 annually.
• This would result in a major shortfall in national budgets, as VAT on electricity generates tens of billions of euros in revenue across the EU annually. This revenue is critical for funding public services that support health, education, and social protection, all key components of the SDG framework.

Principles and Recommendations for SDG-Aligned Electricity Pricing

To navigate these trade-offs, policy interventions must be guided by principles that embed sustainable development at their core.

Guiding Principles for Sustainable and Equitable Pricing

1. Prioritize Energy Policy Goals for SDG 7 and SDG 13: Electricity pricing should primarily incentivize decarbonisation and efficient system operation. Broader social and industrial objectives should be met through dedicated fiscal instruments, not by distorting energy markets.
2. Incentivize Efficiency for SDG 12: Prices must reflect real-time system conditions to encourage demand-side flexibility and responsible consumption, which reduces overall system costs and supports the integration of renewables.
3. Price Externalities for SDG 13: The cost of carbon emissions must be consistently applied via mechanisms like the EU ETS to ensure polluters pay and to drive investment in clean technologies.
4. Ensure Equitable Cost Recovery for SDG 10: The fixed costs of the system should be recovered in a way that does not disproportionately burden low-income households or disincentivize electrification. This may involve shifting from purely volumetric charges to blended tariffs that include flat components.

Policy Recommendations for Coherent Action

• Develop Transparent Analytical Tools: The European Commission should create a public, transparent electricity market model to assess the distributional impacts of policy proposals, ensuring decisions are evidence-based and aligned with SDG 10.
• Learn from the Energy Crisis: A comprehensive EU-level evaluation of the policy measures enacted during the recent energy crisis is needed to understand their effectiveness and equity implications, providing lessons for future interventions.
• Establish EU Guidelines on Electricity Cost Recovery: To promote coherence under SDG 17, EU-level guidelines should be developed for the fair and efficient recovery of all electricity system costs, including networks, renewables, and backup capacity.
• Provide a Policy Toolbox for National Governments: The Commission should issue updated guidance for member states on policy options to reduce electricity prices in a manner consistent with the SDGs, including tax reform and tariff design.
• Pursue Deeper System Integration: The long-term strategy must focus on deeper physical and institutional integration of the European electricity market. This is the most effective structural path to reducing costs for all consumers, thereby achieving SDG 7, strengthening SDG 9, and advancing the overall energy transition.

Analysis of Sustainable Development Goals (SDGs) in the Article

1. Which SDGs are addressed or connected to the issues highlighted in the article?

• SDG 7: Affordable and Clean Energy

  This is the central theme of the article. The text repeatedly discusses the challenge of ensuring “affordable” electricity for households and industries in the EU while transitioning to “clean energy” through decarbonisation and renewables. The entire “Action Plan for Affordable Energy” mentioned is a direct link to this goal.

• SDG 8: Decent Work and Economic Growth

  The article connects high electricity prices directly to economic performance, stating that “Expensive electricity undermines the industrial competitiveness of energy-intensive industry in the European Union.” This impacts economic growth and the viability of industrial jobs.

• SDG 9: Industry, Innovation, and Infrastructure

  The article highlights the critical role of infrastructure in achieving affordable and clean energy. It calls for “deeper physical and institutional integration of the European electricity sector,” investment in “electricity networks,” “backup generation,” and “cross-border interconnection” to structurally reduce prices.

• SDG 10: Reduced Inequalities

  A major focus of the article is the “distributional effects” of electricity pricing policies. It analyzes how costs are shared between households and industry, noting that “Almost all EU countries place a greater relative burden on households.” It also raises concerns about energy poverty and the financial impact on “low-income households.”

• SDG 13: Climate Action

  The context for the discussion on electricity pricing is the broader “green transition.” The article explicitly mentions the goal of “net-zero greenhouse gas emissions,” the role of “carbon pricing under the EU emissions trading system (ETS),” and the need for “decarbonising electricity production” to meet climate targets.

2. What specific targets under those SDGs can be identified based on the article’s content?

1. Under SDG 7 (Affordable and Clean Energy):
   • Target 7.1: By 2030, ensure universal access to affordable, reliable and modern energy services. The article’s core problem is affordability, stating, “electricity must be affordable enough for consumers to electrify their increasingly elastic energy consumption.”
   • Target 7.2: By 2030, increase substantially the share of renewable energy in the global energy mix. The article discusses how “variable electricity generation costs will fall with more renewables in the electricity mix” and analyzes the costs associated with supporting renewable energy projects.
   • Target 7.a: By 2030, enhance international cooperation to facilitate access to clean energy research and technology… and promote investment in energy infrastructure and clean energy technology. The call for “deeper physical and institutional integration of the European electricity” and “more cross-border electricity infrastructure” directly aligns with this target.
2. Under SDG 8 (Decent Work and Economic Growth):
   • Target 8.2: Achieve higher levels of economic productivity through… technological upgrading and innovation… The article links affordable electricity to the “industrial competitiveness of energy-intensive industry,” which is essential for maintaining economic productivity.
3. Under SDG 9 (Industry, Innovation, and Infrastructure):
   • Target 9.1: Develop quality, reliable, sustainable and resilient infrastructure… to support economic development and human well-being, with a focus on affordable and equitable access for all. The article’s recommendations for a “European grid package,” “greater electricity system flexibility,” and “cross-border interconnection” are all aimed at developing such infrastructure.
   • Target 9.4: By 2030, upgrade infrastructure and retrofit industries to make them sustainable… The discussion on electrifying “large shares of heating and transport energy demand” and the need for industry to adapt to the green transition relates to this target.
4. Under SDG 10 (Reduced Inequalities):
   • Target 10.2: By 2030, empower and promote the social, economic and political inclusion of all… The article’s analysis of how electricity costs are distributed and its concern that “cost increases raise concerns about the financial impact on low-income households” directly address the need to prevent policies from exacerbating inequality.
5. Under SDG 13 (Climate Action):
   • Target 13.2: Integrate climate change measures into national policies, strategies and planning. The entire article is framed within the context of EU climate policy, such as the “European Green Deal” and the “EU emissions trading system (ETS),” which are examples of integrating climate measures into policy.

3. Are there any indicators mentioned or implied in the article that can be used to measure progress towards the identified targets?

1. For SDG 7 (Affordable and Clean Energy):
   • Final electricity prices for households and industry: The article extensively uses this as a primary indicator of affordability. Figure 2 presents “final household electricity prices,” and Figure 4 shows “European energy-intensive industry electricity prices.”
   • Share of renewables in the electricity mix: The article implies this indicator by discussing the increasing penetration of renewables and the associated costs, stating that “the share of fixed costs in the total cost of the electricity system will rise as the capital costs of electricity networks, renewable generation… become central.”
   • Level of cross-border interconnection: The call for “more cross-border electricity infrastructure” implies that the capacity of such interconnections is a key metric for measuring progress towards an integrated and efficient market.
2. For SDG 8 (Decent Work and Economic Growth):
   • Electricity prices for energy-intensive industry: The article uses this as a direct proxy for industrial competitiveness. The analysis in section 4.1 is based on reducing these prices to 2019 levels to “alleviate cost pressures on large energy users.”
3. For SDG 10 (Reduced Inequalities):
   • Household vs. industry electricity price ratio: Figure 2 explicitly charts the “EU household/industry price ratio,” which serves as a direct indicator of how the cost burden is distributed between different consumer groups.
   • Share of electricity system costs borne by different consumer groups: The analysis in Figure 5, which shows the household share of costs rising from “53 percent to 56 percent” in a hypothetical scenario, is a quantitative indicator of distributional effects.
4. For SDG 13 (Climate Action):
   • Carbon price (EU ETS): The article mentions that the EU ETS adds “a cost to electricity production based on its carbon-dioxide emissions.” The price level within this system is a key indicator of the economic signal for decarbonisation.
   • Tax revenue from energy taxes: The article notes that energy taxes are a “major source of tax revenue, accounting for 3.8 percent of total tax revenues… in the EU in 2022.” This can be used to track how taxation policies are aligned with climate goals.

Summary of Findings

Source: bruegel.org