## IMF Staff Background Note on EU Energy Market Integration ## Source details **Canonical URL:** [IMF Staff Background Note on EU Energy Market Integration](https://www.imf.org/-/media/files/miscellaneous/background-notes/imf-background-note-on-eu-energy-market-integration-january-2025-to-publish.pdf) ## Other formats - [Markdown version](/-/media/files/miscellaneous/background-notes/imf-background-note-on-eu-energy-market-integration-january-2025-to-publish.pdf.md) - [Structured JSON version](/-/media/files/miscellaneous/background-notes/imf-background-note-on-eu-energy-market-integration-january-2025-to-publish.pdf.json) --- ### Context and scope - Produced at the request of the Polish Presidency of the Council of the EU; presented by Alfred Kammer, Director of the IMF European Department, to the EU’s Economic and Financial Committee on January 13, 2025. - Focus: current fragmentation of EU energy markets, costs of fragmentation, benefits of greater energy market integration, impediments to integration, and policy recommendations. - Main emphasis: integration of the electricity grid and market, given increasing electrification of the energy system. ### The case for further energy market integration - Integration would deliver three closely interrelated benefits: lower energy prices, enhanced energy security, and decarbonization. - Lower energy costs: - Move away from a fossil-fuel-based energy mix towards low-marginal cost energy technologies requires rapid and widespread electrification. - Integration lowers energy prices by optimizing generation choices, enabling electricity trade across parts of the EU with different renewables potential, avoiding over-investment, and reducing energy storage needs. - Enhanced energy security: - Integration is the best protection against country-specific or regional shocks; shared markets absorb shortfalls from technical interruptions, weather phenomena, or other factors. - The 2022 gas shock highlighted the resilience from sharing gas and the vulnerabilities when infrastructure is insufficiently integrated. - Example: electricity prices spiked in some South-Eastern European economies in the summer of 2024 due to limited interconnections. - Delivering on decarbonization: - More integrated markets enable faster and more cost-efficient achievement of decarbonization goals by exploiting renewables potential across member countries, while also enhancing energy security. ### A brief overview of energy prices (key figures) - Historical gaps: - No transatlantic gas price gap in 2005; EU industrial natural gas prices averaged around 2.5 times US prices over 2006-2019. - Electricity prices were about twice the US level over that period. - Higher energy taxes in Europe accounted for less than 20 percent on average for the EU as a whole for non-household consumers. - Post-2022 crisis dynamics: - Prices spiked to as much as ten times the pre-shock average initially in 2022; they receded but stabilized well above pre-pandemic levels. - Overall energy prices in the EU relative to the US have roughly doubled compared with the three years before the pandemic. - The ratio of electricity prices increased from around 2 to 3. - For natural gas the ratio rose from 2 to 4.5 in 2024. - Electricity-specific metrics: - Median wholesale electricity price across EU countries over 2023-24 has doubled relative to the pre-pandemic level. - Electricity price dispersion within the EU has tripled. - Electricity price volatility over time and across hubs remains more than three times its pre-pandemic average. - If there were no cross-border trade at all today, volatility could be more than five times the observed level. - Regional example: - Average wholesale electricity price in Bulgaria, Greece, Hungary and Romania increased by 130 percent between April and July 2024 compared to a 35 percent increase for the rest of the EU. ### Macro impact of the energy shock and the EU–US price gap - Short-run and sectoral effects: - The ECB (2023) estimates the 2022 price spike decreased industrial production by about 2 percent in 2022 in the euro area in the first year. - Energy is a notable cost factor in certain sectors (e.g., close to 10 percent for chemicals). - Economy-wide and longer-run effects: - Di Bella et al. (2024) estimate a full shutoff of Russian pipeline gas in the summer of 2022 could have reduced EU GDP by 0.4 to 2.7 percent; integrated markets helped achieve economic effects toward the lower end of this range. - Forthcoming IMF work (Lan et al.) suggests that after accounting for endogenous improvements in energy efficiency, the impact of the energy crisis on potential output in the euro area was around 1 percentage point. - This corresponds to an output loss of nearly €200 billion a year by 2027. ### Estimated gains from closer energy integration (selected quantitative findings) - Direct cost savings: - Studies estimate cost savings of around €40 billion per year from greater integration. - Other studies: hypothetical gains of €34 billion (in 2021) from a fully integrated electricity market; an estimate of €53 billion annual gains by 2030 from further integration; optimally integrated market and sector-coupling could reduce costs by up to 37 percent relative to a non-integration scenario. - System capacity and storage: - Greater integration within subsets of countries could reduce needed dispatchable generation capacity to meet peak demand by nearly 20 percent and storage capacity by 30 percent compared to unchanged integration. - GDP effects: - A market integration scenario with cross-border electricity trade rising by 50 percent could raise annual EU GDP in 2030 by around 0.1 percent. - Broader investment and competitiveness effects: - Lower energy costs and greater system stability likely foster investor confidence and stimulate corporate investment in energy-intensive and innovative sectors (e.g., data centers, AI, quantum computing, digital services). ### Why integration gains are likely to grow with electrification and renewables - As renewables gain further weight and electrification of end uses (e.g., electrical vehicles and heating) and industrial production (e.g., green hydrogen) progresses, the benefits from integration—in terms of average energy prices and volatility—are expected to increase. - IMF staff estimates suggest a more cost-effective investment mix to meet emission reduction goals could generate considerable savings in aggregate investment costs at the EU level. ### What has impeded energy market integration? - National prerogative and institutional constraints: - Energy policy remains an intrinsically national prerogative with limited formal EU-level powers; EU treaties leave the aggregate energy mix choice to national governments. - The EU-level green transition goals and crisis responses have increased cooperation (e.g., solidarity agreements for natural gas; a voluntary 15 percent demand reduction target) but the overall institutional setup has not changed significantly. - Differing national incentives and political economy: - Member countries differ in energy intensity, renewables potential, and financing costs, creating diverging incentives for integration. - Exporting-country end users may fear higher electricity costs from exports; importing-country domestic generators may lobby against greater interconnection. - Infrastructure is not always the binding constraint—member states could increase utilization of existing interconnector capacity but sometimes choose not to. - Failure to internalize network externalities: - National regulators prioritize minimizing costs today for rate payers; national governments focus on meeting national targets. - Many network externalities are not fully internalized, leading to under-investment in market integration despite long-term EU- and country-level gains. ### What needs to be done? — Overview - Lowering prices, enhancing energy security, and decarbonizing the European economy will require an energy transformation centered around the electricity system. - EU members will need to overcome barriers to integration and develop a coordinated strategy for efficiently transforming the EU’s energy system (generation, storage, transmission) into a fully integrated, single energy market. - The optimal approach will take a Europe-wide perspective but be tailored across countries and regions. ### Five policy recommendations - First, develop a unified EU “blueprint” for the energy system transformation. - The EU should develop a comprehensive, data-driven energy transformation strategy centered on the electricity system. This strategy should: - Close information gaps. Invest in data, modeling, and analytical tools to identify the most cost-effective and critical investments in generation, storage, transmission and complementary infrastructure. - Design an overarching blueprint. Using the improved data and estimates on critical investments, design a forward-looking roadmap for the next few decades that prioritizes efficiency, cost-effectiveness, energy security, and decarbonization while internalizing the various externalities and national incentives that have hampered integration thus far. - This blueprint could serve as a foundation for coordinating EU and national policies, aligning resources and actions to maximize the collective impact. It will also help identify where EU-level action is most needed, including to address the externalities and incentive problems discussed above. - Second, strengthen institutional and financing frameworks. - The EU must address structural deficiencies in markets and institutional barriers to integration with bold, systemic reforms. - Establish an EU entity to ensure the development of the grid: The existing institutional and market structures are unlikely to deliver the network capacity the EU needs (Cremona 2023). Solving this may require a new EU entity to coordinate or even implement the necessary investments, such as an EU grid interconnector operator. - Design harmonized instruments: Ensure new instruments, such as capacity mechanisms, are based on a common framework to prevent fragmented approaches that could undermine the single market.11 - Reform EU budget allocations: Reform existing funding instruments to prioritize facilitating the energy transformation and an efficient use of resources, as well as support for complementary reforms. - Third, pool resources to accelerate innovation and mitigate risks to the single market. - Beyond addressing coordination failures, collaborative action and pooling resources at the EU level can maximize economies of scale, mitigate risks to the single market, and accelerate breakthroughs in clean energy technologies. - Boost EU level resources for R&D in energy and clean technologies: Scale up research into developing next generation technologies, such as grid-scale storage technologies to cover intermediate duration periods of low renewable power generation. Moreover, pooling resources to develop new technologies to tackle decarbonization in hard to abate sectors, such as agriculture, will help to ensure the green transition is politically and socially sustainable. - Coordinate funding to support the scale up of new clean technologies: Providing such resources at the EU level on a meritocratic basis will help to mitigate risks to the single market posed by state aid.12 - Fourth, streamline permitting processes and optimize demand management. - To accelerate the deployment of renewables and grids, the EU must tackle longstanding bottlenecks. - Simplify and digitize permitting processes: Standardize and expedite permitting timelines, including across member states, to fast-track renewables and grid infrastructure. Despite some progress, delays due to permitting processes are a major impediment to the rapid deployment of both renewables and grids, with the overall permit-granting process taking several years in some member countries.13 - Enhance demand management: Improving demand management and responsiveness to electricity prices could also reduce volatility and lower average prices.14 - Fifth, pursue coordinated action across all levels of governance of the energy market. - Achieving a fully integrated, single energy market requires better collaboration across all levels—EU, national, regional and local. - By aligning policies, reducing inefficiencies, and fostering innovation, Europe can achieve a clean, affordable, and secure energy future. ### Key analytical findings and evidence cited - Without the existing extent of EU grid integration, estimates suggest electricity price volatility would be more than five times as high as it already is. - Europe paid nearly five times as much as the US for natural gas and more than double for electricity in 2023. - On average over 2023-24 the median wholesale electricity price is double the pre-pandemic level and the average dispersion (difference between maximum and minimum) has tripled. - Both the level and dispersion of wholesale electricity prices across EU countries shot up in 2021-22; while they have declined from their peaks, prices and dispersion remain elevated. - Interconnection capacity has expanded across Europe, but important gaps remain and substantial new capacity will be required as the EU energy system electrifies and decarbonizes. - Renewable generation potential differs widely across Europe: more solar potential in the south and onshore wind in the north (2030Mean Solar Capacity Factor; 2030Mean Onshore Wind Capacity Factor). - Energy market integration would reduce both short-duration and long-duration energy storage needs (Bruegel 2024 based on Roth and Schill 2023). *IMF Staff Background Note on EU Energy Market Integration — Section 1* ### Section 1 ### IMF Staff Background Note on EU Energy Market Integration ### Context and scope - Produced at the request of the Polish Presidency of the Council of the EU; presented by Alfred Kammer, Director of the IMF European Department, to the EU’s Economic and Financial Committee on January 13, 2025. - Focus: current fragmentation of EU energy markets, costs of fragmentation, benefits of greater energy market integration, impediments to integration, and policy recommendations. - Main emphasis: integration of the electricity grid and market, given increasing electrification of the energy system. ### The case for further energy market integration - Integration would deliver three closely interrelated benefits: lower energy prices, enhanced energy security, and decarbonization. - Lower energy costs: - Move away from a fossil-fuel-based energy mix towards low-marginal cost energy technologies requires rapid and widespread electrification. - Integration lowers energy prices by optimizing generation choices, enabling electricity trade across parts of the EU with different renewables potential, avoiding over-investment, and reducing energy storage needs. - Enhanced energy security: - Integration is the best protection against country-specific or regional shocks; shared markets absorb shortfalls from technical interruptions, weather phenomena, or other factors. - The 2022 gas shock highlighted the resilience from sharing gas and the vulnerabilities when infrastructure is insufficiently integrated. - Example: electricity prices spiked in some South-Eastern European economies in the summer of 2024 due to limited interconnections. - Delivering on decarbonization: - More integrated markets enable faster and more cost-efficient achievement of decarbonization goals by exploiting renewables potential across member countries, while also enhancing energy security. ### A brief overview of energy prices (key figures) - Historical gaps: - While there was essentially no transatlantic gas price gap in 2005, EU industrial natural gas prices averaged around 2.5 times US prices over 2006-2019. - Electricity prices were about twice the US level over that period. - Higher energy taxes in Europe accounted for less than 20 percent on average for the EU as a whole for non-household consumers. - Post-2022 crisis dynamics: - Prices spiked to as much as ten times the pre-shock average initially in 2022; they receded but stabilized well above pre-pandemic levels. - Overall energy prices in the EU relative to the US have roughly doubled compared with the three years before the pandemic. - The ratio of electricity prices increased from around 2 to 3. - For natural gas the ratio rose from 2 to 4.5 in 2024. - Electricity-specific metrics: - Median wholesale electricity price across EU countries over 2023-24 has doubled relative to the pre-pandemic level. - Electricity price dispersion within the EU has tripled. - Electricity price volatility over time and across hubs remains more than three times its pre-pandemic average. - If there were no cross-border trade at all today, volatility could be more than five times the observed level. - Regional example: - Average wholesale electricity price in Bulgaria, Greece, Hungary and Romania increased by 130 percent between April and July 2024 compared to a 35 percent increase for the rest of the EU. ### Macro impact of the energy shock and the EU–US price gap - Short-run and sectoral effects: - The ECB (2023) estimates the 2022 price spike decreased industrial production by about 2 percent in 2022 in the euro area in the first year. - Energy is a notable cost factor in certain sectors (e.g., close to 10 percent for chemicals). - Economy-wide and longer-run effects: - Di Bella et al. (2024) estimate a full shutoff of Russian pipeline gas in the summer of 2022 could have reduced EU GDP by 0.4 to 2.7 percent; integrated markets helped achieve economic effects toward the lower end of this range. - Forthcoming IMF work (Lan et al.) suggests that after accounting for endogenous improvements in energy efficiency, the impact of the energy crisis on potential output in the euro area was around 1 percentage point. - This corresponds to an output loss of nearly €200 billion a year by 2027. ### Estimated gains from closer energy integration (selected quantitative findings) - Direct cost savings: - Studies estimate cost savings of around €40 billion per year from greater integration. - Other studies: hypothetical gains of €34 billion (in 2021) from a fully integrated electricity market; an estimate of €53 billion annual gains by 2030 from further integration; optimally integrated market and sector-coupling could reduce costs by up to 37 percent relative to a non-integration scenario. - System capacity and storage: - Greater integration within subsets of countries could reduce needed dispatchable generation capacity to meet peak demand by nearly 20 percent and storage capacity by 30 percent compared to unchanged integration. - GDP effects: - A market integration scenario with cross-border electricity trade rising by 50 percent could raise annual EU GDP in 2030 by around 0.1 percent. - Broader investment and competitiveness effects: - Lower energy costs and greater system stability likely foster investor confidence and stimulate corporate investment in energy-intensive and innovative sectors (e.g., data centers, AI, quantum computing, digital services). ### Why integration gains are likely to grow with electrification and renewables - As renewables gain further weight and electrification of end uses (e.g., electrical vehicles and heating) and industrial production (e.g., green hydrogen) progresses, the benefits from integration—in terms of average energy prices and volatility—are expected to increase. - IMF staff estimates suggest a more cost-effective investment mix to meet emission reduction goals could generate considerable savings in aggregate investment costs at the EU level. ### What has impeded energy market integration? - National prerogative and institutional constraints: - Energy policy remains an intrinsically national prerogative with limited formal EU-level powers; EU treaties leave the aggregate energy mix choice to national governments. - The EU-level green transition goals and crisis responses have increased cooperation (e.g., solidarity agreements for natural gas; a voluntary 15 percent demand reduction target) but the overall institutional setup has not changed significantly. - Differing national incentives and political economy: - Member countries differ in energy intensity, renewables potential, and financing costs, creating diverging incentives for integration. - Exporting-country end users may fear higher electricity costs from exports; importing-country domestic generators may lobby against greater interconnection. - Infrastructure is not always the binding constraint—member states could increase utilization of existing interconnector capacity but sometimes choose not to. - Failure to internalize network externalities: - National regulators prioritize minimizing costs today for rate payers; national governments focus on meeting national targets. - Many network externalities are not fully internalized, leading to under-investment in market integration despite long-term EU- and country-level gains. *IMF Staff Background Note on EU Energy Market Integration — Section 1* ### Section 2 ### What needs to be done? ### Overview - Lowering prices, enhancing energy security, and decarbonizing the European economy will require an energy transformation centered around the electricity system. - EU members will need to overcome barriers to integration and develop a coordinated strategy for efficiently transforming the EU’s energy system (generation, storage, transmission) into a fully integrated, single energy market. - The optimal approach will take a Europe-wide perspective but be tailored across countries and regions. ### Five policy recommendations - First, develop a unified EU “blueprint” for the energy system transformation. - The EU should develop a comprehensive, data-driven energy transformation strategy centered on the electricity system. This strategy should: - Close information gaps. Invest in data, modeling, and analytical tools to identify the most cost-effective and critical investments in generation, storage, transmission and complementary infrastructure. - Design an overarching blueprint. Using the improved data and estimates on critical investments, design a forward-looking roadmap for the next few decades that prioritizes efficiency, cost-effectiveness, energy security, and decarbonization while internalizing the various externalities and national incentives that have hampered integration thus far. - This blueprint could serve as a foundation for coordinating EU and national policies, aligning resources and actions to maximize the collective impact. It will also help identify where EU-level action is most needed, including to address the externalities and incentive problems discussed above. - Second, strengthen institutional and financing frameworks. - The EU must address structural deficiencies in markets and institutional barriers to integration with bold, systemic reforms. - Establish an EU entity to ensure the development of the grid: The existing institutional and market structures are unlikely to deliver the network capacity the EU needs (Cremona 2023). Solving this may require a new EU entity to coordinate or even implement the necessary investments, such as an EU grid interconnector operator. - Design harmonized instruments: Ensure new instruments, such as capacity mechanisms, are based on a common framework to prevent fragmented approaches that could undermine the single market.11 - Reform EU budget allocations: Reform existing funding instruments to prioritize facilitating the energy transformation and an efficient use of resources, as well as support for complementary reforms. - Third, pool resources to accelerate innovation and mitigate risks to the single market. - Beyond addressing coordination failures, collaborative action and pooling resources at the EU level can maximize economies of scale, mitigate risks to the single market, and accelerate breakthroughs in clean energy technologies. - Boost EU level resources for R&D in energy and clean technologies: Scale up research into developing next generation technologies, such as grid-scale storage technologies to cover intermediate duration periods of low renewable power generation. Moreover, pooling resources to develop new technologies to tackle decarbonization in hard to abate sectors, such as agriculture, will help to ensure the green transition is politically and socially sustainable. - Coordinate funding to support the scale up of new clean technologies: Providing such resources at the EU level on a meritocratic basis will help to mitigate risks to the single market posed by state aid.12 - Fourth, streamline permitting processes and optimize demand management. - To accelerate the deployment of renewables and grids, the EU must tackle longstanding bottlenecks. - Simplify and digitize permitting processes: Standardize and expedite permitting timelines, including across member states, to fast-track renewables and grid infrastructure. Despite some progress, delays due to permitting processes are a major impediment to the rapid deployment of both renewables and grids, with the overall permit-granting process taking several years in some member countries.13 - Enhance demand management: Improving demand management and responsiveness to electricity prices could also reduce volatility and lower average prices.14 - Fifth, pursue coordinated action across all levels of governance of the energy market. - Achieving a fully integrated, single energy market requires better collaboration across all levels—EU, national, regional and local. - By aligning policies, reducing inefficiencies, and fostering innovation, Europe can achieve a clean, affordable, and secure energy future. ### Key analytical findings and evidence cited - Without the existing extent of EU grid integration, estimates suggest electricity price volatility would be more than five times as high as it already is. - Europe paid nearly five times as much as the US for natural gas and more than double for electricity in 2023. - On average over 2023-24 the median wholesale electricity price is double the pre-pandemic level and the average dispersion (difference between maximum and minimum) has tripled. - Both the level and dispersion of wholesale electricity prices across EU countries shot up in 2021-22; while they have declined from their peaks, prices and dispersion remain elevated. - Interconnection capacity has expanded across Europe, but important gaps remain and substantial new capacity will be required as the EU energy system electrifies and decarbonizes. - Renewable generation potential differs widely across Europe: more solar potential in the south and onshore wind in the north (2030Mean Solar Capacity Factor; 2030Mean Onshore Wind Capacity Factor). - Energy market integration would reduce both short-duration and long-duration energy storage needs (Bruegel 2024 based on Roth and Schill 2023). *IMF Background Note — Section 2* --- _Source: https://www.imf.org/-/media/files/miscellaneous/background-notes/imf-background-note-on-eu-energy-market-integration-january-2025-to-publish.pdf_