By Belén Carreño and Sergio Goncalves

MADRID/LISBON (Reuters) – Surging energy prices pushed Spanish inflation to a peak of just under 10% in March, the highest in the euro area and nearly double the 5.3% in neighbouring Portugal – despite the fact the two Iberian economies share a wholesale electricity market.

This disconnect is due to the fact that Spanish energy prices are included in the headline Spanish inflation number – an statistical anomaly with real-economy implications because of Spain’s extensive indexation of rents, wages, and pensions.

Decoupled electricity at Iberia https://graphics.reuters.com/SPAIN-ECONOMY/dwpkrywgovm/chart.png

Iberian inflation gap https://graphics.reuters.com/SPAIN-ECONOMY/gkvlgkogxpb/chart.png

Below is an explanation of what’s at stake.

HOW SPAIN’S CONSUMERPRICE INDEX IS CACULATED

Caixabank analysts pointed it out first: The inflation index does not include regulated electricity contracts that were taken out at variable rates tied to fluctuations in wholesale market prices.

These types of contracts used to be a popular choice for the majority of consumers. But, this has changed to just one-third over the past five years. The majority of Spanish citizens now follow the lead of their Portuguese counterparts, who have 85% on fixed-term agreements offered by distributors. Problem is, the Spanish inflation index doesn’t include the price they paid.

HOW MUCH WILL THIS DISTORT CPI?

Normal fixed-tariff customers expect to be charged a premium for certainty and predictability over the term of three years. However, they have been blessed in that the Ukraine war has not caused wholesale price increases.

A senior official in the government suggested that the government data could be underestimating Spain’s inflation rate by about two percentage points. Indeed, Spain sees an average inflation of 6% for this year and Portugal expects it to rise to 4% by 2022.

Similar data is available in monthly reports. The headline inflation in Spain fell to 8.4% in April, after a slight decline in electricity prices. This compares to Portugal’s 7.2%. This gap, which excludes energy and fresh foods prices, was entirely caused by volatile components. In Spain, core inflation reached 4.4% in April and Portugal at 5% in April.

WHAT IS OVERESTIMATED CPI IMPORTANT FOR SPAIN?

Fedea’s economics research group calculated that each percentage point increase in CPI would mean an extra 1.7 billion Euros for the state to raise pensions. This means the statistical anomaly could cost Spain at most 3.4 billion euro in public pensions.

Other knock-on consequences include the fact that rents in Spain have been indexed to inflation, though it has been suspended for the three-month period through June. The indicator is also widely used by employers and unions to guide their wage negotiations.

HOW TO FIX IT

Spain’s INE Statistics Office has begun to improve the inflation indicator through the incorporation of free-market price. However, the reform will require companies to provide millions of pieces on a similar-for-like basis. Not all companies are cooperating equally.

Nadia Calvino, the Economics Minister, stated last week that “in order for the CPI price to accurately reflect electricity’s true cost we require data from electricity companies. We have tried for months to obtain this data.” Everyone is needed to assist.

It is expected that the Iberian countries will approve this week a temporary cap by Brussels on sky-rocketing coal reference prices. The goal of the cap, which is temporarily imposed to control the rising electricity prices in regional wholesale markets (MIBEL), is approved.

The prices at which Spanish or Portuguese generators can sell electricity on the regional wholesale market, MIBEL (regional wholesale market) is determined by the marginal cost of production. Currently it’s the gas-fired and coal power stations.

Although it may reduce inflation in Spain, this measure does not resolve its statistical problems.

THE PORTUGUESE “ELECTRICITY MIRACLE”

The Portuguese pay lower electricity prices than the rest of the world, despite this statistic mismatch.   

Portugal has a fixed price that is regulated annually by the local watchdog, ERSE. It can, however, be adjusted quarterly to a certain extent. Portuguese customers can freely choose from regulated and free market tariffs.

Moreover, Portugal has a lower regulated tariff than Spain. According to the current formulae, this means that the tariffs for the entire system are being lowered.

This renewable energy component accounts for around 40% of the Portuguese energy bill, excluding taxes.