The EU’s energy price cap is destined to fail

analysis

1:00 pm

The bloc is unable to deal with a crisis of its own making

By Thomas Fazee

A protest against rising energy prices in Brussels, December 2022. Credit: Getty.

After months of wrangling, EU energy ministers finally Confirmed The first ever cap on fuel prices, which is due to come into force in February. The purpose of the measure is to curb the crisis that shook Europe last year as a result of the jump in gas and energy prices to unprecedented levels.

To understand how the cap works, it’s important to understand what’s driving the energy crisis in the first place. It is commonly thought that the increase in fuel prices is the result of Vladimir Putin increasing the bills in revenge for the West’s support for Ukraine. But that’s not how energy markets work.

Today, the price of European gas is no longer determined by semi-permanent long-term contracts linked to the price of oil – as was common until a decade ago – nor can it be changed unilaterally from day to day based on the whims of exporters. Instead, it is related to the price at which gas is sold in virtual trading markets, or spot markets, such as TTF in Amsterdam (for the European Union) or the NBP In the UK, where every day hundreds of energy traders and financial operators buy and sell large quantities of gas. This means that the price of gas mainly depends on the fluctuations of the financial markets.

The transition from oil-dependent provinces to spot market pricing has been a pet project of the European Commission since the early 2000s, in keeping with the European technocrats’ belief in the virtues of economic liberalization and marketization: the idea that market forces, if left to their own devices, will always produce the optimal outcome – and the optimal price. As a result, over the past decade spot pricing has become the norm across Europe.

As it turns out, allowing the financial markets – especially prone to irrational behavior, speculation and price manipulation – to set the price of the most important commodity in the economy, energy, was a very bad idea. This became clear at the beginning of 2021, a year before the start of the war in Ukraine, when the price of gas traded in the TTF, to which most of the European Union’s gas contracts are linked, began to climb significantly.

By the end of the year, the price of European gas reached 100 euros/MWh – the highest ever recorded, and an incredible increase of 1,000% from the beginning of the year, when the price was around 10 euros/MWh.

There was no economic basis to justify such a drastic increase. Yes, there was a recovery in energy demand due to economies starting to reopen after the lockdown, but global oil and gas production also increased compared to the previous year. And, the supply of Russian gas to the European Union – which in 2021 accounted for about 50% of the bloc’s total supply – yes. down A little in the second half of the year. To the extent that there was a mismatch between supply and demand, it was not enough to justify a tenfold increase in prices.

Enter the recently approved EU cap, which sets the maximum price at which gas can be traded on the TTF at €180/MWh. This is not a restriction on price gouging by Russia (or anyone else); This is a limitation on the speculative trading system that the EU has deliberately imposed on its energy markets. In other words, this is another case of an organization trying to fix a problem of its own making. Worse, it is likely to fail: not only is this price (and even the current price) still a massive increase compared to pre-2021 rates, but there is also a risk that the move could actually lead to a decrease in gas supplies. And winter has just started.