The price cap we have all been waiting for

It’s here. The gas price cap we have all been waiting for is a fact, summarised in a one-pager from the European Commission, featuring phrases like “a temporary and well-targeted instrument”, “a safety price ceiling”, and, of course, “safeguards to avoid disruption to the energy and financial markets”. Rejoice. Or don’t.

Almost as soon as the EC’s proposal for the “safety price ceiling” — I admit I love this cute euphemism, as if “price cap” is too lowly a phrase — was published the attacks began. They came from traders, they came from exchange operators, and they came from diplomats. Let’s dig in.

Here’s what the European Commission proposed: a cap of 275 euros per MWh for natural gas traded on the TTF front-month futures market that will be triggered automatically only if and when gas prices remain at that level for two whole weeks and if, at the same time, they remain 58 euros/MWh higher than “the LNG reference price for 10 consecutive trading days within the two weeks.”

In other words, two very strict conditions need to be met simultaneously for the cap to be activated. In case you are, like me, wondering what this activation will look like, it will look like a lot of reporting.

“When these conditions are met, the Agency for the Cooperation of Energy Regulators (ACER) will immediately publish a market correction notice in the Official Journal of the European Union and inform the Commission, European Securities and Markets Authority (ESMA) and the European Central Bank (ECB),” the EC said in its proposal.

A day later, with everyone relevant properly informed that both conditions for the safety price ceiling a activation have been met, “orders for front-month TTF derivatives exceeding the safety price ceiling will not be accepted.” Simple, elegant, perhaps a bit heavy on the reporting front, but still quite smart-looking.

Sadly, that’s all it is: looks. Traders were the first to slam the proposal for making their life difficult and riskier. The cap, they said, would move trade from transparent exchanges to the OTC market, which is essentially non-transparent, it would increase their margin obligations, and destabilise the market, per this report in the FT.

“Even a short intervention would have severe, unintended and irreversible consequences in harming market confidence that the value of gas is known and transparent,” said the European Federation of Energy Traders and I have to agree with them even though I am not a trader myself.

The intervention means that if you refuse to accept offers on the regulated market and I really do want to buy some gas, whatever the price, because I really need it, urgently, I’ll just go to the OTC market and do my business there.

Incidentally, the European Central Bank (one of the authorities on the reporting list for the cap, if you remember) warned against any measures that would move trades from exchanges to the OTC market. I can’t imagine why unless the above quote by the traders’ organisation is true.

That’s not all, either. The price cap would add to traders’ financial burden, apparently. According to ICE, as quoted by the FT, this additional burden could reach $33 billion in new margin payments resulting from the mechanism, after these already doubled this year, according to ECB data referenced in the report.

Another problem, pointed out by the head of European Energy Exchanges, is that the proposed mechanism will enter into effect from January without being tested. That’s right, the EC is proposing to launch a mechanism without spending a few months testing it for adverse side effects, as it were.

So, the head of the exchanges association, Europex, warned this is dangerous and said that without rigorous testing, the mechanism could put the energy market in jeopardy. “It is unrealistic to assume this can be achieved within a short timeframe and certainly not before the end of this winter,” Christian Baer noted.

Now, these are all serious causes for concern, communicated in simple enough terms as to be understandable to a broad audience, including the European Commission. They are also delicate compared to accusations of the cap being a joke that reportedly came from some observers.

According to yet another FT report — because the FT has been doing perhaps the best coverage of the whole price cap affair this week — one energy analyst called the proposed mechanism “a joke” and “a non-cap” because the level, at which the mechanism would be triggered, was set too high. Some European diplomats seem to agree.

Indeed, the highest gas prices went this year in Europe was 300 euros per MWh and even then, as the report notes, prices did not stay at 275 euros/MWh for two whole weeks.

Now add to this the second condition required for the mechanism to kick in and it becomes even more unrealistic to expect it to ever kick in, unless, of course, Gazprom stops all gas deliveries to Europe. At least that’s a silver lining for traders and exchange operators.

Naturally, EU members are already wrangling about the price cap level. They will probably continue to do so for a while, until December 19, to be precise, when the EU is supposed to vote on it.

Some, like Bruegel’s senior fellow Simone Tagliapetra who called it a joke, appear to be surprised by the Commission’s proposal. Yet if one is of a suspicious nature the proposal would arouse suspicions that it was deliberately devised in such a way as to be almost impossible to implement.

Indeed, if one is really suspicious, one might go as far as to suggest it was carefully ascertained that the mechanism would be almost impossible to implement before the proposal was made public. And this would not be a conspiracy theory because the Commission was very clear from the start of discussions of a price cap that it did not believe it was a good idea.

The Commission was quite openly against a price cap, siding with Germany, the Netherlands, and Denmark in the belief that capping the price of gas could do more harm than good.

Yet there were too many proponents of the cap, and it had to be proposed. Still, nothing obliged the EC to make this proposal actually implementable, so it made it largely non-implementable. From today’s short-term perspective, at least. From a longer-term perspective, everything is even worse.

“This is designed to be ready for next year for the filling season and for the challenging situation where we have to fill our underground gas storage without the access to Russian gas,” Energy Commissioner Kadri Simson said after the release of the proposal.

Call me paranoid but the way I understand this statement is as follows: “We expect gas prices next year to surge a lot higher than they were this year, including during the summer peak, so we’ll need to do something to avoid mass bankruptcies and the best we could come up with was this price cap.”

From that perspective, which is certainly a pessimistic one, I grant you that, the price cap may well become implementable. The context, in which it becomes implementable, however, is not a context that would bring anyone any joy.

Quite the contrary, it’s a context that’s best avoided. And this inevitably raises the question of whether it is worth devising a mechanism that could only be implemented in such an extreme scenario that you should be putting all your efforts into eliminating the risk of such a scenario materialising.

That came out a bit convoluted, so let me paraphrase. If you know that the only way your fire extinguisher will start working is if your house is set on fire, what would you focus on: the extinguisher’s maintenance or fireproofing your house, extinguisher be damned?

I admit the question has more than one correct answer, depending on things like presence or absence of home insurance and overall financial state in case there is insurance but let’s keep it simple: you have no home insurance. It’s fire-triggers-extinguisher or fireproofing. What do you choose? I know what I would choose. I’m very attached to my house and to the people who live in it.