Energy crisis: An EU cap on gas prices would end the market as we know it, experts warn

As the European Union stares into the abyss of a potentially catastrophic energy crisis, policymakers are becoming increasingly frantic about what to do next, what message to give and what relief to offer for households and companies under extreme financial stress.

The bloc has so far focused its efforts on collecting extra funds for cash-strapped governments, who are pumping out billions in emergency aid to help cushion the pain from soaring bills.

But with traditional market tools exhausted, public coffers running dry and winter looming, some countries are now turning towards drastic solutions.

Last month, a group of 15 EU countries, including France, Italy and Spain, joined forces in a public letter calling for an EU-wide cap on the price of all gas imports and transactions.

The signatories argue the wholesale cap would help curb prices before expensive gas supplies enter the common market, reach power plants and spill over into electricity bills.

For elected politicians fearing popular unrest and dismal opinion polls, the cap represents a fix worth a shot. But for energy experts, the cap is a leap of faith – one taken out of despair rather than conviction.

“It’s kind of a cry for help,” Elisabetta Cornago, a senior energy researcher at the Centre for European Reform (CER), told Euronews in a phone interview.

The joint letter, Cornago said, reflects the bloc has run out of “low-hanging fruit” to address the energy crisis and is gradually moving away from orthodoxy, despite the potential perils the shift entails.

“My impression is that member states are looking at prices and quantities in isolation and that’s difficult because of economics,” the researcher said. “Prices are high because of scarcity.” 

Uncharted territory

The EU’s energy sector is largely liberalised and operates under the fundamental rules of supply and demand.

For the past two decades, the rules worked in sync and offered consumers reliable and stable prices. But when Russia, the bloc’s leading energy provider, decided to launch the invasion of Ukraine, the system was turned violently upside down, exposing its most radical version.

As Western countries imposed sanctions on the Kremlin, Vladimir Putin fought back by actively manipulating much-needed gas flows.

The geopolitical tension threw the supply-demand balance out of the window and prices soared to record highs, leaving the EU scrambling to replace almost 150 billion cubic metres of Russian gas (over 40% of its total annual consumption).

A shopping spree ensued to get hold of as much liquefied natural gas (LNG) as possible, a highly flexible but costly commodity that can help offset the Russian losses.

By late August, prices at the Dutch Transfer Title Facility (TTF), Europe’s main benchmark for gas trading, reached an astonishing €339 per megawatt-hour, about 12 times the mark registered a year before.

By late September, the joint letter asking for an EU-wide gas cap was published. 

“With the price cap, I feel there’s a tension between price mitigation, which is the measure’s objective, and the security of supply, which can be at risk,” Cornago said.

“It’s hard to picture such level of market intervention,” she added. “This is uncharted territory.”

Cornago, like many other energy experts, fears LNG supplies, which are traded around the world on specialised ships, could be easily re-routed to other international markets where a price cap does not exist and larger profits can be earned.

Asian markets, in particular, can be an alternative destination. The region, whose pipeline structure is limited, has long relied on LNG to support its economic growth and is used to withstanding the intense global competition.

The EU is comparably late to the LNG bonanza and initially struggled to get a foothold in the crowded market. However, a drop in demand from China, whose economy slowed down this year under a stringent zero-Covid policy, and strong diplomatic outreach has allowed the bloc to attract record levels of LNG tankers, mainly from the US.

As a result, the EU’s existing network of LNG terminals is virtually running at full capacity (around 157 billion cubic metres per year). Brussels wants to keep it as such.

“This winter, we will also need every molecule of LNG that we can secure,” said Kadri Simson, European Commissioner for energy, after meeting with national ministers.

A Chinese recovery and a colder-than-usual winter in Asia would inevitably heat up the race for LNG carriers, said Dr Jack Sharples, a research fellow at the Oxford Institute for Energy Studies.

“Historically, LNG buyers in Asia were used to paying a premium over Europe,” Sharples told Euronews.

“Now that Europe has emerged as a region that is willing to compete with them on prices, that’s probably less comfortable for them because it means they can’t always be certain of getting the cargoes.”

In order to win the race, the EU’s gas cap would have to be dynamic and always remain above the prices set at the Japan/Korea Marker (JKM), Asia’s equivalent to the Dutch TTF. 

The EU would have to raise its cap every time Asian demand were to increase. This could trigger a race-to-the-top between the regions, driving prices further up and rendering the cap useless.

“By doing that, you’ll make national governments and LNG buyers in Asia quite unhappy,” Sharples said. “But that means you’ll probably have quite a high price cap for LNG coming into Europe.”

At the same time, a distinct cap would have to be introduced for imports of pipeline gas, of which Norway is now the leading provider. Oslo has openly expressed scepticism towards the idea and warned a gas cap would fail to solve the underlying cause of the crisis: the scarcity of gas.

The end of the free market

Security of supply is just the tip of the iceberg when it comes to a gas cap, experts warn.

Currently, gas supplies are distributed across the EU through price signals: the different prices that countries pay for gas according to their energy needs and their purchasing power. These signals allow the free market to function and ensure supplies go where demand is, which changes on a daily, or even hourly, basis.

But under a uniform gas cap, all 27 countries would pay the same price, making it impossible to discern where demand is higher and where it is lower. In essence, the market forces as we know them would disappear and a brand-new mechanism would have to be established to manage distribution.

“Deciding on gas flows administratively is without precedent in Europe and there is currently nobody at EU level […] which has this experience and technical capability to undertake this task,” said the European Commission in a non-paper published last month.

Setting up an administrative entity in charge of allocating gas supplies across 27 countries in the midst of a devastating energy crisis could prove to be politically explosive, analysts say, particularly in the event of shortages, when all capitals would be lobbying hard to get hold of as much gas as possible.

“When Europe introduces a price cap, markets will stop functioning and cross-border trade will cease,” Lion Hirth, a professor of energy policy at Hertie School, wrote on his LinkedIn page. “Governments will negotiate about gas allocation instead.”

Cornago and Sharples expressed similar views, warning that price signals would cease to exist under a regulated gas cap and further market intervention would be required to ensure the distribution of supplies.

“This is totally different from the COVID-19 crisis when the Commission created a market for vaccines out of thin air,” said Cornago. “For gas, there is already a market.”

Even if the 27 countries do manage to strike an agreement to impose an EU-wide price cap, convince suppliers to keep bringing in LNG tankers and establish a new entity with centralised powers to handle distribution, they could soon bump into a new obstacle: a surge in gas consumption.

“If you are successful and prices are low and you still get gas, consumers will increase their demand: low price means high demand. Especially now that winter is coming,” said Bram Claeys, a senior advisor at the Regulatory Assistance Project (RAP), a non-partisan organisation focused on the green transition.

“This increase in demand will push up prices again, putting pressure on your gas cap or your government budget. Again, there will be a risk of not getting enough gas.”

Claeys believes the cap would “quickly start costing billions” because it would force governments to continually subsidise the difference between the real market price and the artificially capped price.

Germany, which is opposed to an EU-wide cap, has unveiled a €200 billion programme to shield households and factories from soaring bills. The enormous plan has raised fears of unfair competition across the bloc.

Most EU countries “face strong public pressure and don’t have the deep pockets that Germany apparently has to support vulnerable consumers and businesses directly through government funds,” Claeys told Euronews.

“I think they really believe they can make a cap work.”

Simone Tagliapietra, a senior fellow at Bruegel, a Brussels-based economic think tank, went further and warned that a substantial cap would encourage gas demand to such an extent that full-scale rationing would become necessary to make gas supplies last long enough.

“You cannot make a price cap without a strong rationing plan. The two go hand in hand. Now I see countries calling for caps, but I am not so sure there are ready to coordinate a rationing plan. That’s the key issue,” Tagliapietra told Euronews.

“Asking for the cap without the rationing plan is not going to work. This has to be made clear. Otherwise people might think the cap is the silver bullet – which is not.”