Earlier this week, the European Commission issued a statement setting a so-called “safety price cap” on gas prices at €275, or $283 per megawatt-hour.
Hailed as the long-awaited gas price cap that EU members have been discussing for weeks, the Commission says the cap target will serve as a “temporary and targeted tool to automatically intervene in gas markets in the event of extreme gas price hikes.”
While national governments may be happy with this new tool, market participants are the opposite of happy. In fact, traders have warned that using the tool could cause irreversible damage to energy markets in Europe.
“Even a brief intervention would have serious, unintended and irreversible consequences, as it would damage market confidence that the value of gas is known and transparent,” the European Federation of Energy Traders said this week, following news from the European Commission, as quoted by the Financial Times. What traders – and exchanges – are arguing is that the threat of a gas price cap on gas contracts in the front month would weigh on the market and effectively make it less transparent. In her opinion, the EC’s idea of tying the European reference prices for gas futures to the price of liquefied natural gas on the spot market is even worse.
Related: Europe Gas Crisis Subsides: Trafigura
Commitment to LNG prices is one of two conditions that must be met for the “safety price cap” to be triggered automatically. As stated by the EK, these are first when “the front month settlement price for TTF derivatives exceeds €275 for two weeks” and second when “TTF prices are €58 above the LNG reference price for 10 consecutive trading days within two weeks.”
Once those two things happen, the regulators will take action and after a day of notifications to all relevant authorities, the cap will come into effect and front month orders for gas name prices above 275 euros will no longer be accepted.
The Commission considers that limiting the price cap to front month contracts ensures the stability of the financial system and futures markets by allowing traders the freedom to trade gas OTC and on the spot market.
According to traders and exchange operators, this is not the case. According to the FT report on the matter, the industry is concerned about unexpected and excessively high margin demands in the over-the-counter market, as well as the ability of exchanges to handle outages.
The LNG tie is of particular concern as LNG markets are much more illiquid and volatile than the TTF market, which is based on actual transactions, according to traders.
The trading world is so concerned about the gas price cap that the European Federation of Energy Traders warned the Commission this week that the cap could force exchanges to suspend trading if they “fail to meet obligations to operate fair and orderly markets”.
Meanwhile, the European Central Bank has also warned against moving deals from exchanges to the over-the-counter market, which is much more opaque and much less regulated than the stock exchange, with direct transactions between parties.
Traders are not alone in their concerns, which include concern that the proposed cap mechanism has not been bug tested. The Commission just said it would come into force next January.
“It is unrealistic to assume that [ensuring the cap won’t put markets in jeopardy] can be realized in a short time and certainly not before the end of this winter,” said the head of the European Association of Energy Exchanges, Christian Baer.
According to FT, some European diplomats seem to share these concerns. An unnamed member of the diplomatic panel said this week that “security checks are carried out only after the fact [so] How to ensure compliance with the guarantees once the measure is in place? It’s akin to installing airbags after your car is involved in an accident.”
According to the Commission’s proposal, there are two ways to ensure that the cap does not harm markets: first, by deactivating it or preventing its activation “in the event that the competent authorities, including the ECB, warn of such risks”.
The language of the price cap statement is fairly general, as the language of all such statements tends to be. There is little concrete, or even example, of the above risks that would trigger the deactivation of the cap – facts that undoubtedly add to traders’ concerns.
There is another concern that could potentially be bigger and has nothing to do with trading and financial markets. Several EU members are concerned that the price cap will encourage higher gas demand at a time when demand needs to be reduced.
The Commission has an answer to that: it triggers the mandatory energy saving mechanism agreed earlier this year and introduced in its voluntary version a few months ago. Whether this would be sufficient and, more importantly, whether it would not have serious unintended consequences remains to be seen for the time being.
By Irina Slav for Oilprice.com
Other top reads from Oilprice.com: