Energy ministers agreed to impose a limit on natural gas prices if month-ahead electricity prices remain above 180 euros ($191) per megawatt-hour for three consecutive trading days on the Dutch Title Transfer Facility (TTF) gas hub’s front-month contract, which serves as Europe’s benchmark. The cap is the E.U.’s latest attempt to lower natural gas prices that have pushed energy bills higher as the E.U. grapples with the reduction in Russia’s natural gas supplies to Europe. The TTF price must also be 35 euros per megawatt hour higher than a reference price based on existing liquefied natural gas (LNG) price assessments for three days. Once triggered, trades would not be permitted on the front-month, three-month and front-year TTF contracts at a price more than 35 euros per megawatt hour above the reference LNG price. The cap can be triggered beginning February 15, 2023, at which point a dynamic formula would kick in to limit prices for certain natural-gas contracts for a period of 20 working days. While the mechanism may prevent extreme price swings, it may leave Europe vulnerable to supply shortages and stronger competition for LNG from Asia. There are worries that the price cap could distort energy markets rather than limit price.
The price-cap agreement does not apply to private gas trades outside E.U. energy exchanges, over-the-counter trades or day-ahead or intraday trading. It will be suspended if the E.U. faces a gas supply shortage, or if the cap causes a drop in TTF trading, a jump in natural gas use or a significant increase in gas market participants’ margin calls. The EU’s energy regulator cast doubt on the possibility that the price cap on natural gas would even lower energy costs.
Implementing the cap could be messy. The cap clearly needs to be flexible to continue attracting gas cargoes to Europe. An inflexible limit could have diverted the gas to other regions where traders could make more money. If gas prices breach the E.U.’s conditions, transactions at a price that is more than €35 per megawatt-hour above a global LNG reference would be banned. The LNG benchmark would be calculated using prices in various regional markets without specifying the formula. The European Commission suggested using an average of LNG prices in the Mediterranean region and Northwest Europe. If the LNG reference is below €145 per megawatt hour, the trading limit would be set at €180.
The TTF front-month contract has rarely closed above 180 euros per megawatt hour, occurring on just 64 days in its history–all those occurrences in 2022. Benchmark European gas futures hit a record high of about €350 per megawatt hour in late August. Some believe that the conditions that caused that spike – a plunge in Russian gas supply and little capacity to quickly replace it – are unlikely to be repeated, given the rapid expansion of Europe’s LNG import infrastructure. Germany, Europe’s biggest gas consumer, opened its first floating gas terminal recently, with more to follow next year. Other countries including the Netherlands and Poland are also expanding LNG infrastructure. Since late October, benchmark European gas futures have traded in a range between just below €100 per megawatt hour and just below €150 a megawatt-hour.
Uncertainties
There are a number of uncertainties, including whether a price cap could inadvertently lead to shortages because suppliers could sell their gas on other markets where they could achieve higher prices. LNG exporters, for instance, may send fuel to Asia if prices are better. According to traders, the price cap could create distortions rather than limiting prices because it could create a situation in which gas costs the maximum allowed in the futures market but participants buy gas from a private, off-exchange market instead in which prices are much higher.
The decision to impose a price cap sets up a potential fight with Intercontinental Exchange Inc. (ICE), which runs the biggest market in European natural-gas futures from Amsterdam. ICE indicated that it could move its gas market outside the E.U. if the bloc pursues the policy. Its analysis suggests the proposals risk leading to tens of billions of dollars in additional cash requirements—known as margin payments—for traders in European gas. Soaring energy prices have already forced European utilities and traders to secure extra funds from governments and banks to cover margin call requirements.
Mild and windy weather contributed to lower European natural-gas prices recently. Futures for TTF fell 7.6 percent to €106.60 a megawatt-hour, extending their recent decline and pulling prices well below the cap levels. According to traders, some companies were selling gas to avoid holding risky positions over the holiday period.
Conclusion
E.U. energy ministers agreed on a gas price gap, which triggers starting February 15 if prices exceed 180 euros ($191) per megawatt hour for three days. The E.U. settled on a natural gas price cap to avoid spikes in natural gas prices that have occurred since Russia reduced its natural gas supplies to Europe. Implementing the price cap will be messy and it must be flexible to avoid shortages and other uncertainties. According to E.U. officials, the price cap could be suspended if risks emerge that would affect the security of gas supply, financial stability or the flow of gas within Europe. It could also be suspended if demand for gas increases above a certain level.
Traders are uneasy about the price cap, feeling that buyers may go to other markets that sell at higher prices because the cap does not apply to private gas trades outside E.U. energy exchanges, over-the-counter trades or day-ahead or intraday trading. Messing with markets is dangerous, but that is how Europe is coping with high energy prices due to its decision to transition to renewable energy (mainly wind and solar), ban hydraulic fracturing, and essentially cease oil and gas lease sales. Europe’s energy decisions are limited by its obsession with weather dependent intermittent renewable energy sources. Americans should watch closely as the U.S. is adopting similar proposals.
