EU Gas Price Cap Could Cause Permanent Damage to Markets, Europe’s Energy Exchanges Warn

Pipes at the landfall facilities of the Nord Stream 1 gas pipeline are pictured in Lubmin, Germany, on Mar. 8, 2022. (Hannibal Hanschke/Reuters)

With the European Union (EU) pushing ahead with its proposal to cap gas prices, leading energy exchanges are warning that the decision could pose a serious economic threat to the region.

In a Nov. 19 letter to members of the European Commission, the Association of European Energy Exchanges (“Europex”) pointed out that gas derivatives were a crucial tool for producers and consumers to hedge against gas spot price volatility. If price caps on gas derivatives, like the Title Transfer Facility (TTF) front-month futures contracts, are put into place, it could trigger “major risks to financial stability and security of supply.”

If the real gas price were to exceed the price cap of the TTF futures, market participants might move the trading into over-the-counter (OTC) space which will create a “significant decrease in transparency.”

The letter cited a warning by the European Central Bank about how a shift toward the OTC space will imply “greater risks for counterparties and the financial system.” In addition, market participants holding open interest positions will get exposed to “incalculable uncertainty.”

There is also a risk that market participants may decide not to hedge their production or consumption through TTF contracts, seeking to balance their positions by trading in the spot market.

As far as liquefied natural gas (LNG) is concerned, the EU “must ensure” that it remains competitive to prevent diversion of shipments to other destinations which are willing to pay the “real price,” the letter stated.

“No matter whether it’s a hard or soft one—a cap restricts the ability of market participants to enter into a transaction at the price that they both would be willing to accept,” Tobias Paulun, the chief strategy officer at the European Energy Exchange AG, said in an interview with Bloomberg.

Price Cap

The European Commission is set to propose the gas price cap after a meeting of EU energy ministers on Nov. 24, EU energy commissioner Kadri Simon told Reuters.

“We have done our homework. I think that this kind of price cap can allow us to calm the market ... It also removes the risk that we will not receive cargoes at all,” she said. The proposed cap on gas prices is aimed at containing the energy crisis facing Europe following Russia’s invasion of Ukraine.

The EU is split over the price cap proposal. While nations like Greece, Belgium, Italy, and Poland support the move, others like Germany, which is highly dependent on gas, have raised concerns.

In a recent report, independent energy research firm Rystad Energy warned that price caps might turn out to be impossible to implement once “trades go off-exchange,” according to The National News.

“Any move to limit prices on the headline TTF will distort market signals on the most established gas hub on earth with potential unintended consequences for supply security or demand-reduction measures,” the report said.