Earlier this week, the European Commission issued a declaration declaring what it called a “safe price ceiling” for gas prices set at 275 euros, or $283 dollars, per megawatt-hour.
Hailed as the long-awaited gas price cap that EU members have been discussing for weeks now, the target cap, according to the Commission, will be used as a “temporary and well-targeted tool to automatically intervene in gas markets in the event of extreme increases in gas prices.
While national governments may be happy with this new tool, market participants are far from happy. Indeed, traders have warned that using the instrument could cause irreversible damage to energy markets in Europe.
“Even a brief intervention would have serious, unintended and irreversible consequences in damaging market confidence that the value of gas is known and transparent,” the European Federation of Energy Traders said this week, following the news released by the European Commission , how quoted from the Financial Times. What traders – and exchanges – are arguing is that the threat of a gas price cap on first month gas contracts would strain the market and actually make it less transparent. Even worse, according to them, is the EC’s idea of basically tying the prices of European benchmark gas futures to the price of liquefied natural gas on the spot market.
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The link with LNG prices is one of the two conditions that must be met for the “safety price cap” to activate automatically. As stated by the EC, these are, firstly, when “the settlement price of the front-month TTF derivative exceeds €275 for two weeks” and, secondly, when “TTF prices are €58 higher than at the reference price of LNG for 10 consecutive trading days within the two weeks.”
As soon as both of these things happen, regulators will spring into action, and after a day of notifications to all relevant authorities, the cap will go into effect and first month orders for gas denomination prices above €275 will not they will be accepted.
According to the Commission, the fact that the price cap is limited to front-month contracts ensures the stability of the financial system and futures markets, leaving traders free to trade gas over the counter and on the spot market.
According to traders and stock traders, this is not the case. According to the FT report on the matter, the industry is concerned about unexpected and excessively high margin calls on the over-the-counter market, as well as the ability of exchanges to deal with defaults.
The link to LNG is of particular concern because, according to traders, LNG markets are much more illiquid and volatile than the TTF market, which is based on actual transactions.
The trading world is so concerned about the gas price cap that the European Federation of Energy Traders this week warned the Commission that the cap could force exchanges to suspend trading if they cannot “meet to manage fair and orderly markets”.
Meanwhile, the European Central Bank has also warned against the shift of trading from exchanges to the over-the-counter market, which, characterized by direct transactions between parties, is much more opaque and far less regulated than on the exchange.
Traders are not alone in their concerns, which also include concerns that the proposed cap mechanism has not been tested for defects. The Commission has just said it will come into force next January.
“It is unrealistic to assume this [ensuring the cap won’t put markets in jeopardy] can be achieved in the short term and certainly not before the end of this winter,” said the head of the European Energy Trading Association, Christian Baer.
Some European diplomats appear to share these concerns, according to the FT. An unnamed member of the diplomatic corps said this week that “safeguard controls are only applied ex post [so] How can guarantees be respected when the measure is in force? It’s similar to installing airbags after an accident with your car.”
According to the Commission’s proposal, there are two ways to ensure that the limit does not harm markets: one, by deactivating it or preventing its activation “in case the competent authorities, including the ECB, warn that such risks are materializing”.
The language of the maximum price statement is quite general, as the language of all such statements tends to be. There are few specifics or even examples of the aforementioned risks that would trigger the deactivation of the limit, facts that undoubtedly heighten traders’ concerns.
There is also another concern that could potentially be bigger and has nothing to do with trading and the financial markets. Several EU members fear the price cap will encourage higher gas demand at a time when demand needs to be curtailed.
The Commission has an answer to this: activate the mandatory energy saving mechanism agreed earlier this year and launched in its voluntary version a couple of months ago. Whether this would be sufficient and, more importantly, whether it would not have serious unintended consequences remains an open question for now.
By Irina Slav for Oilprice.com
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