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Monday, May 20, 2024

Gas Price Cap Could Cause Irreversible Harm To Energy Markets

By Irina Slav of OilPrice.com

Earlier this week, the European Commission issued a statement declaring what it called a “safety 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 ceiling’s aim, according to the Commission, will be used as a “temporary and well-targeted instrument to automatically intervene on the gas markets in case of extreme gas price hikes.”

While national governments may be happy with this new instrument, market players are the opposite of happy. In fact, traders have warned that using the instrument could cause irreversible harm to energy markets in Europe.

“Even a short intervention would have severe, unintended and irreversible consequences in harming market confidence that the value of gas is known and transparent,” said the European Federation of Energy Traders this week, following the news broken by the European Commission, as quoted by the Financial Times.

What traders—and exchanges—argue is that the threat of a gas price cap on front-month gas contracts would strain the market and effectively make it less transparent. Even worse, according to them, is the EC’s idea to basically tie benchmark European gas futures prices to the price of liquefied natural gas on the spot market.

The tie to LNG prices is one of two conditions that must be met for the “safety price ceiling” to be triggered automatically. As stated by the EC, these are, first, when “the front-month TTF derivate settlement price exceeds €275 for two weeks” and, second, when “TTF prices are €58 higher than the LNG reference price for 10 consecutive trading days within the two weeks.”

As soon as both of these things happen, regulators will swing into action, and after a day of notifications to all relevant authorities, the ceiling will enter into effect, and front-month orders for gas naming prices that are above 275 euros will not 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 by leaving traders free to trade gas over the counter and on the spot market.

According to traders and exchange operators, this is not the case. Per the FT report on the topic, the industry is worried about unexpected and excessively high margin calls on the over-the-counter market, as well as the ability of exchanges to tackle defaults.

The LNG tie is of particular concern because, according to traders, LNG markets are a lot 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 warned the Commission this week that the cap might force exchanges to suspend trading in case they could “not meet obligations on running fair and orderly markets.” 

Meanwhile, the European Central Bank has also warned against moving trades from exchanges to over-the-counter market, which, featuring direct transactions between parties, is a lot more opaque and a lot less regulated than the exchange.

The traders are not alone in their concerns, which also include a worry that the proposed cap mechanism has not been tested for faults. The Commission just said it would become effective next January.

“It is unrealistic to assume this [ensuring the cap won’t put markets in jeopardy] can be achieved within a short timeframe and certainly not before the end of this winter,” the head of the European association of energy exchanges, Christian Baer, said.

Some European diplomats appear to share these concerns, according to the FT. One unnamed member of the diplomatic body said this week that “Safeguards checks are only applied ex-post [so] how can compliance with the safeguards be ensured when the measure is in place? It is similar to installing airbags after you ran your car into an accident.”

Per the Commission’s proposal, there are two ways to ensure the cap does no harm to markets: one, by deactivating it or by preventing its activation “in case relevant authorities, including the ECB, warn of such risks materialising.”

The language of the statement about the price cap is quite general, as the language of all such statements tends to be. There is little specificity or, indeed, examples of the risks mentioned above that would trigger the deactivation of the cap—facts that no doubt intensify traders’ worries.

There is also another worry that may potentially be a bigger one, and it has nothing to do with trading and financial markets. Several EU members are concerned that the price cap will encourage greater gas demand at a time when demand needs to be reduced.

The Commission has a response to that: triggering the mandatory energy savings mechanism agreed upon earlier this year and launched in its voluntary version a couple of months ago. Whether this would be enough and, more importantly, whether it would not have some severe unintended consequences remains an open question for now.

(This article is posted as it appeared on ZeroHedge)

This post was originally published on this site

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