Europe Implements Trading Cap to Curb LNG Price Wars
The EU's energy ministers have agreed to a European Commission plan to limit natural gas prices, an effort intended to limit escalating bidding wars for LNG cargoes going into next winter.
In August 2022, Europe's wholesale gas prices soared to an all-time high of more than €300 per megawatt-hour as EU nations scrambled to fill storage. The surging energy costs have driven up the annual rate of inflation to a damaging 11.5 percent, and Europe has every intention of preventing a recurrence.
The new price cap mechanism takes effect from mid-February, and it is designed to turn on and off in response to changing market conditions. When EU gas benchmark prices exceed €180 per megawatt-hour, and are at least 35 euros higher than global LNG benchmark prices, and have been so for three working days, a "dynamic bidding limit" will be imposed on EU natural gas transactions. This will cap the EU price at the prevailing global LNG benchmark price plus €35. The cap will be in effect for at least 20 days; after that, it will deactivate when EU gas benchmark rates fall below €180 per megawatt-hour again.
At these set levels, the cap would have applied to European gas markets for a period of about 40 days this year during the peak of the gas price spike.
The cap can be deactivated by the European Commission at any time with a declaration of emergency, which is intended to be used for risk to security of the energy supply, financial stability, flows of gas between EU countries, or increased gas demand. The EC has indicated that it would quickly use this power and "push the button" to deactivate the cap if it detected any risk to Europe's energy security.
"The regulation aims to limit episodes of excessive gas prices in the EU that do not reflect world market prices, while ensuring security of energy supply and the stability of financial markets," said Jozef Sikela, Czech minister of industry and trade. "We have succeeded in finding an important agreement that will shield citizens from skyrocketing energy prices."
The European Commission originally proposed a much higher maximum price for the cap at €275 instead of €180. Traders have voiced concerns that the cap could disincentivize sales to Europe because it would inject uncertainty into futures transactions.
“Gas traders would likely liquidate short positions and stop selling futures if they fear the break could be activated imminently, for fear of the resulting losses," analysts at Eurasia Group told CNN.
The cap could also simply push more trading activity into unregulated over-the-counter transactions, as the mechanism only applies to trades on public exchanges. Exchange operator ICE has warned that the cap could make it difficult to continue operating the benchmark TTF trading platform as a "fair and orderly market."
Europe's price cap could also make LNG more accessible for Asian importers, who have been unwilling to bid against the stratospheric rates paid by European buyers in recent months. The cap could discourage EU-Asian bidding wars for LNG spot cargoes - but it could also alter the market dynamics in ways that disrupt the LNG supply to Europe, according to skeptics.
“I remain worried about major disruptions on the European energy market, about the financial implications and, most of all, I am worried about European security of supply,” said Dutch energy minister Rob Jetten this week.
Whether successful or not, the cap illustrates the extreme prices that Europe has had to accept since the start of the Russian invasion of Ukraine. The cap's maximum of €180 per megawatt-hour ($56 per mmbtu) is nearly eight times the current American benchmark gas price ($7.20 per mmbtu).