Earlier this week, the European Commission published a statement declaring what he called a “safety cap” for gas prices set at 275 euros, or $283, per megawatt hour.
Hailed as the long-awaited gas price cap that EU members have been discussing for weeks now, the cap’s objective, according to the Commission, will be used as a “temporary and well-targeted instrument to automatically intervene in gas markets”. gas in the event of extreme increases in the price of gasoline.
While national governments may be satisfied with this new instrument, market players are quite the opposite satisfied. In fact, traders have warned that using the instrument could cause irreversible damage to energy markets in Europe.
“Even a short intervention would have serious, unintended and irreversible consequences by undermining market confidence that the value of gas is known and transparent,” the European Federation of Energy Traders said this week, following a the news announced by the European Commission, while cited by the Financial Times. What traders – and exchanges – argue is that the threat of a gas price cap on first-month gas contracts would strain the market and effectively make it less transparent. Worse still, they argue, is the EC’s idea of essentially linking benchmark European gas futures prices to the price of liquefied natural gas in the spot market.
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The link to LNG prices is one of two conditions that must be met for the “safety cap price” to trigger automatically. As stated by the EC, these are, firstly, when “the first month’s TTF derivative settlement price exceeds €275 for two weeks” and, secondly, when “TTF prices are €58 above the price of LNG benchmark for 10 consecutive trading days within two weeks.”
As soon as those two 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 euros will not will not be accepted.
According to the Commission, the fact that the price cap is limited to first-month contracts guarantees the stability of the financial system and the futures markets by 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’s report on the subject, the industry is concerned about unexpected and excessively high margin calls in the OTC market, as well as the ability of exchanges to deal with defaults.
The LNG nexus is of particular concern because, according to traders, LNG markets are much more illiquid and volatile than the TTF market, which is based on real 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 could force exchanges to suspend trading in case they “cannot meet obligations functioning of fair and orderly markets”.
Meanwhile, the European Central Bank has also warned against moving transactions from exchanges to the over-the-counter market, which, with direct transactions between parties, is far more opaque and much less regulated than the stock exchange.
Traders are not alone in their worries, which also include a concern that the proposed capping mechanism has not been tested for defects. The Commission has just said that it will enter into force next January.
“It is unrealistic to assume that [ensuring the cap won’t put markets in jeopardy] can be achieved in a short period of time and certainly not before the end of this winter,” said the president of the European Association of Energy Exchanges, Christian Baer.
Some European diplomats seem to share these concerns, according to the FT. An anonymous member of the diplomatic corps said this week that “safeguard checks are only applied ex-post [so] how can safeguards be ensured when the measure is in place? 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 cap does not harm the markets: one, by deactivating it or preventing its activation “in case the competent authorities, including the ECB, warn materialization of such risks”.
The language of the price cap statement is quite general, as the language of all such statements tends to be. There is little specificity or, in fact, examples of the risks mentioned above that would trigger the deactivation of the cap – facts that undoubtedly escalate traders’ concerns.
There is also another concern that may be more important, and it has nothing to do with the trading and financial markets. Several EU members fear that the price cap will encourage greater demand for gas at a time when demand needs to be curtailed.
The Commission has an answer to this: trigger the mandatory energy savings mechanism agreed earlier this year and launched in its voluntary version a few months ago. Whether that would be enough and, more importantly, whether it wouldn’t have serious unintended consequences remains an open question for now.
By Irina Slav for Oilprice.com
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