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Europe's Shift from Russian Gas to Pricey LNG

Europe's Shift from Russian Gas to Pricey LNG

Europe's switch from Russian pipeline…

Irina Slav

Irina Slav

Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.

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EU Gas Price Cap: An Exercise in Futility

  • Last week, the European Union saw a cap on natural gas prices come into effect.
  • After a long period of discussions, the EU Commission came up with a revised price cap at 180 euro per MWh.
  • Right now, natural gas is trading at around 50 euros, or around $53, per MWh on the EU spot market.
Gas flame

Last week, the European Union saw a cap on natural gas prices come into effect in hopes of curbing the risk of a repeat of last year's eye-watering gas price jump to more than $350 per megawatt-hour.

That spike in prices, which occurred in the summer after the Nord Stream pipeline—the biggest conduit of Russian gas to Europe—was blown out of commission saw businesses shut down and people gather to protest shy-high electricity bills. And the EU really doesn't want this to happen again.

The agreement for the price cap was no easy feat. It was fraught with problems from the start. Some EU members—the richer ones such as Germany and the Netherlands—opposed the very idea of capping the price of a commodity that sells on a free, unregulated market. Others, such as Spain, Italy, and the Eastern European states, defended the cap as a means of keeping gas relatively affordable.

The initial proposal of the European Commission was to cap gas prices at 275 euro per MWh, or $287 if this price remains unchanged for two weeks on the spot market. Also, the price of gas in Europe had to be at least 58 euro above the average LNG price on the spot market for 10 consecutive days within those same two weeks to make matters even more complicated and unlikely to happen.

Because of the level of this original price cap, the length of time it had to be in place in order to trigger the cap mechanism, and the LNG-related requirement, that first idea ended up being rejected on the grounds that it is effectively pointless.

The Commission came up with a revised one that set the cap at 180 euro per MWh, equal to around $197. The cap would be triggered if prices remained at that level for three consecutive days and if that price was also 35 euro higher than the brand new EU benchmark for LNG prices. While officially approved, the cap mechanism remains largely pointless.

Related: U.S. Gasoline Prices Are Dropping, Except In The West

Right now, natural gas is trading at around 50 euro, or around $53, per MWh on the EU spot market. The chances of this changing so radically that the cap needs to be triggered are, for now, remote. Gas in storage is at much higher levels than usual at this time of the year, so European buyers will not need to worry about refill season too soon.

According to the Wall Street Journal's Carol Ryan, a late cold snap could potentially empty these storage sites and push gas prices closer to the cap. But, the report notes, traders' behavior will likely start changing before the TTF benchmark hits 180 euro per MWh. And the first thing they do will be to move their activity from the transparent and strictly regulated stock exchange to the murkier landscape of over-the-counter trades.

This was one major concern that traders and ICE were quick to express during the discussions on the level and conditions for the cap. Trader associations and even the European Central Bank said the cap could destabilize the EU financial system. ICE said it could be forced to move out of the EU.

"If agreed, the market correction mechanism will be imposed on customers and the market infrastructure with no time for resilient testing and thorough risk management," ICE told Reuters in December.

"It is the responsibility of ICE as the market operator to consider all options if this mechanism is agreed, up to and including whether an effective market in the Netherlands is still viable," the exchange operator also said.

ICE has not moved out of the EU yet, but it has set up a TTF market in the UK, just in case. For now, the circumstances necessary to trigger the cap are not particularly likely to emerge anytime soon. Theoretically, this should make everyone happy. In reality, it's a bit more complicated.

The European Union is ending winter with record-high gas in storage. Yet it bought this gas at prices that were multiple times higher than current prices. And it cannot sell that gas because it would mean losses of billions of euro.

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In other words, while from a certain perspective, the EU is safe with enough gas to weather any late winter cold spells, from another perspective, the EU is stuck with gas it bought at 100-350 euros, and now this same gas is trading at 50 euro. And at some point, buyers will have to begin buying again for next winter, and prices will be certain to jump, adding to the bill.

The gloomy predictions are already out: the IEA's Fatih Birol recently reiterated his pessimistic view of the near-term global energy supply security by noting LNG competition is set to intensify as China demand increases while supply remains unchanged. We may yet see the conditions for triggering the EU gas price cap. And it would be interesting to see how many sellers will be willing to abide by the EU cap.

By Irina Slav for Oilprice.com

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