The EU gas cap is an indirect signal to reduce demand

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Barómetro en un almacén de gas natural de Storengy en Saint-Illiers-la-Ville (Francia).

It is so high that it may never trigger, but it can be beneficial if the price avoids spikes by being high.

The new European plan to cap the price of gas looks like a fig leaf. After months of heated debates, the European Commission proposed on Tuesday to set an emergency brake at 275 euros per megawatt hour. The limit is so high that it may never kick in. But it can indirectly encourage more efficient use of energy.

The cap proposed by the Commission would apply from January to gas delivered a month later in the Securities Transfer Mechanism, the de facto reference for European gas prices. But it would only come into force if prices remained above the 275-euro mark for two weeks and, in addition, they remained for 10 days at least 58 euros above a reference price for liquefied natural gas (LNG) that the Commission has yet to create.

Fulfilling all the conditions seems like a difficult task. Since October 2021, European gas prices have been exceptionally high, trading well above the pre-2021 historical monthly average of €32 per MWh, according to an energy expert. However, in daily terms, they only exceeded €275 per MWh for four days in August, as EU countries scrambled to fill up warehouses amid dwindling Russian gas supplies. The key benchmark is currently trading at just €123 per MWh.

Being so high, the cap is unlikely to divert valuable LNG flows to the big Asian economies. In the event of a supply crunch, it leaves enough room for European gas prices to rise above those offered in Asia, which historically haven’t risen much either, to keep Europe attractive to sellers. That should please countries like Germany and the Netherlands, which have opposed introducing a cap for fear of distorting market flows.

However, the proposal may disappoint Italy, Greece and Poland, which had sought a much lower ceiling to curb energy costs. The proposed mechanism will not magically lower gas prices. But it can have a beneficial effect. If prices avoid the worst spikes by staying relatively high, European governments and businesses will be pushed to save energy to save money, thus dampening demand, which in turn drives prices down. Danone, which promised on the 17th to be 30% more efficient in its use of energy by 2025, is already doing so.

Gas prices in Europe may continue to rise in the coming months if Russia further tightens supply, as it warned it might on Wednesday. But ultimately the main role of the EU gas cap is to be an indirect signal to curb energy demand.

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Brian Adam
Professional Blogger, V logger, traveler and explorer of new horizons.