Why the EU’s Proposal to Impose a Cap Only on Russian Natural Gas is Wrong?

In the past two weeks the structural pathologies responsible for the EU’s energy gridlock have combined with a series of extreme weather events – such as unprecedented drought – to record unimaginable energy prices. The day-ahead electricity prices in France, the EU’s traditional electricity exporting power, reached on September 2 even above 1,000€/MWh, while natural gas prices on the TTF stock market reached a historic record of 335.38€/MWh on August 26.

The causes of the problem

Despite its low liquidity, the stock market price is used as a benchmark for determining gas supply contracts pan-European. On August 18, these prices were at 239.92€/MWh, without any substantial change in the actual data of natural gas supply in Europe. The fact that they increased by around 100€/MWh after about a week is indicative of the fact that we are experiencing an unprecedented stock market bubble.

This bubble drags down electricity prices through the system cap mechanism, i.e. pricing based on the most expensive offer each hour, and demonstrates the bankruptcy of the model of full deregulation of the EU gas and electricity markets that has been followed for the last fifteen years, when this was called upon to face crisis conditions. However, if a market model collapses after the “suffering” of the first serious test, the problem is not only with the person causing the crisis, but also with the model itself.

The EU’s energy problem did not arise only because of Vladimir Putin’s predictable tactics. These were predictable for anyone who understands the Russian president’s new mercantilist way of thinking. Putin has never hidden his willingness to instrumentalize energy flows to serve vital geopolitical goals of Russian grand strategy, among them the partial restoration of Russian empire in former Soviet territories that should never have joined NATO in Russia’s view. These have been written by Putin himself in his PhD since 1997 and he has put them into practice against Ukraine in different phases (2004, 2008-2009, 2014) decades before his second invasion of Ukraine in 2022. No one will should be surprised when Russia reacts with threats of an embargo on gas exports to the EU, when the G7 attempts to impose a ceiling on the selling prices of its oil even to countries outside the EU that have not imposed any boycotts on it. This is exactly what any good “mercantilist” would do and exactly what they have done – keeping in mind – many of the great powers in their history when vital economic and geopolitical interests have been threatened with the US first and foremost (an oil embargo against Japan in 1940-41 and against Britain and France 1956). Attributing all of the EU’s energy problems to the geopolitical instrumentalization of Russian energy is an oversimplified approach that does not help to understand and address the problem.

The nature of the problem

1. If the problem causing prices (because we don’t have a meaningful weighted average loss of supply) was primarily caused by Russian natural gas and its threats/acts to cut it off, then, how do you explain the surge in prices in Spain, Ireland and Portugal that never imported Russian natural gas?

2. If the problem was only in Russian natural gas, why was there no reduction in gas/electricity prices in the countries where (Bulgaria, Finland, Poland) gazprom exports have been suspended for months? while the supply of these countries with natural gas continues to a large extent as normal for seasonal demand data.

The problem beyond setting the price of electricity through the system cap lies in the coupling of electricity markets which transfers the price of one member country to another, through electricity interconnections regardless of the level of participation of natural gas in each country’s electricity generation mix member. In this way member countries that have a very high dependence transmit their high prices to those where natural gas plays a comparatively much smaller role.

This is for example the case between Greece, Bulgaria and Romania, where the participation of natural gas in the electricity production of the three countries ranges respectively at 65%, 35% and 21%, but the differences in the fluctuation of electricity prices between the three countries are minimal. It is obvious that we cannot and should not abolish electrical interconnections because they are a necessary condition for strengthening the electrical security of member countries, but it is absolutely necessary to move to a new hybrid model with greater predictability that will provide greater security and stability both in sellers/producers as well as buyers through multi-year contracts in natural gas and electricity respectively.

The solution

An entire energy security system cannot be based on short-term spot gas/electricity contracts lasting days, weeks or months, even if there were no precarity of the kind created by the acceleration of the green transition.

The pro-liberal model of market deregulation breaks down because unlike the “Keynesian” or “mercantilist” model respectively, it has no “sense of political risk” because it treated all gas and electricity import/production flows as zero geopolitical risk and because it encouraged the collapse of domestic natural gas production.

The completely “anti-liberal” imposition of a ceiling is not a panacea, however. It is a weapon that if not used properly can injure the wielder more. The Commission President’s proposal to cap only the price of Russian natural gas is suicidal, as it will cause an immediate cutoff and unilaterally violate the fundamental terms of gazprom’s long-term contracts, allowing Russia to claim tens of billions of euros in damages from non-compliance with the conditions of compulsory consumption.

For a cap to be effective, it should:

1. set at the market price of natural gas in general and not target a producer;

2. to be applied pan-European and

3. be financially supported by an energy “Eurobond” that will allow the gap between the actual EU import price and the subsidized intra-EU disposal price to be bridged on a transitional basis, as not all LNG/natural gas exporters will voluntarily adapt to the new lower prices. These prices must be sufficiently high for geopolitically EU-friendly exporters to continue to supply it with their expensive product.

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Trust Economics is a specialized independent economic research, analysis and consultancy business. Our team provides ingenious analysis in the macro & micro economic field, in the field of financial market, regional and sectoral analysis equally, forecasts, consultancy, specialized studies-research/projects from its headquarters in Athens, Greece.

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