Wary Market Warns of Potential Chaos Once EU Natural Gas Price Cap Takes Effect

The European Union’s (EU) decision to cap natural gas prices could jeopardize the bloc’s efforts to refill storage inventories this summer and upend the region’s energy markets, industry and market participants have warned since the mechanism was finalized on Dec. 19. 

The price cap would be triggered if the month-ahead Title Transfer Facility (TTF) contract were to surpass 180 euros/MWh, or about $56/MMBtu, for three business days. The month-ahead TTF must also be 35 euros, or around $11 above a reference price for LNG over the same three days. That’s well below an initial proposal in November to cap prices if they were to exceed 275 euros, or roughly $86. 

“This in our view significantly increases the likelihood the price cap is triggered versus the previous proposal, hence significantly increasing the risk of a market disruption event,” said Goldman Sachs Commodities Research analysts led by Samantha Dart. 

‘Unprecedented’ And ‘Untested’

If activated, the cap would stay in place for at least 20 working days. EU energy ministers included a provision that would allow regulators to suspend the mechanism if supply, demand or financial markets were jeopardized by it.  It is taking effect Feb. 15 and would apply to month-ahead, three-months ahead and year-ahead derivative contracts on all EU gas trading hubs. It would not apply to over-the-counter (OTC) trades.

Prompt TTF reached nearly $100 last summer. The contract stayed above the threshold and durations set forth in the price cap mechanism. The severe price spikes came as European buyers were scrambling to fill a supply gap left by declining Russian exports ahead of the winter heating season. 

EU’s Christian Zinglersen, director of the Agency for the Cooperation of Energy Regulators (ACER), said the cap is “unprecedented” and “untested.” He told the Financial Times days after ministers reached an agreement on the mechanism that he would be “reluctant to rely on this price cap” to prevent last summer’s price spikes.

In a note to clients, Goldman analysts said a price cap without any demand limits would do little to ease trouble in Europe’s gas markets. Instead, the measure “risks making the ongoing deficit worse by incentivizing consumption.”

Dart’s team said TTF prices would need to be near 180 euros this coming summer to limit demand enough to fill storage inventories to 90% of capacity by Nov. 1 as the EU has mandated. 

Without Russian gas imports, the International Energy Agency expects the bloc’s members to face a supply shortfall of more than 1 Tcf in 2023. 

Analysts at Evercore ISI led by Sean Morgan said a price cap would allow Asian buyers like China and India to be more competitive in the spot market. Other Asian buyers with long-term contracts, such as Japan, Korea and Taiwan, would also be less likely to re-export cargoes to Europe for profit, the firm said.

“In our view, the announced EU gas price cap greatly increases the likelihood of acute shortages of gas for European industry and consumers when the market gas clearing price exceeds that cap,” Evercore said in a note to clients shortly after the agreement was announced. 

The European Federation of Energy Traders (EFET), which has repeatedly warned of the cap’s potential harm, said EU governments should prepare for the next level of decision-making. 

“Even with some useful safeguards to limit or suspend the mechanism, we can still expect there to be changes in the market behavior,” EFET said. 

The trade group warned that governments must be prepared to best direct supplies in the event of shortages and determine which supply contracts would be interrupted in such a case. 

“Authorities will need to monitor closely what happens to EU gas supply and demand in the light of this decision – a process which EFET will seek to support – and make sure the mechanism can be suspended if the effects are seen to be damaging.”

Potential Liquidity Impacts

Trident LNG’s Toby Copson, global head of trading, said the mechanism might not be effective for physical trades in the liquefied natural gas market given that OTC transactions made on exchanges aren’t included. 

“Sellers will just opt to sell to other participants who abide by the market dynamics of supply and demand,” he told NGI. 

Goldman analysts also said that capping gas prices at the exchange level could reduce liquidity and disrupt commercial risk management. More OTC deals would impact liquidity.

Intercontinental Exchange Inc., where TTF is traded, warned EU members of the instability a price cap could create. It threatened to move operations out of the Netherlands and said traders would be required to post billions of dollars of additional margins to cover their risks. 

To be sure, European gas prices have plunged recently on warmer weather, record LNG deliveries and strong storage stocks. Prompt TTF is at its lowest point since June. 

Rystad Energy analyst Nikoline Bromander said lower demand, the mechanism’s suspension provision and lower prices heading into the winter could curb the price cap’s impacts on the market. 

“Given that the cap has been set significantly higher than current and normal gas prices, we do not believe it will reduce supply or worsen Europe’s gas deficit,” Bromander said. 

Worries that the price cap could create more demand are also “less likely considering where the market is presently trading, but is a valid concern if drastic demand reduction is required during periods of extreme deficit,” she added.

In addition to targeting extreme price volatility, some EU members supported the price cap as a way to limit Russia’s influence over the continent’s gas market. The deal came after months of negotiations. 

The European Securities and Markets Authority and ACER are expected to issue reports by March reviewing the effects of the price cap on financial and energy markets, as well as supply security.  The European Commission could then modify the mechanism by March 31. The commission also plans to review the regulation by Nov. 1 to see if it needs to be extended.