“We have a policy that is reducing the effectiveness of the market and is sending gas trading to locations outside the EU, that is somewhat bizarre from my perspective and is not sending the right messages to investors or traders about the stability of the European framework.”
That was one of the core sentiments expressed by Mark Copley, CEO of the European Federation of Energy Traders (EFET), in a discussion about how Europe’s new gas price cap will impact markets.
Copley stressed that despite Europe’s well-established regulatory framework, price caps and national interventions ultimately make a regulatory framework more risky and that translates into price premiums and decreased willingness to trade and invest in Europe.
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Price caps don’t address the supply problem
Copley explains that the price cap is a newly introduced market correction mechanism that places a cap on the price at which derivative contracts can be bought.
However, according to Copley, the price cap is not a solution to the supply and demand issue which he believes to be the cause of the current energy crisis.
“We warned against the introduction of price caps…because the energy crisis we have experienced over the past year to 18 months was around not having enough gas… or power and our view is very clearly that you need to tackle that by increasing supply or reducing demand.
“If we’re talking about increasing supply in the short term at least you have to make sure that LNG cargos reach Europe.”
Not only do price caps not address the issue of supply, but it also leads to negative consequences that could make the situation worse, says Copley.
Price caps could have negative consequences
Even though it’s too early to say what changes might result in market behaviour, Copley suggests that capping derivative prices could result in the following negative effects:
- Reducing the incentive for gas to flow to Europe and largely making markets other than Europe more attractive.
- Increasing the uncertainty in Europe’s regulatory framework means people are less likely to want to deliver gas to Europe.
- It reduces incentives to reduce demand.
We would expect to see traded volumes moving away from exchanges and towards over-the-counter markets, argues Copley. “People might also start looking to trade in venues outside of Europe, such as the UK, Singapore, or US.”
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Ultimately, there is a chance of a general increase in uncertainty, leading to traders being more risk-averse and deciding to trade less. This will lead to a fall in market liquidity, increasing market volatility and risk.
How safe are the safeguards?
Although attempts have been made to ensure the price cap is only triggered in exceptional circumstances, says Copley, there are some challenges around figuring out when it will be triggered and under what circumstances.
“It’s good that safeguards have been built in, but what we need to realise is that the cap doesn’t need to be triggered to have an effect on market behaviour. What we worry about is its effects of merely existing”.
“If you’re trying to hedge gas transactions long term, you’re thinking about what to buy and how to manage the risks associated with it. If you don’t know if the policy will be triggered, how the policy will be triggered, or in some cases how it will be implemented…all of that translates into an increase in risk and a greater unwillingness to trade.”
The way forward
According to Copley, despite the search for the magic bullet, there simply isn’t one.
In a crisis of short supply, there are however ways to alleviate the problem. He suggests expanding LNG capacity, resolving bottlenecks in the grid, making as much cross-border power available as possible, working with member states on security of supply arrangements and coordinating filling tenders.
Copley suggests that taking more time on policy-making is critical now. It’s time to carefully consider how to remove these temporary interventions and if this is done in consultation with stakeholders, it would be a measure welcomed by the market and would go a long way to rebuilding lost trust.
For more insights from Mark Copley, listen to the Energy Transitions podcast episode: