The Problem With Oil And Gas Price Caps

This week saw two documents published by two government departments: the European Commission in Brussels and the Department of Treasury in Washington. The Commission’s document was a proposal for “a new instrument” aimed at limiting excessive gas prices in Europe. The Treasury’s document was guidance on the implementation of a price cap policy towards crude oil originating in the Russian Federation. Both were slammed by critics within hours of their publication.

The two documents represent the long-awaited price caps that have been discussed since June for the oil price cap on Russian crude and since September for the gas price cap. Neither of the final results appears to be satisfactory.

The U.S. Treasury’s oil price cap guidance, for instance, provides 12 pages of information on how the cap would be enforced but stops short of actually naming the level of the cap. The reason is that it is still being discussed and there is no consensus on what it should be.

The cap needs to be agreed upon by both the G7 and the EU. As the EU acts as an eighth partner in the group in addition to having three members in G7 itself, the U.S. is now waiting for the EU to agree on a cap level. This is proving to be a challenge.

Reuters reported on Thursday that the European Union’s leaders had failed to agree on a cap level because the G7’s proposal to consider a band of between $65 and $70 per barrel was considered to be too low for some EU members and too high for others.

For others, such as U.S. oil industry vet and commentator David Blackmon, the cap was a joke – Russia is already selling its oil to China and India at prices in the proposed range, so the cap will not, in fact, cap anything at all.

Energy Intelligence’s OPEC correspondent Amena Bakr was also blunt. In a tweet thread on Wednesday, she said that “If you can’t deliver on something then don’t make false promises! The EU looking to cap oil at 65-70 is a joke. How will that price range hurt Russia’s war financing?” after which she called the proposed cap range toothless.

Yet Bakr also said that if this is the level the price “cap” is agreed at, it would be evidence that the EU has recognized the importance of energy security over geopolitics. Whether will be an agreement remains uncertain because differences appear to be quite significant.

Poland, for instance, would not agree to a cap above $30 per barrel, while Cyprus wants compensation for the shipping business it would lose because of the cap. Even before it is finalized, the Russian oil price cap is already being ridiculed.

Meanwhile, the European Commission proposed a gas price cap for all imports in the European Union that immediately became a target for jokes. At 275 euros per MWh, the cap price is way too high, according to some. And it won’t be triggered even in a price spike like the one the EU saw this summer, the FT reports.

The EC’s proposal says that gas prices on the EU market need to stay at the level of 275 euros for two weeks before the capping mechanism is triggered, but the FT recalls that even this summer, when prices soared to 300 euros per MWh temporarily, they never stayed at 275 euros per MWh for two entire weeks.

This is enough to make the cap useless but in addition to being useless, some have warned it could be harmful to the European gas market. Traders and exchanges slammed the Commission for risking disturbing the energy markets on the continent and pushing deals from the transparent exchanges to the opaque over-the-counter market.

When talking about the gas price cap, the European Federation of Energy Traders said this week that “even a short intervention would have severe, unintended and irreversible consequences in harming market confidence that the value of gas is known and transparent”.

ICE, the exchange operator, went further and claimed the cost of such an intervention would be $33 billion. This is the size of additional margin payments for traders operating on the TTF market as these payments increase by 80 percent because of the cap. This, ICE said in a memo to the EC seen by the FT, could destabilize the market.

So, on the one hand, the G7 is proposing a price cap on Russian oil that aims to reduce Russia’s oil revenues while keeping the oil flowing to international markets—a paradoxical goal—and, on the other, the EC is proposing a price cap mechanism for natural gas prices that will likely never be used given the price level set for the cap.

This is certainly worth ridiculing, but at the same time, a more serious look is warranted because both moves tell the same story. Trying to cap the price at which Russia sells its oil is risky and that’s a risk not worth taking right now with inflation already where it is. Trying to cap natural gas imports to the EU is also risky and that’s another risk not worth taking, especially as winter begins in Europe.

Related posts