Gas cap regulations   

The EU recently adopted regulations capping gas prices, which took effect in 2023 for one year. What are these regulations?

Since the Russia – Ukraine tension in early 2022, the European Commission (EC) brought up a variety of plans to counter gas supply shortages and price volatilities. Finally after intense negotiations within the EU, it was decided to enhance solidarity through better coordination of gas purchases, reliable price benchmarks and exchanges of gas across borders and to introduce temporary mechanisms to protect citizens and the economy against excessively high prices, by way of a temporary intra-day volatility management mechanism for excessive price movements and an ad hoc LNG benchmark, to be developed by the European Union Agency for the Cooperation of Energy Regulators (ACER).

Limiting gas prices

Council Regulation (EU) of 19 December 2022 enhancing solidarity through better coordination of gas purchases, reliable price benchmarks and exchanges of gas across borders takes effect for one year. This Regulation introduces temporary mechanisms to protect citizens and the economy against excessively high prices, by way of a temporary intra-day volatility management mechanism for excessive price movements and an ad hoc LNG benchmark, to be developed by ACER. This Regulation establishes temporary measures, for the case of a gas emergency, to distribute gas fairly across borders, to safeguard gas supplies for the most critical customers and to ensure the provision of cross-border solidarity measures. It would include coordinating natural gas purchasing within the EU, demand aggregation and joint purchasing, increased use of LNG facilities, gas storage and pipeline, setting up temporary intra-day volatility management mechanisms to apprehend excessive price movements more efficiently, and empowering ACER to specify all the parameters of the market data that should be reported to it.

In the second regulation, an article pertains to market correction mechanism (MCM) for Title Transfer Facility (TTF) Virtual Trading Point derivatives takes effect on 15 February 2023 for one year.

The MCM activates if the month-ahead (or front-month) TTF prices (i) exceed €180/MWh for three consecutive days while (ii) being €35 above an LNG reference price to be set by ACER. 

The base price is determined based on the average price of LNG delivered to Northwest Europe, the Mediterranean, Northeast Asia, National Balancing Point (NBP) Price and LNG daily assessment by ACER. This mechanism does not apply to TTF daily transactions or over-the-counter (OTC) ones.

20 working days

Once activated by ACER, the dynamic bidding limit shall apply for a minimum of 20 working days, unless suspended by the Commission.

The dynamic bidding limit shall be deactivated, 20 working days from the occurrence of the market correction event, if the reference price is below EUR 145/MWh for three consecutive working days.

Where a regional or a Union emergency has been declared by the Commission, notably in case of a significant deterioration of the gas supply situation leading to a situation where the gas supply is insufficient to meet the remaining gas demand (‘rationing’), the dynamic bidding limit shall be deactivated. That assessment shall take into account price developments in other relevant organized marketplaces, notably in Asia or the United States. The European Securities and Markets Authority (ESMA) and ACER are tasked with assessing the impacts of these mechanisms on financial markets, as well as energy and supply security to report to the EC by 1 March 2023.

Assessment

The MCM for the front-year TTF derivative settlement price shall be activated when a market correction event occurs. A market correction event shall be considered to occur when the front-month TTF derivative settlement price, as published by ICE Index B.V. (the Netherlands):

exceeds € 180/MWh for three working days; and

is € 35 higher than the reference price during the period referred to in point (a).

Therefore, only for a 49-day period, stretching from 26 July to 13 September 2022, both conditions have been fulfilled and Europe has absorbed a significant volume of LNG cargoes to meet its gas demand and fill its storage facilities for winter.

It is possible that if MCM was implemented in this period, Europe would not be able to absorb enough LNG cargoes and the cargoes would be directed to other markets. However, the EU could have suspended the mechanism in this period, too.

Disruption

The outstanding point in this regulation is the gradual elimination of Russia from Europe’s gas market, which would impose heavy burdens on the bloc at least in the short-term. Governments have no option but to support consumers who cannot support high gas prices, but when the price ceiling is set below a balanced price, the supply-demand balance disappears and the market mechanism will be automatically disrupted. It is the first time the Europeans are experiencing a serious gas crisis. That is why they have worked out such a mechanism in order to disrupt the market themselves.

The Europeans have regularly accused OPEC of market manipulation, but it is the first time they are manipulating the market due to increased gas prices. Adam Smith's invisible hand is apparently working in Europe’s markets against the backdrop of the Ukraine war and concomitant impacts on Europe.

The Europeans have set a price cap for Russian gas imports. In the crude oil market, their objective is to restrict Russia’s oil income while guaranteeing oil supply to Europe. As far as price ceiling on gas retailing is concerned, they want to make sure that consumers would be spared any harm from high energy prices. But the price ceiling set by the EU in the gas market follows the Netherlands’ TTF benchmark with a view to slowing down price excess in gas transactions. That is while prices in the TTF market is artificially higher than other benchmarks and may not be a good criterion for limiting prices in gas transactions.

Long-term deals

The main faults found with this European policy is the incompatibility of the proposed plan with deregulation and price liberalization policies in Europe, ambiguity in pricing policymaking and calling into question long-term gas contracts and their terms.

Gas producing nations have always been in favor of long-term gas prices. They maintain that gas deals should be long-term in order to ensure the supply security as the gas supply chain is capital-intensive and may not be expanded based on intra-day prices. In simpler terms, you cannot tell them to build first and then go for marketing and margins.

The Netherlands’ market regulation section has criticized this European policy on the grounds that making efforts for imposing price ceiling on futures transactions would result in negative consequences such as physical shortage of gas. The European Federation of Energy Traders (EFET) has also announced that imposing price ceiling would increase demand, lower supply and reopen talks about LNG contracts, where energy suppliers would get the upper hand.

Another consequence of price ceilings is disruption in gas supply to Europe and access to gas customers and artificial lowering of prices. Therefore, cargoes will be headed to Asia’s market and Europe will be left with problems in access to gas.

Thus, by interference in the market, price discovery will hit snags and margins will drop in the stock market. That is why many operators prefer to focus on gas transactions in markets outside Europe. Of course, it’s no question of moving towards Asian markets. However, if this method is intensified it may drive LNG cargoes towards Asian markets and affect long-term investment in the gas sector. 

GECF revenue

Europe is a major destination for gas cargoes supplied by the Gas Exporting Countries Forum (GECF). Therefore, such regulations may significantly impact the GECF member states’ revenue from exports. Setting a price ceiling in the TTF market and its impact on other European gas hubs may result in lower revenue by GECF member states whose LNG contract prices are linked with the hubs affected by the price ceiling. However, under the current circumstances in the gas market, the MCM mechanism is unlikely to be activated unless serious disruptions come up in further gas supply to the EU. GECF member states are required to solidify their position vis-à-vis these new regulations, developed various scenarios, assess possible risks and design specific measures to minimize any negative impact from these regulations. Simultaneously, the GECF Secretariat will continue to monitor developments associated with the EU regulations and any new interference in the market to assess its potential impacts on the global gas market and GECF member states.

Stock exchange impact

The EU’s latest gas regulations may have significant impacts on the natural performance of Europe’s gas market. Gas price measures including intra-day fluctuations management and MCM mechanisms may negatively impact stock exchange transactions and increase margin call and manipulate the price discovery function.

Setting a price ceiling in TTF transactions can directly affect Europe’s gas market, not to mention its impact on the global gas market. Over the past two years, LNG spot prices in Asia have been largely affected by European hub prices. Therefore, imposing a price cap in Europe may reduce LNG spot prices in Europe. However, as LNG demand increases in Asia, there would be more competition for the cargoes and any price restrictions in the TTF may divert LNG cargoes away from Europe to Asia. That would bring about gas shortage within the EU and finally disrupt gas demand in this zone, as well as reducing investment in the gas industry.

Therefore, numerous trading companies and financial institutions have expressed concern with the EU’s recent regulations. ICE operators have also expressed concern over the EU’s market interference and its potential risks for the TTF and financial stability.

Assessing the technical and financial feasibility of operating the TTF gas hub is under way by ICE. Then, it may be decided that the TTF be moved out of the EU. Furthermore, the European Central Bank (ECB) has announced that these regulations may negatively impact the eurozone’s financial stability and result in further fluctuations and margin calls.

Iran Petroleum