March 30, 2023

Natural gas in Europe is now trading at a ceiling, but prices should only reach it in the summer

The cap on gas prices in Europe has already come into force, but the market trend suggests that the mechanism will only be activated in the summer. Already in 2022, the limit would have been triggered on 44 days of high prices

After four months of protracted negotiations, European Union ministers agreed to adopt what would become one of the most alarming measures among key players in the financial and energy sectors. The cap on natural gas prices in the European market comes into force from Wednesday 15 February. The risks have already been pointed out, but there is a possibility that the mechanism will only be activated in the summer if the market behaves similarly to last year.

On December 19, the European Commission and energy ministers agreed to trigger a temporary cap on gas contracts on the European market if two conditions are met at the same time. On the one hand, the cap is triggered if the price in gas contracts for the next month is, for three consecutive business days, higher than 180 euros per megawatt hour (MWh) on the Dutch TTF (Title Transfer Facility) platform. , the reference to the European natural gas markets.

At the same time, for the limit to take effect, it should be verified that the VAT reference price is 35 euros higher than the liquefied natural gas (LNG) reference price, also for three consecutive working days.

It should be added that this gas price limit only applies to the monthly, quarterly and annual price of the TTF index, which is the price at which natural gas is traded at the Rotterdam hub. It does not apply to shorter time frames such as daily or weekly price.

However, looking at gas prices traded on the TTF, you have to go back to October 5, 2022 to find gas futures trading above €180/MWh. Since then, the price of this resource has been falling, trading below €100/MWh from the end of 2022. This Tuesday, contracts for March delivery were trading around €53/MWh.

Securities Transfer Facility (TTF) – Intercontinental Exchange (ICE)

On the day the proposal was approved, former energy minister João Galamba hoped the mechanism would never be activated “for good reasons”. “Not because of a flawed design of the proposal,” he clarified, but because it would be a sign that the gas market in Europe would stabilize.

And, while this is no guarantee, as the war in Ukraine still has no visible end, there is indeed a chance that the mechanism won’t be activated until after winter.

At ECO/Capital Verde, Daniel de Nicolás, Energy Optimization and Market Research Consultant at Schneider Electric, recalls S&P Global Commodity Insights estimates: “If this measure were active in 2022, the gas price cap would have been activated for 40 days in the summer’, when natural gas prices crossed the 180 euro/MWh mark on July 26 and peaked a month later at 338 euro/MWh.

“With this data, we believe that the peak moment will be in the summer of 2023, when the underground facilities [na União Europeia] The gas storage tanks must be recharged,” predicts the official.

Looking at data from Gas Infrastructure Europe (GIE), an association representing European gas infrastructure operators, cited by the European Commission, it is possible to verify that the European bloc’s stock fill level has always been below 80 % by August, having peaked at 96% in November.

Since then, when temperatures got colder due to the onset of winter, natural gas reserves began to be used, but never fell below 80%. On February 2nd, the date of the last update, natural gas reserves in the European Union, in terms of January, stood at 82%.

Gas infrastructure Europe

The gas stocks of the 27 member states began to be monitored in August, when the EU executive called on the rest of the countries to to reduce natural gas consumption for electricity production by 15% by March 2023. In this way, and without access to Russian gas, it would be possible to ensure that the European bloc would face the colder period safely. Portugal was one of the exceptions and by the end of winter it is committed to reducing this consumption by 7%.

If this measure were to take effect in 2022, the gas price cap would have been activated for 40 days in the summer. With this data we believe that the peak moment will be the summer of 2023, when the underground gas storage facilities will have to be recharged.” Daniel de Nicolás, Energy Optimization & Market Research Consultant, Schneider Electric.

The mechanism will have risks if activated

The limit of this mechanism was one of the reasons why the negotiations between the energy ministers took several months.

Before settling at €180/MWh, the European Commission’s original proposal called for the cap to be triggered if the gas price traded on the TTF was above €275/MWh, while the reference price on the TTF was €58 higher than the reference . price for LNG, for 10 consecutive trading days. The proposal was hotly contested among the 27 member states.

But now, with this reduced limit, there are risks that have been highlighted by the main financial and energy market players in the European Union, including the European Central Bank (ECB), the Agency for the Cooperation of Energy Regulators (ACER). ) or the Intercontinental Exchange (ICE) itself.

“One of the main risks that might exist would be in the over-the-counter market,” meaning bilateral contracts that trade directly between a buyer and a seller and which are not covered by this cap.

“If the mechanism is activated, operators can change their contracts on the OTC market and this will have consequences that are difficult to detect at the moment. The alerts that are raised are without a doubt legal, but it will be necessary to observe them over time, because, if the mechanism is activated, only then will we have an idea of ​​its real consequences”, emphasizes Daniel de Nicolás.

Among the warnings are concerns from the bank led by Christine Lagarde related to the risk to financial stability in the eurozone, noting that the price correction mechanism “may increase volatility and margin calls, challenge the ability of central banks to manage financial risks. means and encourage the transition of negotiations to the secondary gas market”.

If the mechanism is activated, operators could change their contracts on the OTC market, and this will have consequences that are difficult to detect at this time. The warnings raised are undoubtedly legitimate.” Daniel de Nicolás, Energy Optimization & Market Research Consultant, Schneider Electric.

But precisely because of these risks, revealed during the period of negotiations between the 27 Member States, a series of safeguards were also secured which allow the gas price cap mechanism to be suspended the day after these risks occurred. For example, the cap is deactivated if there is an increase in gas consumption of 15% in two months or 10% in one month, or if there is a drop in gas purchases in the FTT or between Member States, or even if there is a quarterly decrease of LNG imports in the European bloc.

In addition, the Commission guarantees that the limit will also be deactivated automatically, at any time, if the Community executive declares an emergency at regional or European level, as provided for in the Security of Supply Regulation.

In any case, ACER, which was responsible for monitoring the evolution of natural gas prices in Europe, will publish a “deactivation note” on its website formalizing the decision.

“The good news now would be that the mechanism did not need to be implemented, and if it was, it would be limited and temporary,” the analyst defends.

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