The European Union’s Misguided Energy Price Cap Proposal

Only 15 years ago, the European Union produced more natural gas than Russia exported, according to the EIA. Repeating past mistakes and maintaining a failed energetic interventionist policy would only worsen what is already a structural disaster.

The European Union's Misguided Energy Price Cap Proposal

The prohibitive cost of electricity and gas in Europe is not a result of market flaws, but of a completely unsustainable cost structure where consumers are forced to pay escalating taxes, a hidden CO2 tax, subsidies, and other rising regulatory costs. More than 60% of an average euro area country household bill is made up of taxes and regulated costs, according to Eurostat.

Brussels cannot turn water into wine, and, similarly, the European Union cannot “cap” the price of natural gas and oil. It is almost ironic, but European leaders are spending days debating whether to impose a cap on Russian oil that would be set above the current Urals price and significantly above the five-year average levels.

The only thing that these so-called “caps” would achieve in a global energy market is to provide a massive subsidy that would then have to be repaid with higher tariffs or taxes afterwards. In Spain they already made the horrifying mistake that led to what was called the tariff deficit: Putting a cap on a tariff and passing the difference with the actual price to the following year with added interest charges. What the tariff deficit mechanism did was perpetuate higher tariffs even in periods of low commodity prices as the tariff deficit ballooned. The proposed gas cap would produce a comparable tariff deficit but at an enormous level if implemented throughout Europe.

Additionally, in a globalized and international market, the cap would create enormous arbitrage incentives that would only benefit China, which would continue purchasing cheap Russian commodities and exporting to Europe its more competitive goods.

We must not forget that the natural gas “cap” in Spain has been a genuine catastrophe. Elevating it to Europe would be worse.

According to Enagas data, natural gas demand in Spain soared while it declined in the rest of Europe, due to the disguised subsidy that the “cap” entails. Additionally, the cost of the measure for the country has increased to 13 billion euros, according to the power sector, which all citizens will pay with higher taxes, and this has led to a massive transfer of funds to France, which benefits from purchasing subsidized energy from Spain at a discount price while Spanish consumers pay the cost in higher bills.

The total cost of exports to France has exceeded 715 million euros (from 15 June to 4th November, according to sources of the power sector). Additionally, a significant increase in tariffs (+98 €/MWh) is added for clients with fixed contracts, converting their fixed contracts into variable ones due to the subsidy of natural gas prices.

The creation of a tariff deficit, which is what the current proposal would do to Europe, implies higher future costs and a larger debt burden. Short-term price “cuts” on gas and oil disguise the reality, incentivize demand while also creating an overcharge whose financing will result in higher prices and taxes in the future.

A European gas and oil cap causes no harm to Russia at all. We should have learned by now and that through exports to China, India, and other Asian countries, Russia continues to set trade surplus records.

A European “cap” on Russian gas and oil would be a subsidy to China at the expense of European taxpayers.

Additionally, by short-term subsidizing the price, the gas cap would create an artificial demand and a perverse incentive. More natural gas consumption and the long-term reliance on fossil fuels is maintained.

A cap on natural gas prices leads to higher consumption of fossil fuels, higher taxes, and bills while it penalizes renewable investment and a competitive energy transition.

What should the European Union do then?

The European Union needs a competitive energy policy that makes use of all available technologies. Eliminating, delaying, and placing bureaucratic barriers to investments in supply-chain security is a luxury no nation can afford.

. Use the EU’ extraordinary tax receipts from the sale of CO2 emission rights, which are estimated at more than twenty billion euro in the EU for 2022, to lower tariffs for the neediest families.

. Reduce the taxes on gasoline and gasoil that are more than 50% of the final price for the least fortunate and small businesses. The same for natural gas, where taxes add up to more than 30% of the tariff.

. Reduce the regulated costs burden included in consumer tariffs. Most of those regulated costs and subsidies have nothing to do with energy consumption and ought to be included in each country’s budget.

. Extend the life of nuclear plants and invest in new reactors.

. Support renewable energy eliminating the regulatory risk that negatively impacts capital attraction.

. Supporting renewable energy means securing the necessary amounts of lithium, copper, and cobalt.

. Facilitate investments in natural gas development and lifting the ban on the exploration and exploitation of unconventional gas.

. Reach long-term contracts with the major producers of liquefied natural gas, as China did when it closed its 27-year contract with Qatar.

. Eliminate taxes imposed on energy companies. They are the key to invest in security of supply.

. Strengthening the security of supply and stability provided by hydroelectric energy through contract extensions and investments in mini hydro.

. Provide tax benefits for investing in cogeneration.

. Supporting long-term investments in grid and networks and energy sources like green hydrogen with tax benefits.

The most important lesson is that the European Union will not solve an energy crisis created by interventionism by adding more bureaucracy, legal and regulatory instability and penalizing with higher taxes those that can invest in energy security.

The energy crisis, which was already a high-cost issue for European citizens in 2019, will become a price and supply issue soon if the European Union disregards these measures and continues to impose interventionist policies, raising taxes and imposing idealistic and industrially unviable models.

If the necessity of securing supply and mining of copper, cobalt, lithium, and rare earth metals is not understood, together with the need to strengthen nuclear, natural gas and hydro, the European Union will switch from being dependent on Russia to being dependent on Russia and China.

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

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