Current issues related to economy, (responsible) investment, pension and income: every week an APG expert gives a clear answer to the question of the week. This time: equity investor Martijn Olthof, on the European Commission's crisis plan to meet the challenges of exploding natural gas and electricity prices. “The developments in the energy markets are hurting consumers, no matter what and there is nothing you can do about that. All you can do is spread out the pain.”
As the effects of sharply increased natural gas and electricity prices become painfully obvious to more and more citizens and companies, the European Commission (EC) launched a plan on Sept. 14, 2022. The three main measures in this energy emergency plan: a price cap for fixed-cost electricity producers, an additional tax on the profits of oil and gas companies and a mandate for EU member states to consume less energy.
The proposal contains market interventions that were not thought possible in Europe until recently. The question therefore arises: how effective are the intended measures really? Olthof goes through them one by one.
Price cap on power
“For electricity from nuclear power plants, hydropower plants, solar farms, wind farms and lignite-coal power plants, the European Commission wants to apply a maximum output of 180 euros per megawatt hour. Such a price cap is in itself a logical step, since the cost of generating this electricity has hardly gone up - unlike electricity from gas-fired or coal-fired power plants. Meanwhile, the price of electricity has gone through the roof ten times over, leaving producers with fixed costs making excessive profits. It is understandable that the EC is creating a mechanism to skim them off and use that money for users who need it most.”
Member states may also set a price cap lower than 180 euros. That would give more air to customers who need a lot of electricity for their production process, such as aluminum producers.
“For a producer of electricity not generated via gas or coal, 180 euros is still an extremely good price. But for customers who use a lot of electricity for their production process, such as aluminum producers, that rate is disastrous for competitiveness. So a lower price ceiling is preferable, but also not so low that it discourages producers of renewable energy from making new investments in, for example, wind turbines and solar parks. That is also the reason why the EC did not want to set it too low.”
Extra taxes for oil and gas companies
It’s not just fixed-cost power producers that are the lucky ones in today's electricity market. So are oil and gas companies. The second measure in the EC plan is therefore to have these companies pay a third of their profits as a “solidarity contribution” and use the proceeds to relieve citizens and other companies. But again, Olthof says the dosage is important.
“Oil and gas companies are making a lot of money right now. The gas they extract elsewhere in the world and bring to Europe is suddenly worth five times as much here now. As a result, it is fairly easy to say that they can afford the extra tax. To a certain extent, it is logical to skim off their profits. But to compensate for the loss of Russian natural gas supply, we will have to look for alternative natural gas supplies in addition to expanding wind and solar energy. If Europe skims off the profits of oil and gas companies too much, it will no longer be attractive for them to invest in this search. To drill new gas fields, companies like Shell or BP will then choose the U.S. rather than the North Sea. As a result, less gas will come to Europe, and we do need that gas.”
Following the plan announced in mid-September, the EC is looking at whether it can intervene further in the natural gas market. However, it is still remains to be seen how that will play out, Olthof says.
“On the international market, the gas price is determined by LNG. That is liquefied gas, which can be traded worldwide and sent anywhere by ship. Basically, those ships go where the price is highest. In recent years, the price for LNG moved along with the price of gas in Europe. When the price in Europe was very low because of an overcapacity of gas in the world, the LNG price was also at that low level. Now there is scarcity in the world gas market. The European gas price is sky-high and so is the price on the international market for LNG. Available LNG now goes to Europe, because even now it is the highest bidder. Proponents of a price cap for natural gas in Europe assume that an artificial price cut in Europe is bound to lead to a similar movement in the international LNG price - which Europe can then still buy that liquid gas for.”
But it is questionable whether that is the case, Olthof says. “If other buyers of LNG, such as Japan or Korea, are willing to pay more than the maximum price in Europe, then Europe will not get this gas. There will still be LNG coming to Europe on long-term contracts, but the portion not yet sold will go to Asia. Southern Europe is in favor of a European maximum price for gas but Northern Europe is not, so there is still a lot of wrangling and debate about that.”
Consume less electricity
The third measure in the EC’s energy emergency plan focuses on reducing electricity demand. Member states are asked to reduce consumption by 5 percent at times of peak electricity demand and to reduce total consumption by 10 percent in the long term.
Olthof: “How they achieve that 5 percent reduction is up to member states to decide. In any case, they are given the option of offering financial compensation to energy-intensive companies to shut down production at peak times. But for achieving the 10 percent target, not very many tools, rules or details have been disclosed yet.”
So the effectiveness of the energy contingency plan depends mainly on the dosage that member states choose to use in utilizing the tools put in their hands for this purpose?
Olthof: “Yes. The EC in itself has proposed good measures to deal with this crisis, but from the perspective of energy-intensive companies it is not yet sufficient. These companies will have to wait and see if individual member states will do more, and how they will distribute the skimmed-off profits. Either way, developments in energy markets are hurting consumers, and there’s nothing you can do about that. All you can do is spread out the pain – as best you can.”