December 21, 2022 - 1:00pm

After months of wrangling, EU energy ministers finally approved the first ever cap on gas prices, which is scheduled to come into force in February. The aim of the measure is to curb the crisis that has been rocking Europe over the past year as a result of gas and energy prices surging to unprecedented levels.

To understand how the cap works, it’s important to understand what is driving the energy crisis in the first place. It’s commonly thought that the spike in gas prices is a consequence of Vladimir Putin ramping up bills in retaliation for Western support of Ukraine. But that’s not how energy markets work.

Today, the price of European gas is no longer determined by long-term semi-fixed contracts linked to the price of oil — as was the norm until a decade ago — and neither can it be unilaterally changed from one day to the next based on the whims of exporters. Rather, it is linked to the price at which gas is sold on virtual trading markets, or spot markets, such as the TTF in Amsterdam (for the EU) or the NBP in the UK, where every day hundreds of energy traders and financial operators buy and sell large volumes of gas. This means that the price of gas essentially depends on the fluctuations of financial markets.

The shift from oil-indexed contracts to spot market pricing has been a pet project of the European Commission ever since the early 2000s, in line with the European technocrats’ faith in the virtues of economic liberalisation and marketisation: the idea that market forces, if left to their own devices, will always produce the optimal outcome — and the optimal price. As a result, over the last decade spot pricing has become the norm across Europe.

As it turns out, allowing financial markets — which are notably prone to irrational behaviour, speculation and price manipulation — to set the price of an economy’s most crucial commodity, energy, was a very bad idea. This became apparent in early 2021, a year before the start of the war in Ukraine, when the price of gas traded at the TTF, to which most EU gas contracts are linked, started to climb substantially.

By the end of the year the price of European gas had reached €100/MWh — the highest ever recorded, and a staggering 1,000% increase from the beginning of the year, when the price had been around €10/MWh.

There was no economic fundamental to justify such a drastic rise. Yes, there was a rebound in energy demand due to economies beginning to reopen after lockdown, but global oil and gas production also increased compared to the previous year. And yes, the supply of Russian gas to the EU — which in 2021 accounted for around half of the bloc’s overall supply — did decline a bit in the second half of the year. To the extent that there was a mismatch between supply and demand, though, this was not sufficient to warrant a tenfold price increase.

The reality is that the main factor driving the surge in the price of TTF gas was, quite simply, speculation (which was then further exacerbated by the actual drop in supplies caused the war in Ukraine and the sanctions regime).

Enter the newly-approved EU cap, which sets the maximum price at which gas can be traded on the TTF at €180/MWh. This isn’t a cap on price-gouging by Russia (or anyone else); it’s a cap on the system of speculative trading that the EU has deliberately foisted upon its energy markets. In other words, it’s yet another case of the organisation attempting to fix a problem of its own creation. What’s worse, it’s likely to fail: not only is that price (and even the current price of €100/MWh) still a massive increase compared to pre-2021 rates, but there’s also a risk that the measure may actually lead to a drop in gas supplies. And the winter has only just kicked in.

Thomas Fazi is an UnHerd columnist and translator. His latest book is The Covid Consensus, co-authored with Toby Green.