Price cap, how to realize it?

With the price reaching quotations around € 300 per Megawatt hour, gas has ceased to be a topic for specialists and now dominates the pages of newspapers and the political debate. A cap on the price of gas is the solution that is being put forward in European capitals. But what is meant by the price cap? What are its chances of realization? And what goals should inspire it?

There are two objectives, that do not always coincide, declared by European governments. The first is the containment of the burden on energy, gas and electricity services, the latter dragged upwards by the cost of electricity production with gas-fired power plants. The second stems from the international situation of the war in Ukraine, the need to be free of imports from Russia and reduce Russia's hard currency revenues from the sale of gas.

There are also two ways in which a price cap can be put into effect. One is by controlling the price paid by end users, either in a generalized way or compensating for vulnerable groups, low-income families and energy-intensive industries. This is a measure that the Draghi government introduced in the autumn of 2021, when the price of gas and electricity began to rise, and which it has repeatedly renewed, with a significant burden on the public budget. It is financed, at least in part, by an increase in the tax on extra-profits made by energy companies that have benefited from the high price of raw materials. However, this move has only partial effects: it does not interrupt the increase on the price of electricity and on other energy input channels that lead to higher costs in many industries and contribute to rising inflation. Moreover, this form of price cap does not affect the wholesale price of gas or the hard currency revenues made by Gazprom, and thus achieves only the first of the two stated objectives. The real advantage of this measure, which in more or less similar forms has been introduced by many European countries, lies in the fact that it can be implemented directly by governments in a short time.

The other, more ambitious approach is that of a price cap applied to the wholesale price paid to Russia on imports into Europe, a measure that can only be implemented by the European Commission but which to date has not yet been specified in its practical details. The basic idea is to replace the many energy importers in the liberalized European market with a single subject, the Commission, to negotiate as a monopsonist buyer the quantities and prices of gas consignments with Gazprom, a monopolist on the sale side. The solution, apparently simple, however, hides many difficulties. The first arises from the need for a consensus of the countries and operators involved to delegate this role to the Commission, including the rationing mechanisms between countries that may be necessary if the quantities of gas fall. Secondly, the confrontation between a monopolist and a monopsonist takes place in the form of a negotiation, where interests are obviously opposed and the outcome depends on the negotiating power of the parties. The Russian side could soon be affected by the difficulties of permanently reducing export flows to Europe without compromising extraction and transport infrastructure. On the European side, the difficulties of a reduced supply arise in the short term, once storage capacities have been exhausted, due to the impossibility of completely replacing Russian gas with that imported from other sources.

The Italian government has moved quickly to replace, as far as possible, Russian imports with those from other countries, but is constrained by the ability of other pipelines to make up for the reduction in Gazprom's supplies. Only the gas pipeline from Algeria provided sufficient transport capacity for a significant increase in flows, which were achieved with the agreements concluded recently. Soon the other front on which to intervene will concern forms of demand rationing, an unexplored terrain that presents challenging problems of implementation and monitoring.

Finally, it should be remembered that, even if Europe succeeds in negotiating a reduction in the price of gas from Russia, it will not be possible to apply similar cuts to other countries like Algeria, Qatar, and so on, when at the same time we ask them to increase exports to Europe. After the flare-ups in gas prices of recent weeks subside, the prospect in any case is that of replacing a historically low-cost supplier like Russia with other sources, including expensive liquefied natural gas, which will keep the cost of energy high. Unfortunately, the period we have entered does not offer easy cheap solutions.