Cooking figures is not the solution to European energy prices

Government price caps, subsidies and excess profit taxes will not solve Europe’s energy crisis. The best remedy is to increase the supply of all forms of energy.

Energy prices
European Commission President Ursula von der Leyen is offering a mix of price caps, tax hikes and subsidies to solve Europe’s energy crisis. Only a long-term commitment to increasing energy production will solve the problem.

The cost of energy is rising, creating financial problems for households and businesses. Already before the war in Ukraine, Europe’s energy supply was vulnerable. Energy security had not been a political priority, exacerbated by weak and shortsighted policies. In Germany, but also in other countries, energy became a playing field for populist politics infused with considerable emotion. Germany’s Energiewende jeopardized security on the continent by trading reliance on nuclear power for dependence on Russian natural gas.

Market rules typically dictate that reduced supply will show in increased prices. This is a long-term good as it might push supply higher or demand lower. What is happening now? Russia limited its gas exports, diminishing the amount of gas Europe receives. The only sustainable remedy is to increase the energy supply. However, this takes time and the correct policies.

European politicians are desperately trying to shop around the world for gas. This is not a long-term solution. To improve energy security, the continent needs to become more self-sufficient. To generate investments in energy production – whether renewables, nuclear or something else – investors need to see that markets work. This is also essential for public investments. If such investments lack rentability, they will again burden the people.

The European Commission came in with plans to ‘stabilize’ prices by capping them based on an index that does not yet exist.

The European Commission came in with plans to “stabilize” prices by capping them. The price cap should be “dynamic,” the Commission decided, based on an index that does not yet exist. Gas is presently traded in the Netherlands. A cap means that should the price exceed a certain limit, purchases would not be allowed anymore. Gas prices, with consequences for the cost of electricity, are set on the Rotterdam spot market. The virtual gas trading facility in the Netherlands is called TTF, the abbreviation for Title Transfer Facility.

With the reduction in Russian natural gas supplies, Europe needs more liquified natural gas, or LNG, and this is not necessarily traded through Rotterdam. In fixing prices, the Commission intends to base the price cap on an index it will establish on all daily gas contracts. Whether that makes sense or not is debatable. It could result in higher prices, the opposite of what is intended. The simple fact of the matter is that we must concentrate on generating more of our own energy, and not rely on some alchemic caps and indexes.

Further, the Commission is proposing that a minimum of 15 percent of all gas purchases from abroad will be carried out by Brussels to leverage its supposedly stronger bargaining power and to avoid discrimination against smaller countries. It is doubtful that in a seller’s market the purchaser’s pricing power will be decisive. On the LNG market, for instance, Brussels will have to compete with all large Asian purchasers with similar or higher powers. It might not be the solution, but it is worth a try. We can assume that the Commission will have learned from procurement disasters in the purchase of Covid-19 vaccines.

On top of all these machinations, European Commission President Ursula von der Leyen announced a third pillar of the package: A “solidarity mechanism” for sharing gas among the 27 member states of the European Union. This solidarity mechanism is reminiscent of the idea, which unfortunately appears to be coming true, of the unionization of sovereign debt.

Fiddling with indices to control prices is not sustainable, as is the superstition that deficit and debt problems can be solved by printing money.

There is, however, a difference. The value of fiat money, the money issued by central banks, is in theory backed by the total economic performance of the currency area. It maintains its purchasing power if the people and market believe in it, requiring an element of trust. But the long-term consequence of increasing the money supply beyond the level of economic performance is high inflation. This, in the short run, allows politicians to engage in irresponsible deficit spending. It will finally shatter public trust.

The only sustainable solution is to create market conditions that stimulate an increase in energy production. Everything else is hocus-pocus, including the Commission’s proposal for an excess tax on the profits of energy companies.

Energy is harder for European politicians to manipulate than fiscal and monetary policy. It can only be used if it is available.

The only sustainable solution is to create market conditions that stimulate an increase in energy production. Everything else is hocus-pocus, including the Commission’s proposal for an excess tax on the profits of energy companies.

In this context, the German coalition created a masterpiece in non-statesmanship.

The government of Angela Merkel decided to phase out nuclear energy by the end of 2022. In doing so, Germany’s ex-chancellor bowed to the populist notion that nuclear power plants could be easily substituted by renewable energy, with Russian natural gas providing a transitional bridge. It was an extremely risky idea then and even more so today. Now, after weeks of haggling, Germany decided to extend the life of its last three working nuclear power plants for the first three months of 2023.

This temporary extension might give some comfort during the next months but does not solve the problem. The question is: Is the energy from these nuclear power plants needed? The answer is: Yes, clearly. Russian President Vladimir Putin will not start supplying natural gas through the Nord Stream pipeline on April Fool’s Day 2023 just to please Germany.

To “help” industry and households cope with high energy prices, the German but also other governments will provide subsidies. These will be financed by a tax on the “excess profits” of energy producers in renewables, coal and nuclear. Who will then still invest in these areas?

Should we laugh or cry?

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