Not only Putin: this is how the European system drives up energy prices

Not only Putin: this is how the European system drives up energy prices

A “ceiling on the price of gas“Imposed by the buyer? Why is the gas market based in Amsterdam and how are prices determined? Why does the European system contribute to the increases we see every day?

We are in the local supermarket, the usual one-liter milk package passes on the belt. At the checkout the code is scanned, the price appears but we rebel: we have decided on a ceiling on its price equal to 50 cents. The supermarket readily accepts and we go out satisfied with our milk at the controlled price. From this experiment (failed in our case) the idea for this interview was born.

We wanted to understand how those who buy (in the case of Europe) can impose a “Gas price cap” to those who sell (often foreign suppliers, at least one of which is vaguely hostile to current European policy). To do this we could interview some minister or undersecretary, or even some luminary in the sector. But we preferred to talk to those who really work, an expert in the energy sector who for years worked for ENI.

MARCO HUGO BARSOTTI: First of all, two words of introduction.

DAVIDE CORNAGGIA: They are Davide Cornaggia (@ominodelgas), I have been dealing with gas since 1996, I have worked for 15 years in ENI as a market analyst and head of access to foreign gas infrastructures, then in private companies such as Gas Plus And Energetic. I have been a sales company since 2016 and I continue to deal with the evolution of the markets.

The European system rewards the most expensive source

MHB: Let’s start with the statement of Ursula Von der Leyenthat on August 29 he claimed “The skyrocketing electricity prices are now exposing the limitations of our current market design”. Can you describe the cornerstones of this “design” and how long has it been in existence?

DC: Von der Leyen refers to the model of pricing adopted in all electricity markets, namely that of marginal pricing. According to this model, the price of energy at any time is equal to price of the most expensive energy source in the same amount of time.

This model exposes critical issues when prices are very high or very low, given that when they are very high the sources that have low variable costs (nuclear, solar, wind) have a very high marginswhen they are low, the same sources have problems in rewarding investments.

MHB: What measures does the European Commission have in mind?

DC: The hypotheses launched in these days are of separate markets guaranteeing, on the one hand, an acceptable remuneration to the aforementioned sources, on the other hand, a creation of the price that mediates between the price of gas / coal generation and that of other sources.

Gas penalized

MHB: Last year, when the price of energy started to rise, Minister Cingolani said that “the price of gas increases and the price of CO2 produced increases” (that’s right: the price of CO2). From what we understood he was referring toEuropean Union’s Emission Trading System (EU ETS) and its “permits” to pollute. If so it seems to us a self-inflicted punishment

DC: ETS rises to the wheel of the bad performance of nuclear power, obviously less nuclear and less wind power is produced (like this summer) the more we need to resort to gas and coal (which increase in price as penalized by the European system for being polluting).

The Amsterdam Stock Exchange

MHB: There has been a lot of talk about the Amsterdam stock exchange where they are traded futures on the gas. Is there also a problem? Besides, is that really the only market?

DC: TTF (www.theice.com, www.eex.com) is the most representative continental market. The most liquid before the Brexit it was the NBP (English) but then lost in relative terms. It is the most important because it is at the union of the main non-Russian European sources of supply, namely Norwegian gas, and because in the past the Dutch had fields with a lot of flexibility, guaranteeing liquidity to the markets at the beginning.

MHB: The Dutch?

DC: Yes, the Dutch had the Groningen fieldone of the largest in the world, which was characterized by immense flexibility, that is the possibility of varying the supply, and consequently supplying or removing gas from the market (giving or withdrawing liquidity).

Unfortunately due to earthquakes (actually tremors that in Italy are not even mentioned, but which, given the poor construction quality of Dutch houses, risk creating problems) has been closed. There are ongoing discussions for its limited reopening.

MHB: Can you explain the liquidity issue better?

DC: This market behaves like all markets futurethe fluctuations in prices are due to the lack of liquidity deriving from fewer Russian deliveries for a year already.

Simplifying, if the demand remains stable (or increases due to a little nuclear and little wind) and the supply decreases, the price variations will be larger because it is an unbalanced market. Speculation is based on this physical fact.

Gas makes the price

MHB: What were the arguments that led to link the price of electricity to that of gas? In France it is a choice that risked winning the presidential elections Marine Le Penwhich proposed to sell electricity to the French at the cost of nuclear generation, leaving the European system.

DC: the cost of energy is linked to the cost of gas because gas systems are the most flexible ones. These plants are used to compensate for the variability of demand. In our system the price of energy depends on the more expensive power plant from time to time usedalmost always on gas.

The ceiling on the price of gas

MHB: There is talk of putting a cap on the price of gas. It did not work with the fair canon and many initiatives of the last century, why should it work today?

DC: Indeed, the ceiling on the price of gas can not run. Right now only a reduction in demand or an increase in supply could help.

MHB: Can you explain why?

A.D: “Roof on the price of gas” it actually is an incomprehensible sentence. It may mean “Ceiling on the price of gas paid by end customers”, and therefore in this case it means that the State puts the money of the difference between the real price and the price paid by the final customers. An unimaginable and very high amount of money (in Italy they would be 20-30 billion euros just for the winter).

It may mean “Ceiling on the price of gas paid to suppliers” and here it is not clear why a supplier should supply at a lower price than the market one, there would be less supply and therefore a price that is still rising.

It may mean “Ceiling on gas price fluctuations”perhaps the most practicable hypothesisor change the market rules in order to stop trading when certain percentages of rise or fall are exceeded.

MHB: A circuit breaker!

DC: Sort of: a system to allow trader to update portfolios and give the market the liquidity it asks for. Pretending that the market doesn’t react to a 40 percent cut in supply like Russia did is totally unrealistic.

Russian gas via China?

MHB: The (pseudo?) News came last week that China would be reselling Russian gas to Europe. True or false? What do you think?

DC: China cannot resell Russian gas to Europe, there are no physical connections. The deposits themselves are still separate. China’s behavior influences the European price thanks to LNG, a liquefied gas that can travel by ship. If China required less gas, well that would probably end up in Europe given that European countries are both the richest and the “shortest” in gas at the same time.

National production at the stake

MHB: What is the state of national production?

DC: In Italy the situation for production is very bad, there are too many limitations and the costs are high. Italian production is continuously falling.


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