The Price Cap Era and the Demise of the Free Energy Market | OilPrice.com

Price caps are all the rage these days on the energy scene. The European Union is capping the price of gas and the G7 group is trying to cap the price of exported Russian oil. Both amount to direct market intervention of the type normally associated with authoritarian regimes. Could price caps kill the free market? The idea of ​​a free market is one where the price of a product or commodity is determined solely by its fundamentals: supply and demand. The reality is that there is no completely free market today. There are too many big players in the market – investment banks, for example, or sovereign wealth funds – who have enough power to move prices on any given day.

Still, market fluctuations are one thing. Direct intervention is another. In times of crisis and panic, however, the decisions that must be made are rarely of the popular variety. Gas price caps in the European Union are perhaps the best example of this to date.

About 15 bloc members backed the idea of ​​capping the price of imported natural gas. It looks like a popular decision. It is, however, decidedly not popular among suppliers of this gas, including Norway, Qatar and the United States.

One of the notable opponents of EU-wide gas price caps was Germany, which is also the bloc’s biggest gas importer. A price cap “always carries the risk that producers then sell their gas elsewhere,” said Chancellor Olaf Scholz. said in the cap comments, effectively summarizing the biggest problem with the artificial price cap.

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The biggest problem is that this cap constitutes direct government interference in the functioning of the markets, which prevents them from continuing to function. And that risks a real breakdown.

If we consider price caps as a kind of subsidy – which is how Germany applies its own price caps, with lower gas and electricity prices for a certain level of consumption – the image and risk can become clearer.

Subsidizing a product or service normally results in greater demand for that product or service. But if supply is limited – and gas supply for Europe from producers other than Russia is indeed limited – market prices would rise.

This means that governments that subsidize the product or service would have to pay more to subsidize it. And that, in turn, would lead to higher taxes because the money has to come from somewhere. In the end, consumers end up paying more anyway, just in a more roundabout way.

It is a very fragile system, as evidenced by the collapse of the economies of the former Soviet bloc after the fall of their totalitarian governments and the return to free markets where prices were determined by supply and demand after years of heavy subsidies. It was not a pretty picture.

Meanwhile, as EU leaders mull over their caps, the G7 have announced they will be ready with their price cap on Russian oil in a few weeks. Apparently, the idea of ​​having a floating price was abandoned in favor of a fixed price, to be applied by insurers and financial service providers residing in the members of the group. However, many questions remain unanswered.

These were recently summarized in this Reuters story, who said what the G7 is mainly betting on is that 95% of the world’s shipping fleet is insured by the UK-based International Group of Protection & Indemnity Clubs. If these insurers refuse to cover Russian shipments, then these shipments are not going anywhere.

Of course, commentators have noted that buyers could also insure cargoes, meaning that China and India could continue to receive Russian oil in substantial volumes as long as they can secure ships, which could also be a challenge.

Yet the very fact that the world’s seven richest countries have come together to cap the price of the world’s most traded commodity is a big deal: in a way, it’s an intervention in the market on a larger scale than the idea of ​​EU gas price caps. And that makes it potentially more dangerous.

If Russia implements its plan to stop selling oil to countries that apply a cap, it could lead to a further reduction in its oil production. This, in turn, would reduce the already tight global supply, pushing up oil prices and contributing to the inflation that the whole world is grappling with.

The biggest risk, however, is that these price cap initiatives open the door to more consistent market intervention in the future. If it can happen once, it could happen again, and each consecutive time would be easier and probably more natural. And if this type of intervention were to become chronic, so to speak, it would mark the very end of the illusion of a free market and the beginning of a new era.

By Irina Slav for Oilprice.com

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