Is Setting A Price Cap One Of The Worst Solutions?

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Credit: Maxim Hopman/Unsplash

Without compromising the market, there are better ways to assist consumers and promote renewable energy, as reported by Bloomberg.

Gas price cap

Once again, the European Union is at a standstill. Governments must come up with strategies to lessen the shock of high costs, safeguard the weak, discourage consumption, and hasten the transition to alternative energy sources as a result of Russia’s withholding of the gas supply.

Sadly, EU officials are experimenting with a price cap, which has a very high likelihood of making matters worse.

The threat posed by exorbitant energy prices is undeniable. Natural gas costs around €140 ($148) per megawatt hour at the benchmark Dutch Title Transfer Facility, down from a record of over €300 in August but still significantly more than the pre-crisis average of roughly €20. With the rising cost of living on top of it, many Europeans may find it nearly impossible to afford their winter heating and electricity.

Worst solutions 

However, setting a price cap is one of the worst solutions. For starters, it’s highly unlikely to function as promised because providers would sell as much as they can elsewhere if they can’t receive the market price, worsening shortages. Even worse, if the cap is mandatory, it will stimulate consumption, depleting valuable resources and possibly necessitating restrictions imposed by the government. Therefore, it is fortunate that European leaders have not yet reached a binding cap. The initial plan from the European Commission, which is backed by nations like Germany and the Netherlands, sets the ceiling so high that it is unlikely to ever be triggered. However, this strategy has also angered certain nations, such as Italy and Poland, escalating divides at a time when cooperation in the face of Russian aggression is essential.

Unsatisfactory compromise

When they meet again, officials should abandon the idea of a price ceiling entirely and examine other options rather than coming to an unsatisfactory compromise.

In a perfect world, governments would allow the market to determine prices and provide direct subsidies to the most vulnerable customers to lessen their suffering. This would maintain the price signal, discourage use, and promote the switch to greener fuels.

The second-best option, if that proves difficult, is Germany’s “gas price brake,” which subsidises prices up to a specific percentage of normal use (80% for homes, 70% for industry), but thereafter permits full market rates to prevail. This provides some alleviation while preserving the incentive to preserve, which is advantageous for both Germany and its neighbours, while not being properly targeted for the poor.

Funding investments 

Getting other European governments to embrace these policies is difficult. Italy and other nations support price controls among other reasons because they cannot afford systems like Germany’s, which is projected to cost $54 billion through April 2024. That justifies setting up a fund to address the EU’s energy crisis. Similar to the fund established to handle the coronavirus pandemic, it would lessen the impact of a particular shock that occurs to have an uneven impact on the member countries. It might be used to fund investments in greater energy independence from Russia as well as subsidies intended to lower gas demand. The leaders of Europe should take advantage of this chance to move closer to a greater union rather than fighting over ineffective policies.

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Source: Bloomberg

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