Written by 8:26 am Europe Economy

A Price Cap on Gas Is the Wrong Answer to Europe’s Energy Crisis

Don’t just do something; sit there. So goes an old witticism among meditators. Just sitting there, of course, isn’t a luxury available to policymakers during an emergency such as the energy crisis caused by Russian President Vladimir Putin. Leaders of the European Union feel they must do something — anything, right now, before winter.

Unfortunately, the something they’re converging on is likely to make the continent’s problems worse. Among all the insanely high prices around us, the most obscene is the going rate of natural gas. So the European Commission, under pressure from a majority of the EU’s 27 member states, is proposing a cap on gas prices.

To think through the implications of such a price ceiling, I’ve been corresponding with Lion Hirth, a professor at the Hertie School in Berlin. He started by reviewing the situation we’re in. 

As part of his brutal aggression against Ukraine, Putin has turned off almost all the gas flowing to western Europe via pipelines from Russia, formerly the EU’s biggest supplier. Other providers, such as Norway, are pumping as much as they can, but their capacity is maxed out. New supplies, in the form of liquefied natural gas, will take time to come online, because countries like Germany first have to build the specialized terminals to receive the ships.

All this means that the supply of natural gas is fixed — or perfectly inelastic, in the jargon of economics. That in turn implies that “demand is setting the price,” says Hirth. If companies or households save and consume less, the price falls. If they don’t save or use even more, the price rises.

As ever in economics, the price is therefore merely a summary of all the underlying information in the market. But it is also a signal. By exacting pain on businesses and people, the cost of gas is encouraging those who can to cut down on their usage, by saving or switching to other fuels.

Now ponder what a cap would do. Instead of signaling pain or unaffordability, the new and artificially low price of gas would suggest business as normal. The incentive or imperative to cut back would fade or vanish. Demand would increase again, with no additional supply. At some point this winter, Europe’s storage tanks would be empty. The continent would then be out of gas — physically and nonnegotiably.

Governments wouldn’t quite let it get to that point, of course. They’d instead start rationing some time before the gas runs out. Politicians or technocrats would decide which factories may use how much, and which must temporarily shut down altogether. We’d finally be in the “war economy” that I warned about in June.

One alternative — which the European Commission is including in its rather confused proposal — is to combine a price cap with mandatory savings measures. But that’s just a euphemism for rationing. And if governments did start rationing now, the price of gas would fall all by itself — remember, right now demand alone sets the price. So the cap would be superfluous.

Nobody likes forced rationing (as opposed to voluntary saving), so is there a better alternative? There is. But the prerequisite is to forget about caps and let the price go where it will.

The task of governments then becomes absorbing the resulting political, economic and social pressures by offering direct cash payments to those who need them most, whether firms or households. These handouts wouldn’t be reimbursements for gas bills — that would once again negate price signals. They’d come without strings attached, so that a family that still saves on gas by turning down the thermostat has more left over for food, say.  

Ours being an imperfect world, this policy would also have big drawbacks. It would be more complex to administer than a deceptively simple price cap. Technocrats and politicians would have to decide who deserves the payments — ideally, in a way that minimizes waste and fraud.

This approach would also open up old rifts in the EU between countries that have greater “fiscal capacity” — that is, those that can borrow more cheaply — and others that can’t afford such largess. This tension explains the outrage in France, Italy and other countries at Germany’s latest relief package — worth some 200 billion euros ($197.6 billion). If the EU and Germany want to do this right, they’ll raise the money at the EU level and allocate the relief evenly across the bloc — as they did during the Covid-19 pandemic.

Confusing price with an underlying shortage — in effect, shooting the messenger — is hardly a new phenomenon. One cause of the French Revolution was the soaring cost of bread; but it was as daft to blame price instead of the scarcity of grain as it was for Marie Antoinette to (allegedly) suggest that the mob eat cake. The same applies to rent controls in cities such as Berlin, which may lead to cheap housing for some but also none at all for many others. 

By the political logic of populism, such economic reasoning is irrelevant. It would certainly be easier for Europe’s politicians to give voters the simplest answer. They could cap the prices of nasty expense items, declare victories and hope that their economies don’t tank before the next election. 

By the logic of responsibility and statecraft, however, politicians should leave prices untouched as the best signals we have to guide us through shortages and back to functioning markets. To make that journey bearable, governments must support the most vulnerable with cash. 

Nobody is suggesting this course will be fun or easy. But if you want to get angry, remember who’s to blame: Not a price, not the EU or its politicians, but Vladimir Putin.

More From Bloomberg Opinion:

• Windfall Profit Taxes Are Pure Economic Populism: Andreas Kluth

• UK Power Blackouts May Be Unavoidable This Winter: Javier Blas

• A Crisis Is Coming in Europe. The Only Question Is, Which Kind?: Tyler Cowen

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andreas Kluth is a Bloomberg Opinion columnist covering European politics. A former editor in chief of Handelsblatt Global and a writer for the Economist, he is author of “Hannibal and Me.”

More stories like this are available on bloomberg.com/opinion

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