Price Cap Backlash

You show me a price cap and I will show you a shortage, states Phil Flynn of PRICE Futures Group.

Government meddling and intervention in global commodity prices continue to increase risks for the global economy. Not only have we seen record-breaking strategic oil releases to try to control prices, but threats to cap commodity prices are already raising havoc in global markets. Not only are these actions discouraging much-needed investment in the oil and gas space, but also is threatening to reduce the current supply when it may be most in need. And it is not just Russia that is warning again today of a reduction of supply due to price caps. Today the EU received a stark warning from the Intercontinental Exchange that they may pull its gas trading market out of the Netherlands if Brussels presses ahead with a plan to introduce a cap on prices.

The Financial Times reported, “In a memo sent to member states on Thursday, and seen by the Financial Times, ICE warned that the rapid imposition of a cap would give it no time for customers to adapt or for the market operator to test the system’s resilience and risk management systems. A cap would likely force traders to immediately recalculate their prices, risks, and costs, putting greater strain on the market, it said. “As a consequence, it is the responsibility of ICE as the market operator to consider all options if this mechanism is agreed, up to and including whether an effective market in the Netherlands is still viable,” the memo said.

This could have a huge impact because as Reuters pointed out, “The TTF is the most liquid gas futures market in Europe, attracting a wide range of gas suppliers, wholesalers, and speculators. Reuters says that Dutch gas network operator Gasunie, which set up the TTF in 2003, has said that hosting the TTF trading platform also brings benefits to Europe’s fuel supply since trading activity attracts gas, boosting the stability of supply in the Netherlands. The European Commission last month proposed a cap that would kick in if the front-month price on the TTF gas hub exceeded 275 euros per megawatt-hour for two weeks, and was 58 euros higher than a liquefied natural gas reference price for ten days.”

The reason they say that a price cap is needed is to drain capital from Russian President Vladimir Putin’s war machine as he wages war in Ukraine. They also have a clandestine hope that it may also reduce inflation by keeping energy prices low. Yet the price cap folly will have the opposite effect. 

Russia is warning again today of a reduction of supply due to price caps. Tass reported that, “Vladimir Putin told reporters on Friday that Russia is considering cutting oil production as one of the measures in response to the decision of Western countries to introduce a price cap. “As for our reaction, I have already talked about it—we simply will not sell to the countries that make such decisions. We will think about the possibility of production cuts, if necessary. We have an agreement with OPEC+ on a well-known production target. We will think of something additional if we need it. I mean Russia specifically,” Putin said.

Even with these upside risks to prices, in the short-term oil is caught up with concerns about a slowing global economy. Oil prices sold off along with global stock markets mainly because ECB President Christine Lagarde sounded very hawkish. Christine Lagarde echoed the sentiment from Fed Chairman Jerome Powell’s warning not to get too complacent because the war against inflation has just begun.

The market started to price in higher interest rates and an increased risk of recession thereby raising concerns about future oil demand.

Yet what we should be worried about perhaps is the cold weather that is going to hit large parts of the United States. Oil Price.com’s Juliane Geiger reported that the Texas Railroad Commission is warning oil and gas pipeline operators that next week they will see significantly colder temperatures. They are warning that they should be monitoring weather reports and secure all personnel equipment and facilities to prevent injury as well as prepare for the operation’s potential impacts from the storm. Oil Price points out that in February of 2021 Texas found itself woefully unprepared for freezing temperatures. Right now, they do not want to repeat those mistakes.

We are also going to get an idea of how well they have improved their wind turbine situation which caused major power outages.

We believe that while oil and product prices are struggling now, overall fundamentals are extremely bullish. Be prepared for a lot of volatility. China is reopening its economy and even though that enthusiasm is being tempered a bit because of rising covid cases, the reality is that we’re going to see increased demand out of China. We think fears of global oil demand destruction are being overplayed and we expect a very tight market in the coming months.

Natural gas prices are seeing high volatility ahead of the polar vortex. The big question for this market is how cold it will get. The other question is how long will it stay cold? We are going to see some challenges here and it appears that if the temperatures stay cold for a while, we could be in for a major move to the upside if the polar vortex lingers. One downside risk is the Freeport LNG terminal which still has not filed its restart papers as of now.

Learn more about Phil Flynn by visiting Price Futures Group.