Price caps and exceptional taxes likely won’t solve Europe’s stalled energy market: QNB
Price caps and exceptional taxes will not solve the broken energy market in Europe; QNB said and noted that high energy prices are expected to last at least until next spring, if not longer.
European policymakers are facing an unprecedented constellation of shocks hitting the economy, including stagflation, war in Ukraine and last summer’s record heat waves. Together, these shocks have impacted European energy and power markets, QNB said in an economic commentary.
Gas produces 20% of electricity in Europe and, above all, is often the marginal producer, so gas prices set electricity prices. Indeed, electricity prices have soared in Europe and are breaking new records, reaching more than 10 times their average for the last decade.
In July, members of the European Union (EU) agreed to reduce gas consumption in Europe by 15% until next spring through the European Gas Demand Reduction Plan. This plan, however, was insufficient as Russia continued to reduce and even threatened to continue to stop the volume of gas delivered to Europe. This leaves political leaders desperate for effective policy responses.
According to QNB, European policymakers have made three main policy proposals ranging from windfall taxes to price caps and relief packages.
One concept being considered across Europe is a tax on companies that have made surprisingly high profits from high energy prices. However, there is no agreement within the EU on which companies should be targeted by this tax and on the sources (i.e. oil/gas/nuclear/energy renewables) that must be included.
While some countries like Spain, Greece and Italy have already introduced such taxes, others like Belgium, Germany and Austria have yet to do so. These taxes leave the consumer reallocation mechanism open with an uncertain effect on the desired intent.
Furthermore, their design and implementation might not be harmonized across EU countries and therefore present potential constitutional challenges at the individual country level. It also limits the idea of reinvesting profits for the energy transition from fossil fuels to cleaner and more sustainable energy sources.
The idea of price caps sets a maximum ceiling on the price that European energy companies can charge their customers. This would in principle limit the level of prima facie high energy price inflation for consumers, both households and businesses.
While price caps can help control the effects of rising energy prices, they neglect the consumer wealth effect. Wealthier consumers have less incentive and incentives to reduce their energy consumption than consumers with a lower level of income and liquidity.
Therefore, the effect is limited because in most cases the 20/80 rule applies, where larger companies and wealthier households have the highest contribution to energy consumption.
Moreover, price caps do not constrain energy prices when meeting certain basic energy consumption needs. German policymakers pointed out that price caps would reduce the excess profits of energy companies and therefore limit the effect of windfall taxes.
Finally, relief programs are targeted measures that provide financial support to low-income households, small businesses and essential industries to reduce the economic damage caused by temporary price spikes.
Relief programs are targeted and more likely to generate greater economic benefits than the other alternatives under discussion. Relief programs are likely to be more effective because they encourage users to reduce their consumption.
The measures proposed so far to decouple electricity prices from energy prices seem insufficient and ineffective in reducing energy consumption, protecting consumers from rising prices and avoiding rationing supply for avoid a significant slowdown in economic growth.
“High energy prices are expected to last at least until next spring, if not longer. This represents a significant economic risk for Europe with additional inflation and weak growth, as it will be difficult and time-consuming to find a mutually beneficial consensus in a widely dispersed economic region,” QNB noted.