High energy prices: How a gas price cap works

The federal government has announced a possible upper limit for gas prices. But what could the instrument look like? How much does it cost the state? And where are the catches? An overview.

Thanks to the now full storage facilities, record high imports of liquefied natural gas (LNG) from the USA and new supply agreements, the price of natural gas fell to its lowest level since the end of July at the beginning of the week. Nevertheless, it is still at a historically high level. The federal government wants to present an “overall solution” for the burdens on citizens in the coming days. Part of the plan could be a price cap for gas, which more and more politicians are calling for.

What is a gas price cap?

A price cap represents an upper limit intended to protect consumers and companies from skyrocketing energy costs. At the weekend, Chancellor Olaf Scholz promised timely proposals to curb the high costs. It’s now about “how we can reduce the far too high prices, both those for electricity and those for gas,” said the SPD politician. A commission started consultations on Saturday and is doing “very good, constructive” work. “We will also be able to count on quick results.”

What might the results look like exactly?

In some European countries there are already regulated tariffs that cap the price on the energy markets. There are different models. One possibility is regulation in the wholesale market, as is the case in Spain and Portugal. The measure starts with the transactions between the energy producers and the companies that produce electricity using gas. The companies are prohibited from doing business with each other above a fixed maximum price.

A second way is a model that caps the tariff for end customers. In Great Britain, for example, the regulator does not dictate to the producers, but rather to the suppliers, what maximum price they are allowed to offer to households and companies. This is regularly adjusted to the respective costs of the dealers. The most recent price cap for households of two to three people: an average of £3549 for heating and electricity. Retailers who set their annual prices above this limit will be penalized.

How much cheaper will gas be as a result?

Consumers in Germany will have to dig deeper into their pockets for gas this year than ever before. According to the comparison portal Check24, a model household with a consumption of 20,000 kilowatt hours (kWh) currently has to pay an average of 4371 euros per year. This corresponds to an average price of almost 21.9 cents per kWh. In September 2021, the same amount of gas still cost 1316 euros.

How much customers would save by capping prices depends on consumption. An average family household with an annual gas consumption of 20,000 kWh would save around 200 euros per year with every cent waived per kilowatt hour. For a single household with a requirement of 5000 kWh, it would be around 50 euros per year.

In addition, there may be dampening effects on the general inflationary wave in Germany. Sebastian Dullien, scientific director of the Institute for Macroeconomics and Business Cycle Research (IMK) of the Hans Böckler Foundation, points to a stabilization of inflation expectations, which reduces the risk of a wage-price spiral.

How expensive would a price cap be – and how is it paid for?

Basically, the state has to cover the difference between a defined upper limit and the market price in order not to burden the suppliers additionally. For the first time, the federal government gave figures on the costs of a possible cap on electricity and gas prices on Sunday. According to this, an amount of 2.5 billion euros would be required from the state treasury in order to reduce the end consumer price for gas by one cent per kilowatt hour. This emerges from a response from the Federal Ministry of Economics to a left-wing request that is available to the newspapers of the Germany editorial network.

The President of the German Institute for Economic Research (DIW), Marcel Fratzscher, expects much higher costs: “The magnitude of 30, 40, 50 billion or more are quite realistic,” he told the broadcasters RTL and nv. “The total amount that results in the event of a price cap depends on how high the cap is set and how the end consumer prices continue to develop,” says Patrick Graichen, Secretary of State for Energy. The costs vary accordingly depending on the model. However, they all have one thing in common: the open question of financing.

“I have an idea in which direction this is going,” announced Finance Minister Christian Lindner yesterday in the ARD program Anne Will without giving details. His central promise is to comply with the debt brake again in the coming year. Representatives of the Greens and SPD, on the other hand, have long been calling for the constitutional regulation to be suspended. For Fratzscher, too, the debt brake “actually cannot be complied with, if you are honest” and pointed out that it can be suspended in emergencies.

Similar to the strengthening of the Bundeswehr, there is also a special fund for the economy in the room. For the government, this would have the advantage that the loans would count towards the national debt, but would not fall under the requirements of the debt brake. There have also recently been calls for an excess profit tax for energy companies, which could be used to finance the gas price brake.

What do experts say about this?

In addition to the financing and the high level of bureaucracy, economists refer to two crucial points in the debate. First: the dilution of savings incentives. “We are very concerned that end customers will save too little if the prices are too low,” said Georg Zachmann, an energy expert at the Brussels think tank Bruegel, in an interview with tagesschau.de. The price mechanism is one of the few that actually has a steering effect from an economic point of view.

Economics Veronika Grimm also emphasized that gas had to be saved urgently, otherwise there would be a shortage in winter. A gas price cap therefore only makes sense “if it is associated with major savings incentives”. That is basically the case if it only applies to a basic quota. At the same time, bonuses could also be paid out for those who use little gas.

The second sticking point: the lack of accuracy. Consumers who could actually afford it would also benefit from a general gas price brake, Justus Haucap, Director of the Düsseldorf Institute for Competition Economics (DICE), recently criticized tagesschau.de. “We have to concentrate on those who really need it,” said Clemens Fuest, President of the Munich ifo Institute on Sunday Anne Will.

For IMK director Dullien, on the other hand, a price cap for gas is precise because it reaches exactly those households that heat with gas: “And these are the households that will be particularly heavily burdened by heating costs in the next few months.”

Are there any specific suggestions in that direction?

In the past few days, there have been an increasing number of proposals that respond to the economists’ criticism. For example, Greens leader Ricarda Lang advocates a two-stage model with a defined basic requirement. Only this should be subsidized. Consumers should then buy additional gas at market prices. According to experts, this idea could lead to success – if the basic requirements are not set too high.

A concrete plan for a nationwide cap by the state government of Mecklenburg-Western Pomerania, which is to be discussed this week in the Prime Ministers’ Conference, provides for the energy price for private households to amount to 80 percent of the average consumption in the reference years 2019 and 2020 set a fixed price. The envisaged fixed prices should be at the level that existed on the market in Ukraine before the war, said Economics Minister Reinhard Meyer (SPD) on Friday. If you need more energy, you have to pay current market prices. That is a reasonable incentive to save.

The CSU has also proposed a gas price cap for three quarters of private consumption. The trade union ver.di also demands that the costs for the normal consumption of a family of four of 12,000 kilowatt hours be kept at the 2021 level. The German Trade Union Confederation estimates a basic requirement of 8000 kilowatt hours for 7.5 cents per unit. Households with more people should receive a higher cap proportionately. For comparison: According to Check24, the price per kWh was just under 6.6 cents a year ago.

Are there other catches?

Experts also mention other disadvantages of a price cap – depending on the design. Regulation on the wholesale market could lead to complicated distortions, stressed economist Zachmann. An intervention in the mechanism of supply and demand could ensure that gas is missing somewhere and, as an alternative, oil has to be burned or industrial processes have to be shut down.

Haucap also warns against national solutions if gas is also subsidized for power generation, as is the case in Spain: Due to the entanglements in the European internal market, one must “assume that the subsidized energy will then also be bought in other countries.” Therefore, in this case, a transfer to the whole of Europe should take place, according to the professor of economics. If gas is only reduced for private households, that is not a problem.

And what happens to the gas surcharge?

As of now, the gas surcharge will come on October 1st, which would increase gas prices again. The surcharge is intended to support gas importers who have stumbled due to the lack of Russian gas and ultimately to secure the supply. At the weekend, however, representatives of the traffic light coalition made it clear that they would no longer pursue the gas levy on citizens.

A gas price cap would probably finally mean goodbye to the controversial measure by Economics Minister Robert Habeck. Even from Green circles it was said recently that “it makes no sense to cap prices and at the same time raise the levy”. Finance Minister Lindner also seems to be certain: get rid of the surcharge and bring in a gas price cap. After a meeting of the FDP presidium in Berlin, the party leader urged a “high speed”.