After months of tense negotiations, the EU has agreed a mechanism to cap the wholesale price of natural gas. The breakthrough means a package of accompanying measures including joint purchasing of gas and faster renewables permitting has been unblocked. At the same time, negotiators agreed a raft of new climate and energy legislation pre-dating the current energy crisis that will upend the European energy transition.

Czech Energy Minister Jozef Sikela (centre right) and EU Energy Commissioner Kadri Simson (centre left) post with other energy ministers following their deal on a gas price cap mechanism. Sikela handed out sweatshirts to the ministers with his now-famous phrase: “We will convene as many Energy Councils as necessary”. (Photo by European Council)

On Monday 19 December, EU energy ministers agreed to a “dynamic” gas price cap that will be automatically activated if two conditions happen simultaneously: minimum-length gas contracts exceed €180 per megawatt hour (/MWh) on the Dutch TTF for three working days in a row and the price is €35 higher than a reference price for liquefied natural gas (LNG) on global markets for the same period. The mechanism will take effect from 15 February 2023, and if applied the cap will last for 20 working days. The TTF was trading at around €109/MWh on Monday.

The European Commission, Germany, the Netherlands and other Northern European countries have expressed grave concern that the measure will backfire and turn a price crisis into a supply crisis if gas providers choose to send LNG to global competitors like Japan that are willing to pay more than the EU’s cap.

Speaking after the deal was reached, EU Energy Commissioner Kadri Simson noted, “The mechanism adopted today has a lower level of activation than the Commission proposal.” However, she said conditions had been inserted to prevent a supply disaster. Before the new law enters force on 15 February, the EU energy regulator agencies Acer and ESMA will conduct impact assessments and if they find “possible adverse effects”, as Simson put it, the Commission can pull the plug and the law will not take effect. These impact assessments are due by the end of January.

Czech Energy Minister Jozef Sikela, who led the talks because the Czech Republic holds the rotating EU Council presidency until 1 January, stressed that even after activation, if the cap is causing problems it can be shut down. “We put safeguards in so it can be swiftly [and] in some cases even automatically switched off,” he said. These include if the dynamic bidding limit (the reference price for LNG on global markets plus €35) drops below €180/MWh for three consecutive working days or if the Commission declares an emergency; for instance, if the cap results in a significant increase in gas consumption.

The gas price cap deal means that a wider package of emergency EU energy measures including new legislation for joint gas purchasing, faster renewables permitting, gas-sharing solidarity and a new benchmark for the price of LNG could also be adopted on Monday.

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A new Emissions Trading System (ETS)

A day earlier, negotiators from the EU Council and Parliament ended marathon three-day negotiations with an agreement to set a carbon price on emissions from buildings and road transport fuels. This effectively expands the EU’s carbon market (EU ETS) to two new sectors, but in a ring-fenced separate system with its own prices. The new system will apply to petrol and diesel for cars as well as heating fuels such as natural gas for homes. The carbon price will kick in in 2027, with a ceiling until 2030 of €45 per tonne of carbon emitted. During the course of the negotiations, MEPs were successful in expanding the new system further than the Commission’s original proposal. It will now apply to some process heat from industrial activities that were previously considered building heat and exempt from the regular ETS, as well as office heating.

The EU ETS negotiations were contentious, with many fearing that new fuel costs at a time of already high energy prices would lead to a gilet jaunes-style backlash from the public. Studies have predicted that the new ETS will raise prices at the pump by up to €0.10 for a litre of petrol and €0.12 for diesel. The price rise for heating fuels for buildings is harder to predict but prices will invariably go up. For this reason, the agreement contains a safety clause that would delay the new scheme for a year until 2028 if energy prices remain “exceptionally high”.

To guard against the risk of public backlash and ensure a just transition, the new ETS is accompanied by an €87bn “social climate fund”. The money will start to flow as of 2026, one year before the new ETS starts. The fund will be 75% financed by revenues from the new ETS, with the remainder coming from national budgets. For the first year, the entirety will be funded by national budgets since the new ETS will not have started yet.

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Pascal Canfin, one of the negotiators for the Parliament, insisted that along with the fund, the €45 ceiling makes the new ETS “politically acceptable”. Broader ETS reforms mean “our industries will have to reduce their emissions by 62% by 2030 compared to 43% before this agreement”, he noted. Green MEPs, however, said they were disappointed with the result, with German Green MEP Michael Bloss saying the fund is “not sufficient”. The Greens have warned that layering new fees on households is the wrong approach at a time of spiralling energy costs, a concern Canfin also raised earlier this year.

Carbon border tax and methane

One week earlier, Parliament and Council struck a deal on an EU carbon border tax or carbon border adjustment mechanism (CBAM), which will mean products imported to the EU from countries that do not have equally stringent climate legislation will be charged an import levy. Its basis will be the same carbon price as in the main EU ETS, but it still has to be worked out how that standard will apply to the US, which does not have a carbon price or an ETS but on whom EU lawmakers have insisted the CBAM will not be levied.

“The Commission's initial proposal has been strengthened,” said Canfin. “The scope has been extended to hydrogen. We have also provided for the future integration of processed products such as cars. The message to our industries is clear: there is no need to relocate because we have taken the necessary measures to avoid unfair competition and carbon leakage.”

Last but not least, energy ministers on Monday also agreed a common negotiating position for upcoming talks with the Parliament on a new EU methane regulation. Both the Commission and campaigners reacted with concern to the watered-down approach taken by the Council.

“Member states have repeatedly weakened the methane proposal to the point that, in its current version, it would do very little to cut methane emissions,” said Jonathan Banks, global director for methane pollution prevention at campaign group the Clean Air Task Force. “While other countries are moving forwards with ambitious measures, the Council is going the other way, relinquishing the EU's international leadership on methane. It is up to Parliament to raise the ambition now or Europe will be looking at methane action that is ten years out of date.”

Climate campaigners said the flurry of recent energy decisions in Brussels is an important signal for increased momentum at the start of 2023. The changes to the EU’s flagship tool for fighting climate change, the EU ETS, combined with the new just transition funding and CBAM, will to a large extent define EU climate action for the coming years. At the same time, if the EU’s new gas price cap backfires and turns a price crisis into a supply crisis, these climate actions could yet be pushed aside as the EU grapples with an even bigger energy crisis next winter.