Energy prices in Europe started rising in autumn 2021. Energy demand had increased as the COVID-19 pandemic receded, which coincided with a tight liquified natural gas (LNG) market and relatively low gas storage volumes going into winter 2021/22. In early 2022, Russian aggression towards Ukraine and the corresponding reduction in Russian gas supplies to Europe fuelled further price increases, with gas prices increasing tenfold relative to the previous year. Prices at the Dutch Title Transfer Facility (TTF), the largest and most liquid gas hub in Europe, were particularly high, and price differentials with other market areas and LNG prices also increased over 2022.

This led to concerns about the impact on electricity prices and the wider impacts of inflationary pressures building in the economy. Alongside this, concerns were raised about greater gas price volatility and whether the TTF continued to be representative of market conditions elsewhere in the EU. In response to high gas prices, the European Commission (‘the Commission’) put forward proposals to intervene in the gas market, including a market correction mechanism that would effectively establish a price cap on certain TTF derivatives.

In light of these developments, the Intercontinental Exchange (ICE) commissioned Oxera to analyse the functioning of the gas derivatives market. Our findings indicate that the market is functioning well, providing liquidity to give market participants effective hedging opportunities. The price developments and price differentials between TTF and other markets can be explained largely by market fundamentals, such as infrastructure constraints on pipelines, interconnectors and LNG terminals. This has implications for the most effective policy response. We find that the European Commission’s price cap proposal is unlikely to achieve its intended effect of reducing market prices for gas, and may have unintended consequences. While there is still a rationale for a targeted package to address the consequences of high energy prices on consumers and businesses, it is unlikely that the proposed price cap is the most effective policy tool. Ultimately, the design of any policy package to address the current energy price crisis should consider the benefits, costs and risks of different measures.