Explainer-Europe's much-debated plan to cap gas prices

By Susanna Twidale, Kate Abnett and Gabriela Baczynska

(Reuters) - European Union countries are negotiating a proposal by the European Commission to cap gas prices if they exceed 275 euros ($289) a megawatt hour (MWh) and meet other conditions.

The aim is to shield European households and businesses from the kind of gas price spikes experienced since Russia's invasion of Ukraine. High energy prices in Europe have fuelled the highest inflation in decades.

But the EU's 27 member countries are split over the price cap idea. Countries' energy ministers meet on Dec. 13 to attempt to agree on the cap, but as divisions persist, some EU diplomats do not expect a deal until later this month or even next year.

Here's what you need to know.

WHY CAP GAS PRICES?

Russia has reduced gas deliveries to Europe following its February invasion of Ukraine.

To try to limit the impact of the resulting high prices, around 15 EU countries have called for a Europe-wide gas price cap.

Gas prices have eased in recent months as the EU has agreed some emergency measures, including obligations to fill gas storage, but they remain high.

The front-month contract on the Dutch Title Transfer Facility (TTF) gas hub, which acts as the European benchmark, was trading around 145 euros per megawatt hour (MWh) on Wednesday.

That compares with 95 euros/MWh a year ago and 14.20 euros/MWh two years ago. The price spiked to record highs of above 340 euros/MWh in August.

HOW WOULD THE EU CAP WORK?

The European Commission proposed on Nov. 22 a cap that would kick in if the front-month TTF contract exceeds 275 euros/MWh for two weeks and is also 58 euros higher than a Liquefied Natural Gas (LNG) reference price for 10 consecutive trading days.

If these conditions are met any trades above the cap level would not be accepted. The Commission could immediately suspend the cap if it had negative consequences, including risks to Europe's gas supply.

It would not affect private gas trades outside energy exchanges, which the Commission said were a safety valve for critical deliveries and were unlikely to take over any major share of trade.

WHAT DO EU COUNTRIES THINK?

EU countries widely criticised Brussels' proposal, reflecting long-held divisions between nations over whether to cap prices at all.

Belgium, Greece, Italy, Poland and other countries that want a cap said the proposed level was too high and the conditions to apply the cap were so strict it would never be triggered - with some calling the proposal a joke.

EU countries are considering a revised version of the EU proposal, which would lower the cap to 220 eur/MWh and make it easier to trigger.

But Europe's biggest gas buyer Germany, as well as the Netherlands and Denmark are opposed to price caps. They say capping prices will disrupt the normal functioning of Europe's energy market and make it harder to attract much-needed fuel, if gas suppliers divert cargoes to regions where prices are higher than the EU's capped level.

Spain, the Netherlands and other countries dissatisfied with the EU proposal have also put forward their own alternatives.

WHAT DO GAS MARKET PARTICIPANTS THINK?

Market actors including the Intercontinental Exchange (ICE), which hosts gas TTF trading, have warned the Commission not to go ahead with its proposal.

In a memo sent to the Commission, seen by Reuters, ICE said the proposal could drive up gas prices because liquidity providers were likely to stop selling TTF gas futures if prices climbed even near to the cap level, and that the resulting shortage of sellers would drive prices higher.

The Association of European Energy Exchanges has said the EU plan could pose a major risk to financial stability in Europe's energy markets, and cause utilities to move to more risky private trading to avoid the cap.

Derivatives markets association FIA on Wednesday said the EU proposal would cause "unacceptable levels of systemic and operational risk" and not necessarily reduce energy prices.

The EU energy commissioner Kadri Simson this week met representatives from energy exchanges to discuss their concerns. The EU proposal includes "strong safeguards" to avoid negative consequences, she said.

NEW GAS PRICE BENCHMARK

The price cap is designed to be a temporary fix that would apply from Jan. 1 for one year.

As a longer-term solution, the Commission wants to form a new LNG price benchmark in Europe, and has asked EU energy regulators to launch one by March 31, 2023.

Historically, the gas price at the TTF hub has been used as a benchmark for LNG deliveries into Europe. But the major reduction of Russian gas supplies this year has made the TTF price extremely volatile, and often more expensive than LNG prices in other regions.

Brussels says a new index is needed since the TTF is guided by pipeline supply and no longer represents a market that includes more LNG, as Europe has increased its use this year to replace Russian pipeline gas.

The benchmark's success would depend on whether the gas industry uses it.

($1 = 0.9522 euros)

(Reporting by Susanna Twidale in London, Kate Abnett and Gabriela Baczynska in Brussels; Editing by Barbara Lewis and Jane Merriman)