AS EUROPE CAPS ENERGY BILLS, THE MERITS OF PRICE CONTROLS GET ANOTHER LOOK / THE WALL STREET JOURNAL

As Europe Caps Energy Bills, the Merits of Price Controls Get Another Look

Critics say price controls reduce supply and discourage conservation; advocates say those predictions don’t apply to these energy price caps

By Andrew Duehren

Some European governments, including Germany’s, are seeking to cap the price their households and companies pay through subsidies. Apartment buildings are seen in Berlin at dusk. / PHOTO: SEAN GALLUP/GETTY IMAGES

The highest inflation in decades and the steep drop in Russian natural gas exports to Europe have pushed a growing number of governments to experiment with ways to control energy prices. 

The plans will test the economic wisdom that price controls distort markets and create supply shortages.

In the U.K., the new government is planning to cap household energy costs and pay utilities the difference between the cap and market prices, and Germany is working up plans to cap the cost of electricity and natural gas. 

The European Union has approved both a plan to claw back some energy companies’ profits and redistribute them to consumers, and it is also exploring the creation of a cap on the price of natural gas across the bloc. 

The U.S. is leading an effort with its allies to cap the global sales price of Russian oil, while a United Nations agency last week called for policy makers to opt for price caps and windfall taxes to fight inflation.

Economic textbooks predict that imposing a lower price on a product will reduce its supply. 

Unless demand is also sufficiently reduced, possibly through rationing, the mismatch between supply and demand can create shortages. 

Enforcing price controls can also be difficult and require a large bureaucracy. 

And since controls are usually lifted at some point, higher costs to consumers are only delayed, not prevented. 

The U.S. imposed price controls during World War II but also rationing. 

Lines at gasoline stations in the 1970s were blamed in part on price controls imposed at the time.

“Economists tend to be very skeptical of the efficacy of price controls,” said Christopher Knittel, an economics professor at the Massachusetts Institute of Technology.

Energy-price caps can be difficult to enforce and cause suppliers to send their energy elsewhere. Oil tanks in Wesseling, near Cologne, in Germany. / PHOTO: MARTIN MEISSNER/ASSOCIATED PRESS

Those concerns have arisen in response to a proposal in the European Union, supported by EU leadership and member states like Italy, France and Spain, to cap the price the bloc pays for natural gas. 

Opponents, including Germany, worry this will cause suppliers, who are predominantly outside Europe, to send their gas elsewhere. 

That proposal is separate from an already approved plan to cap the revenue of non-gas energy producers and redistribute the money to consumers.

Mr. Knittel said the plans risk reducing Europe’s access to energy. 

“Especially with the European energy-market policy interventions, what policy makers do not want to do is exacerbate these problems with their policies, and my fear is that is what these proposals would do,” he said.

Similarly, a U.S.-led proposal to allow Russian oil exports only at a capped price has met resistance from industry experts who think it could cause Russia to withhold supply, pushing prices higher. 

Under the price-cap proposal, companies within the G-7 would be barred from servicing Russian oil shipments unless the oil is sold below the cap.

But not all price controls are the same, and advocates say there are reasons some of today’s proposals won’t have the predicted negative effects. 

Germany and the U.K., for example, are seeking to cap the price their households and companies pay through subsidies: Governments will pay the market rate for energy while capping what companies and consumers pay, absorbing the difference themselves. 

This, they hope, will avoid the negative incentive to supply energy that classical price controls involve.

In the U.K., government officials hope their energy plan would reduce peak inflation by 4 or 5 percentage points. A neighborhood in the Mossley district of Greater Manchester, U.K. / PHOTO: ANTHONY DEVLIN/BLOOMBERG NEWS

On the Russian oil-price cap, U.S. officials are aiming to set the cap at a level that would preserve Russia’s economic incentive to produce. 

They believe Russia would accept lower profit margins before shutting in their government’s dominant source of revenue.

Some economists, including the University of Massachusetts Amherst’s Isabella Weber, also argue the predicted increase in demand in response to price controls won’t occur. 

That is because unlike some other goods and services, households need energy to subsist, and how much they consume is relatively insensitive to changes in prices, or, in economic terminology, “inelastic.” 

This means price caps would protect consumers without encouraging them to consume significantly more and exacerbate shortages.

The savings to consumers are indeed substantial: The London-based Institute for Fiscal Studies said a typical household in the U.K. can expect to save £1,800, equivalent to $2,000, during the next year from the U.K. plan. 

Government officials hope their plan can reduce peak inflation by 4 or 5 percentage points.

Still, Peter Levell, an associate director at the IFS, said without reliable access to Russian natural gas, Europe could face an energy shortage for years. 

That means governments need to find a way to reduce demand over the long run, he said. 

Otherwise, unmitigated demand for natural gas across Europe could push gas prices even higher while requiring continuing, large-scale subsidies, he said.

“There’s clearly an expectation in the government that this is going to last for a long time. 

So we need to start thinking about how we can design these systems better,” he said. 

Ms. Weber also thinks governments should encourage reduced demand.

In Russia, a view of Gazprom’s Orenburg natural gas processing plant. / PHOTO: ALEXANDER MANZYUK/REUTERS

In Europe, Brussels is encouraging countries to marginally reduce electricity demand this winter in a bid to avoid shortages. 

The German plan would only apply the cap up to a certain level of consumption, which has yet to be determined. 

Above that level, market prices would apply.

The West’s foray into energy-price controls comes amid a broader debate over whether price controls deserve more attention as a way to address current high inflation. 

To Ms. Weber, who said she helped advise the German government on its price-cap proposal, the turn across the West toward price controls is a long-awaited recognition of the idea’s merit.

For fossil fuels in particular, Ms. Weber believes governments could take more aggressive steps to control prices and cut into companies’ profit margins. 

The Russian oil price cap should apply to all oil sold globally, she said.

“I think this whole paradigm shift is happening here,” she said. 

“The reason I was making these arguments early on was because I saw us heading into an emergency economic situation and others assume we are back on a path to a normal state.”

But Simone Tagliapietra, a senior fellow at Bruegel, a Brussels-based think tank, disagrees. 

Europe’s “real problem is a mismatch between demand and supply, and a price cap will not reduce demand,” he said.