21.10.22 Analytics

Dynamic Ceiling

Germany is looking for a way to get by without Russian gas with minimal economic and social consequences

Artem Orlov
Europe continues to prepare for a winter without Russian gas and develop a strategy to reduce economic losses and prevent social instability. But these two goals are hardly compatible — helping households means aggravating the gas situation for the industry, while too generous subsidies will reduce incentives for consumption savings, the required level of which is about 20%. In Germany, whose economy is a driving force of the EU, the idea of a dynamic price ceiling is actively discussed amid bakery owners' and far-right demonstrations. However, the idea is to introduce it only at the end of winter.

The question of how Germany will handle the winter season is particularly acute not only because it is the largest EU country and a key political player in the European coalition but also because the German economy, the largest in Europe, serves as a certain kind of economical driving force for the EU. As IMF analysts wrote back in the summer in their comprehensive analysis of future energy crisis scenarios, the reduction of production in German industry due to shortages or exorbitant gas prices will severely impact the entire EU economy. As a result, by choosing to support people as a priority this winter, the EU threatens to provoke a stronger economic crisis, which will backfire on households through job losses and reduced incomes. The energy crisis became a central topic of discussion in Germany in the fall of 2022, just before the heating season. The shortage of gas led to a record price and cost-of-living increase. At one point, the cost of gas on the spot market hit $3800 per thousand cubic meters, while before the pandemic, it had been hovering between $200 and $400. High gas prices also led to a sharp rise in the cost of electricity, as its average cost is counted by production from the most expensive source — gas. High prices have led to the closure of small businesses in Germany, such as bakeries. Dozens of traditional and family-owned bakeries close every month in Germany because gas and electricity costs make businesses unprofitable. Monthly protests are held by bakeries all over Germany.

High gas prices have also caused a considerable increase in utility costs. The graphs below show a dramatic rise in gas prices for households and businesses in 2022.

The average cost of gas in Germany in 2014–2022, euro cents per 1 kWh

Cost of gas in Germany when the new gas contract was signed in 2022, Euro cents per 1 kWh

The energy crisis and falling living standards threaten to have political consequences. The latest regional elections in Lower Saxony on October 9 showed the growing popularity of the right wing: "Alternative for Germany" received 11% of the vote, almost twice as much as in the previous elections. In recent weeks, right-wingers have been able to mobilise people and hold mass protests. For example, on October 8, a mass rally organized by the "Alternative" in Berlin in front of the Bundestag attracted about 10,000 participants. 

To minimize the consequences of rising gas prices, German experts and politicians are actively discussing measures to support businesses and the population. The first support measure is a one-time payment. In the year's first half, low-income German households already received €230 payments. Soon, about two million German households will receive another €345 to €540 to pay their utility bills. However, this measure is ineffective and unpopular among the population: Germans say this is a drop in the ocean and a one-time measure that does not change the situation.

German experts and politicians are discussing the possible introduction of a ceiling on gas prices for households and businesses. This means the state plans to cover the difference between the fixed and market prices at its own expense. However, there are two types of this ceiling: rigid and dynamic. With a hard ceiling, a price of around ₵12-14 per kWh should be set for households and businesses for all gas consumed. This is about twice as high as the average values in recent years but significantly lower than the prices at which the new gas supply contracts for households are currently concluded (see figure above). This option is prevalent among households and businesses, but the ruling coalition and experts criticize it. First, it would be costly, and second, it would not create incentives for saving gas. Only strict market (i.e., price) restrictions can create such incentives. That is why some expert centers (e.g., "Center for European Policy", "CEP") suggest introducing a dynamic ceiling on gas prices.

In this scenario, the average gas consumption of each household and company is calculated for the past years, and the state fully subsidizes 60% of this volume. This means each company and family can buy this amount of gas for ₵12-14 per kWh. For the volume of 60% to 80% of average consumption, there will be a transitional regime when the price of gas rises but is partially subsidized by the government. The market price will be fixed for all volumes above 80%. The idea is that those limits will create strong incentives to save gas at a consumption level of 20%.

 The German government has set up a special commission ("Die Expertenkommission zu Gas und Wärme") to work out a final plan and submit it to the government for approval. The proposal is currently to set a dynamic price ceiling but with softer parameters. Consumption up to 80% of the average will be charged at ₵14 per kWh; beyond that, companies and households will have to pay the market price. There is a heated debate on which month this mechanism should start working; for now, it is either March or April 2023. In other words, German families and companies will have to survive the winter of 2022/23 without government subsidies.

The German government promises to leave no one without support. Last week, the ruling coalition agreed on where to get the money to finance the program. A bill has been submitted to the Bundestag that would change the budget for the coming year and spend €200 billion on the program. This measure should help German industry and households survive the energy crisis and prevent the Kremlin's plans to change Germany's position on the sanctions and support for Ukraine.