If You Are A Hammer Everything Is A Nail - The Case Against Energy Price Caps

3rd February 2023

This article is from Epicenter- The European Policy Information Center.
Author - Carlo Stagnaro, Research and Studies Director at Instituto Bruno Leoni.

As energy prices soar this year, policymakers in the European Union and the United Kingdom have proposed various
measures aimed at limiting energy inflation. These include both price controls (such as price caps on natural gas or electricity)
and windfall profit taxes on energy companies.
However well-intentioned, these policies are unlikely to succeed. In fact, they might exacerbate the current crisis. High prices
are not a market failure; they are the tool through which well-functioning markets convey a crucial piece of information
regarding the scarcity of energy supply relative to the demand. High prices incentivise investments to increase the supply of
energy while disincentivising consumption.

This briefing reviews the proposed price caps and windfall taxes and explains why they are short-sighted measures with longterm costs that are likely to exceed expected benefits. It closes by suggesting targeted measures to support low-income
households and energy-intensive businesses while reducing red tape and other obstacles that prevent a rapid rise in the
supply of energy, including renewable energies, nuclear power, and domestic production of natural gas.

If you are a hammer, everything is a nail
British and European policymakers seem to believe that most, if not all, energy-related problems can be solved by capping the
prices of power and gas.
One underlying idea is that the market price of natural gas does not reflect the fundamentals. The balance of demand and supply
- the argument goes - has not changed significantly since the beginning of 2022, whereas prices have been volatile. This must
be due to speculation. To stop it, an emergency break should be introduced to protect energy markets from frenzies.
Second is the political imperative to address high prices. With businesses furloughing operations and staff - and elderly,
vulnerable citizens having to choose between heating and eating –price controls are appealing due to their immediacy, even if
they may give rise to worse problems down the line. Those are problems for future politicians, representing different electorates.
This briefing addresses the main proposals concerning price caps or other forms of price controls. It starts by discussing the
economic role of high prices in well-functioning markets. In a time of scarcity, high prices are a feature, not a bug, of the market.
Then, the briefing reviews the main proposals concerning price caps on natural gas and electricity as well as the proposals on
windfall profit taxes. The briefing concludes by suggesting how governments may address the threat of a recession induced by
high energy prices without tampering with prices and ultimately exacerbating the crisis.
The role of high prices
Policymakers in both the European Union and the UK are struggling to find ways to forcibly reduce wholesale and retail energy
prices. This may be achieved either by capping prices or taxing the revenues of energy companies to fund redistributive policies.
All these attempts consider high prices a problem to be addressed – and possibly to be cancelled out – rather than a tool by
which markets pursue a more sustainable equilibrium between demand and supply. The main assumption, however, is that
governmental interventions targeting the prices (either absolute or relative) of energy products shall only – or mainly – have
redistributive, not allocative, consequences.
This is plainly wrong. Prices are not independent of the current and forecasted demand and
supply. They reflect (actual or expected) scarcity. The current energy prices in Europe
suggest that there is less energy (particularly less natural gas) than what Europeans would
like to have. Therefore, the price system tells consumers that energy is becoming more
scarce – and therefore, more precious – than before and that, therefore, they should use
less of it. Any artificial reduction of energy prices will induce consumers to consume more
energy than optimal, exacerbating the crisis rather than helping fix its causes.
The same applies to whatever happens on the supply side. High prices and (the quest for)
high profits attract new suppliers whose efforts will ultimately provide consumers with the
amount of energy they need. New supplies may take different forms: additional supplies of
natural gas, investments in alternative energy sources (such as renewables), more efficient
technologies that deliver better outputs per unit of energy consumed, and innovative tools to
produce energy. If price caps or taxes reduce expected profits, investors will be less keen to
As energy prices soar this year, policymakers in the European Union and the United Kingdom have proposed various
measures aimed at limiting energy inflation. These include both price controls (such as price caps on natural gas or electricity)
and windfall profit taxes on energy companies.
However well-intentioned, these policies are unlikely to succeed. In fact, they might exacerbate the current crisis. High prices
are not a market failure; they are the tool through which well-functioning markets convey a crucial piece of information
regarding the scarcity of energy supply relative to the demand. High prices incentivise investments to increase the supply of
energy while disincentivising consumption.
This briefing reviews the proposed price caps and windfall taxes and explains why they are short-sighted measures with longterm costs that are likely to exceed expected benefits. It closes by suggesting targeted measures to support low-income
households and energy-intensive businesses while reducing red tape and other obstacles that prevent a rapid rise in the
supply of energy, including renewable energies, nuclear power, and domestic production of natural gas.
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risk their money in the European market, therefore making the crisis longer. While prices today are hitting record levels, as
demand and supply adjust over time, they will tend to revert to historical means. Therefore, the business plans of energy
companies will factor in the fact that high revenues in the short run will be followed by lower revenues in the longer run. If the
former are capped, the incentive to invest as soon as and as much as possible is reduced. Some investments may even be
cancelled if the combination of capped prices in the short run and lower prices in the long run is not profitable enough.

The above is an extract from the article.
To read it in full go HERE
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