Gas Price Cap: Businesses Should Not Be Treated Like Households

The German expert commission on gas and heating prices (“Gas und Wärme”) presented its recommendations on the design of the relief programmes for households and businesses. While the redistribution effect of the gas price cap is currently a highly debated issue, the proposed relief for businesses has received significantly less attention. Yet some fundamental and conceptual issues need to be addressed in this context.

The government commission on gas and heating prices presented its recommendations for a gas price cap. This year in December, households and small and medium-sized enterprises will receive a one-off payment equal to one month’s gas bill. In addition, a fixed allowance amounting to 80% of the previous year’s consumption will be offered at a reduced price from March. For industrial consumption, the relief quota will be set at 70% of consumption in 2021. The relief will be granted on condition that the companies maintain existing sites in Germany and pursue a strategy to permanently move away from fossil fuels. The exact details of the measure are to be determined by the end of October. According to initial estimates, 25 billion euros of the programme’s total budget of 91 billion euros will be allocated to this relief measure.

As expected, the proposed household relief has triggered a lively debate on whether the programme provides a sufficiently strong incentive to save gas (which should be the case if the plan is properly communicated) or whether the approach is too broad and unfocused (which is hard to avoid given the lack of time and adequate data).

There is less of a debate surrounding the relief for businesses. Professor Veronika Grimm, one of the commission’s three chairpersons, said in the economic newspaper Handelsblatt that at first she could not have imagined “to work on and support such broad price cap for industry, since many businesses could cope with the increased costs by raising their prices, for example.” But again, she said, there was a lack of time and presumably a lack of data, which made it “impossible to distinguish between companies that are in danger of going out of business and those that are not.”

As far as the lack of accessible data is concerned, the situation is quite similar for businesses and households. In other respects, however, there are clear differences. For example, some businesses can raise their prices, and thus pass on the additional costs resulting from higher energy prices. In addition, many businesses can raise external funds on the capital market or from banks if they have a convincing long-term strategy that justifies necessary short-term adjustments. Finally, there is the possibility that businesses scale back their production and, in extreme cases, even exit the market. They are then replaced by other businesses whose production or product structure is better adapted to the new economic situation. Given the immediate need to save gas and the medium-term need to move away from fossil fuels, this step may also make sense from an economic point of view. However, none of this applies to households. Therefore, the justification for the support of businesses must follow different criteria than for households. The commission explicitly named “effective protection against excessive financial burdens”, as one of its objectives. As a general objective, this only applies to households. Further objectives, including a “rapid relief effect”, “clear incentives to save energy” and “stabilisation of the national economy and the price level” cannot or only indirectly justify a government aid programme for businesses.

In the current crisis, public aid to businesses aims to alleviate liquidity problems in order to prevent so-called “inefficient insolvencies”. This applies to businesses that are temporarily facing financial difficulties but whose future expectations in terms of profits are positive overall.  We have seen this form of public aid during the financial crisis and the COVID-19 crisis. Today we can benefit from the experience gained in the successful application of certain measures, such as the Economic Stabilisation Fund or the KfW credit programme. New instruments are not needed.  

In contrast to the COVID-19 crisis, the energy price shock caused by the Russian invasion of Ukraine requires short-term measures that are consistent with Germany’s necessary medium- and long-term efforts to restructure its economy. This raises the structural question of which production shifts, conversions and discontinuations should be slowed down by public aid programmes and which must be accepted. The following economic insights can help answer this question. 

As previously mentioned, many businesses have the option to increase prices and thus pass on additional costs. This is not always possible, as the current energy price shock reduces real income across society, leading to lower overall purchasing power and willingness to consume. In many cases, however, this is at least partially possible, especially for businesses with little or no international competition. Local bakeries are often used as an example. If bread becomes permanently more expensive, struggling households – and not bakeries – will require appropriate support on a macroeconomic level. For businesses that compete internationally, it is more difficult to pass on higher costs in this way.

From an economic perspective, reducing activity or even exiting the market makes sense when substitutes for the corresponding products are easy enough to obtain. In general, these are businesses or production fields that are in international competition and whose products can therefore be imported. For industrial policy reasons, it can still be beneficial to support certain businesses and economic sectors. Helping them to survive ensures that they can continue to generate value in Germany after the crisis. In some fields, it is unwise to buy substitutes and thus enter into international dependencies that could prove harmful in future crises. In terms of climate protection, it is problematic to shift the production of emission-intensive products to countries with lower emission standards. Therefore, special attention must be paid to energy-intensive companies with high trade intensity. They are on the so-called KUEBLL list of the European Commission.

Considering the difficult gas situation, a certain drop in production cannot be avoided, ideally in fields that add little value. Many businesses have already taken this into account: expensive gas is used wherever it creates most value, while low-profit activities are reduced. The gas price cap should not counteract this necessary reduction in gas consumption.

As the short-term investments that are currently needed to adapt production are for the most part also necessary to meet medium- and long-term climate protection standards, the capital market plays an important role. Medium-sized and larger businesses that are able to operate profitably in the long term in line with the European climate targets should be able to refinance themselves independently on the capital market in order to manage the upcoming transition. Public interim aid should suffice in this case. Furthermore, it should only be paid after the businesses’ equity capital has been appropriately utilised. Equity serves not only to generate profits in good times, but also to offset losses in bad times and act as a financial buffer for investments in times of liquidity constraints. Support for smaller businesses through government aid or private debt capital can and should be provided by their banks, as was successfully demonstrated by the KfW COVID-19 aid programme. The businesses’ principal banks even know their customers’ IBAN numbers...

In this structural view of the corporate landscape in Germany, however, it should not be overlooked that the vast majority of these businesses are very small. In 2020, almost three million businesses in Germany had fewer than ten employees, most of them only 0-2. A general gas price cap for micro-enterprises also has a socio-political function. Capping the amount of relief paid per enterprise could help to provide targeted support to these micro-enterprises. 

The expert commission on gas and heating prices must present proposals that can be implemented quickly – a Herculean task. Policymakers must then take up and implement these recommendations. Untargeted financial support in the form of “such a broad price cap for the industry” should not be the definitive solution.

The article was first published in the german daily "Rheinischen Post".