Russia’s invasion of Ukraine has sparked an energy crisis in Europe, drastically reducing gas supplies and driving up prices compared to other regions. Despite forecasts of decreasing gas demand by different EU industries in the medium-term (as shown in figure 3), the possible relocation of energy-intensive production marks a serious risk for Europe's industrial base. Moreover, Russia's cutting of supplies together with EU and G7 sanctions on Russian gas and oil have created new threats to energy security.
Major forces driving energy policy in 2023 include the need to slash elevated prices and to transition to renewable sources in response to climate change. The Ukraine war has further led to rising inflation, reduced household incomes, and increased production costs. As a result, a decline in global economic growth and stagnation in the Eurozone are expected for 2023.
Figure 3: Demand for natural gas in the EU in selected energy-intensive industries in 2020 (actual) and 2027 (forecast), in terawatt hours
Governments striving to address the threefold challenge of energy security, climate change, and economic growth have prioritized short-term supply over long-term objectives. About 65% of gas previously bought from Russia will be imported from other regions (4.090 out of 6,251 petajoules, cf. figure 4). The remaining gap will have to be filled by investments in renewables and new technologies, thus enhancing supply security in the medium and long term. By 2030, coal demand is projected to decrease by about a half, and natural oil and gas demand by nearly a fifth. Meanwhile, cost-effective technologies such as wind and solar will account for 30% and 15% of electricity generation, respectively, by 2030, up from 13% and 5% in 2021.
Figure 4: Europe’s changing primary energy mix in response to the reduction in Russian gas imports, forecast 2022-2024, in petajoules per year
In the short-term, high-energy prices are here to stay, even with the EU’s just-passed gas price cap at €180 per megawatt hour. That’s because Russia’s oil and gas lack immediate substitutes, and meagre investments in the energy sector in recent years have exacerbated the current shortages. China’s easing of Covid-19 restrictions, in turn, has caused a surge in new cases there, which may temporarily reduce energy demand there. While weaker-than-expected global economic growth may affect the peak of oil demand and the energy transition, global value chains will be reshaped by trade and commodities becoming more expensive.
Against this backdrop, Europe has begun to develop its energy relationship in particular with countries in the Middle East and North Africa. This gives these new-found suppliers more political leverage, while increasing Europe’s exposure to the region’s complicated geopolitics. Algeria and Morocco, for example, are important energy, and trade and investment partners, respectively, for European businesses. However, they are also in a long-standing row over Western Sahara, a formerly Spanish-controlled disputed area now claimed by Rabat. Positions taken by European governments regarding the territory’s status have in the past led to retaliation: Either by the Algerian government, which supports an independence movement there, or by Morocco. For example, when Spain recognized Morocco’s sovereignty over the territory in early 2022, Algeria responded by banning the import of Spanish livestock. Similarly, Germany's recent gas agreement with Qatar for two billion cubic meters annually may expose Berlin to risks from future disputes within the Gulf Cooperation Council (GCC) states.
Also, the emerging gas infrastructure in the Eastern Mediterranean increases Europe’s security risk from states or non-state actors threatening to unsettle energy markets or disrupt supplies. Iran, for one, may be tempted to target such installations through the Lebanese Hezbollah, after its regional deterrence capabilities weakened due to increased Arab-Israeli security cooperation. Moreover, maritime security at chokepoints such as the Straits of Hormuz or of Bab el-Mandeb becomes more relevant as Europe relies on deliveries along these strategic routes. In their quest for influence, major powers such as China, France, and Russia and regional ones like Saudi Arabia, Qatar, Turkey, and the UAE all have established a presence in the area. This geopolitical competition considerably increases energy security risks.
Then, there are a number of stability risks in energy-producing countries that could impact European businesses. Algeria, Egypt, and Morocco all face significant inflationary pressures which, in the worst case, can increase unemployment, drive up food prices, and stoke popular discontent, with a negative impact on political stability if uncontained. At best, they will deplete foreign exchange reserves and undermine public and foreign investment flows at a critical time when countries desperately need both to sustain economic growth. Potential risks also arise from power struggles between countries like Egypt and Algeria, which are vying for the future role as the region’s energy hub.
In this current energy context, the strategy of companies should be to increase their energy budgets and diversify their energy mix, including self-generation of renewable energy and further innovation.
Investment opportunities in emerging and developing economies for new oil or gas infrastructure have the potential to bring quick returns with minimal impact on climate change goals. The US and the EU, in light of China’s control of the downstream supply chain of critical minerals needed for clean energy sources (such as copper, nickel, and lithium), provide incentives for investments within their territories and through friend-shoring, i.e. the process of re-orienting supply chains to source essential materials from allied countries. Additionally, the energy transition offers long-term investment opportunities in innovative technologies, such as those for renewable energy and electric mobility, carbon-free home heating, carbon capture and storage, and green hydrogen-based fuels. Growing demand for net-zero technologies could create more than $12 trillion of annual sales by 2030, including in transport, power generation, and hydrogen.