Executive Summary
Russia, the once-dominant supplier of oil and gas, has left the European market, with governments coupling massive subsidy programs with enhanced decarbonization targets to buffer the shock.
Major supply-side contingencies for Europe include tight LNG markets as well as domestic climate policies restricting the continent’s ability to secure long-term deliveries of fossil fuels.
Europe’s crisis management also entails geopolitical risks, as keeping energy prices affordable in developing countries will be crucial to maintain their support for Europe’s Russia policy.
The global fallout from the energy crunch has led to the clean industrial transformation gaining speed, not least considering an emerging green race with the US, with knock-on effects for supply chain geographies across the EU.
Implications for
International Businesses
The manufacturing and energy-intensive sectors will see a business environment marked by persistent market volatility as fossil upstream investment is bearish and renewable capacity development is trailing needs.
Companies need to brace for a more interventionist approachto energy market regulation, both in light of the security premium of swift decarbonization and as the Ukraine crisis revealed the political costs of lopsided industry choices regarding their energy supply structures.
The EU will put a high emphasis on (green) industrial policy, possibly at the expense of pro-market and competition policy. This may offer opportunities for businesses investing in clean solutions but alter investment conditions.
State of Play A fundamental shift in energy geographies
2022 marks a fundamental shift in the European energy geography. Russia, the once-dominant supplier in oil and gas, has essentially left the EU market. After Moscow unilaterally cut gas supplies, most of the formerly 150 billion cubic meters of annual European imports from Russia were replaced by globally sourced liquified natural gas (LNG) and additional intake from Norway and other suppliers, whilst the remainder is savings. The EU, in turn, banned the import of Russian coal, oil, and oil products. Until Russia withdraws from Ukraine and ends the war, and possibly beyond, the Russian-EU energy ties built over half a century are severed. Europe is literally finding itself between a rock and a hard place, having to manage the fallout whilst rapidly changing supply structures in a tight market environment.
This shift has come at a cost. With wholesale gas prices at times above €300/MWh, industry and the manufacturing sector responded by fuel switches and savings as well as by replacing energy intensive production through imports, such as ammonia. A flurry of policy initiatives – centrally here the REPowerEU plan – were put in place to reduce energy imports from Russia and to support industrial decarbonization, energy efficiency and fuel switch. Member state-level subsidy programs, albeit highly unequal in terms of scope and volume, started to shield households and industries from high energy costs – a welfare loss of some estimated EUR 800 billion of spent or pledged public money. Significant new LNG import infrastructure, by some estimates amounting to roughly 50bcm until the end of 2023, is about to expand intake capacity but also to sink costs. The 2030 renewable energy targets were significantly upgraded compared to the Fit for 55 program, and some countries like Germany moved to prioritize wind and solar capacity development over environmental concerns The crisis also revealed existing shortcomings in terms of EU cross-border energy infrastructure (e.g. in Central Eastern Europe but also on the Iberian Peninsula) as well as limits regarding energy policy, notably when it comes to energy solidarity.
Key Issues Threats to Europe’s energy security remain, including from the crisis’ geopolitical effects
Remarkable as the swift shift in European gas supply structures may have been, several major contingencies remain. Most importantly, LNG markets will remain tight until 2025 when US export capacity will see significant additions from the Golden Pass, Plaquemines and Corpus Christi projects presently under construction. By 2026, Qatar’s North Field East project will go online and increase the country’s annual capacity by around 50 percent. Moreover, India and China lead the way in enhancing their LNG regasification in Asia, adding to structural questions about securing gas supplies going forward. By the 2030s, Europe’s import needs are set to decrease, as a result of ambitious climate policies and additional efforts to decarbonize the energy system, the heating sector and industry. However, decarbonization pathways limit the possible time horizon to which European buyers can commit in supply contracts and puts them in a structural disadvantage. This means that Europe is facing competition from Asian growth markets which are ready to sign the long-term contracts it eschews based on its climate targets. A case in point is China’s 27-year contract with Qatar covering 108 million tons, which makes Germany’s much acclaimed 15-year deal over 2 million tons pale in comparison. Finally, the blow-up of the Nord Stream 1 and 2 pipeline systems exposed the vulnerability of physical offshore energy infrastructure to targeted attacks. Whilst not an immediate threat to Norwegian or Mediterranean pipelines, it further highlights Europe’s fragile supply structure during times of structurally tight markets and a geopolitically induced Russian supply cut.
Europe will need to hedge against several geopolitical risks emerging from the political responses to the ongoing energy crisis. Two stand out: first, Europe’s LNG shopping spree ended up pricing less well-off countries out of the market. Notably Asian nations had difficulty securing LNG cargos at affordable prices in 2022 – in the case of Pakistan during times of droughts and floods. The resulting power outages were also a function of additional European coal demand replacing Russian gas. Similarly, high energy prices hit African nations hard, many of which were economically weakened in the wake of the Covid pandemic. There is also the risk of EU and G7 sanctions leading to a drop in Russian oil production, which would spike global prices despite an oil price cap on Russian crude. Again, this would over-proportionally impact on poorer countries, deteriorating their economic and political stability. Already, support for Ukraine and Western sanctions on Russia is much less pronounced outside the OECD club of mostly rich nations. Therefore, the extent to which the West manages to keep energy prices – and, consequently, also food prices – at bay will be a determining factor in the developing countries’ perception on who is to blame for the fallout of the present multi-crisis.
Navigating the economic impact of high energy prices and state intervention in an emerging green race
Energy prices will be higher for longer. Judged by future price dynamics, gas prices remain two or three times as high as pre-crisis long-term averages, with knock-on effects for the power market. This raises the specter of deindustrialization in Europe and is likely to put sustained pressure on public budgets to support businesses and households. Industrial and economic output remained remarkably stable across the EU in 2022. Yet, for Europe to retain a competitive industry going forward, much will depend on its ability to nurture a production model coping with higher prices, to incentivize industrial process innovation and – to this end – leverage both the presently established public funds and mobilize new financial instruments such as green bonds. This is not a given. Moreover, the transition may not happen at equal speed across Europe. Already today, most EU state aid is handed out by Germany and France. Both countries also make up more than half of the estimated €600 billion in fiscal support by European governments, with some €264 billion pledged by Berlin and €72 billion by Paris. This is susceptible to tilting the level playing field for industrial competition. Finally, the fine-grained division of labor within the EU is to be affected should the industrial core, that is Northern Italy, Southwestern Germany or the Benelux countries, offshore capacity. Equally, industrial decarbonization will alter sourcing needs, with knock-on effects for peripheral producers in Eastern and Southeastern Europe which – depending on their capacities – may fall of the supply chain.
Russia’s war against Ukraine and the ensuing energy crisis have put in motion a fundamental rethink of EU energy policy, its goals and functioning. The incumbent liberal paradigm informing energy market design is severely questioned, both with a view to ensuring energy security and to successfully delivering on the EU’s decarbonization targets. The nationalization of key players in the gas and power market, including UNIPER, SEFE or EDF, as well as of energy grids (e.g., TENNET) epitomizes the more assertive role the state has acquired in 2022. Also, Western sanctions including the price cap on Russian oil mark a new era of market intervention. This extends to an emerging global ‘green race’ in strategically important sectors such as batteries and storage, clean tech or green hydrogen. The US Inflation Reduction Act (IRA), which attaches a ‘made in America’ clause to some $370 billion clean tech spending programs, caught Europe wrong-footed. Although the EU spends significant amounts of state aid, too, it mainly works through regulation by targets, rules, and directives, rather than through industrial policy. In a volte-face, Europe’s answer to the IRA, the Commission’s Net Zero Industry Act now envisions a 40 percent domestic production target for clean tech by 2030, to enhance competitiveness in green industries.
Building on a strong momentum for more state intervention, the way forward is likely to be marked by a more strategic use of regulation towards key competitors, including the US but also China; a bigger state role in key industries, including through public ownership; and a shift from the EU’s emphasis on market competition to maintaining the ‘public interest’. This new market environment holds great potential for (clean) businesses at home but may also entail significant trade-offs when it comes to activities abroad, that is in competing economic blocs.