Other publication March 2023

Energy crisis: one year on, what priorities for European energy policy?

LES GRANDS DOSSIERS DE DIPLOMATIE

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Berghmans, N. (2023). Crise énergétique : un an après, quelles priorités pour la politique énergétique européenne ?, in Les Grands Dossiers de Diplomatie N° 72, Géopolitique des énergies, Areion Group, Février-Mars 2023.

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First published in Les Grands Dossiers de Diplomatie N° 72, Géopolitique des énergies, Areion Group, February-March 2023: https://www.areion24.news/produit/les-grands-dossiers-de-diplomatie-n-72/.

One year after the outbreak of the Russian invasion of Ukraine, the unprecedented energy crisis continues to permeate the economies of the European Union and the political discussions on the continent.

All Member States have had to deal with the consequences of this crisis. Governments have had to deal with the risk of gas shortages and its consequences for security of supply while maintaining the internal openness of the gas market and energy network. At the same time, they also had to intervene to mitigate the economic consequences for households and businesses. On this second point, the main measures have been poorly coordinated as they are based on essentially national measures, which is at the root of heated debates between European partners, which are continuing into early 2023.

To understand these disparities, it is important to take into account the asymmetric nature of this crisis. It affects the economies of Member States differently depending on their energy mix and level of dependence on imported hydrocarbons, mainly Russian gas from the outset, but also because of differences in the national response to the crisis. Like any asymmetric shock, it challenges the unity of the European Union (EU) as the measures taken by one country affect its neighbours in an interconnected energy system and an open economy. The EU was able to react urgently to fill up natural gas tanks and ensure European solidarity via the gas and electricity networks to get through the winter. It now faces the challenge of implementing its REPowerEU1 energy strategy, which is designed to accelerate the European Green Deal and the measures planned to achieve the 2030 climate target, which was ratified in 2021. The success of this strategy would enable to emerge from the crisis situation within a few years and lay the foundations for a more sustainable and secure energy system, but it nevertheless requires deepening the integration of the energy system, strengthening economic solidarity between Member States and ensuring greater coordination of Europeans in their external action.

A crisis of unprecedented proportions

Natural gas imported by pipeline from Russia still accounted for 45% of European consumption in 2020. The reduction in Russian gas deliveries by pipeline to EU countries has had a major impact on price levels in the wholesale natural gas and electricity markets from which energy suppliers and the most energy-intensive industries are supplied. As a result, prices have reached record levels, up to fifteen times higher than pre-crisis levels, in a context of high volatility. This crisis, which started even before the invasion of Ukraine in the second half of 2021, with the post-Covid economic recovery, thus stems from the dependence on fossil fuels as such and on Russian fossil fuels in particular–which has made the European energy system vulnerable–even though the low availability of French nuclear power and water resources on an EU-wide scale have also increased the tension on the electricity market.

These price increases were reflected partly in the energy bills of households and businesses when they renewed their contracts with their suppliers and partly in the public accounts of the Member States. Indeed, Member States have put in place support measures in order to avoid an explosion of fuel poverty, to limit business bankruptcies and the loss of competitiveness of sectors exposed to international competition and to reduce inflationary pressure in the economy. Overall, this turnaround in the gas market has led to a massive transfer of wealth to gas producers, including Russian ones, which according to some estimates can represent between 3% and 6% of European GDP. It has also led to the emergence of unanticipated profits for producers of other energies (renewables, nuclear, but also coal and fuel oil) and a debate on their redistribution through price contagion, in particular on the electricity market.

In this context, it is also important to note the decisive role played by the open trade in gas and electricity, organised by the European energy market, in mitigating the effects of the energy crisis both in terms of energy security and in economic terms. In the case of the gas network, urgent physical network adjustment measures have even been implemented to redirect gas transfers from West to East. With a reform of the European electricity market expected in spring 2023, it is important to maintain the value of Europe's integrated energy system as a real asset.

An ambitious but incomplete strategy to overcome the crisis

The EU countries reacted in a common way, firstly to ensure short-term security of supply. The emergency strengthening of the rules on gas storage in Europe, followed by the introduction of targets for reducing gas and electricity consumption and crisis preparedness plans, showed the solidarity of Europeans and their willingness to find common solutions to get through the crisis. In parallel, the REPowerEU strategy was presented in May to set a target of leaving Russian hydrocarbons in the European energy system by 2027. It contains objectives for the short-term diversification of natural gas supplies and supports the climate objective of -55% greenhouse gas emissions by 2030, adopted as part of the Green Deal. In practice, it is mainly based on the existing energy strategy currently being translated into legislation, but accelerates it ambitiously to aim for a reduction in energy demand (from -9% to -13% by 2030) and the deployment of renewable energies (from 40% to 45% in 2030).

This new direction would make it possible to meet both the climate objective and the objective of reducing the EU's dependence on energy imports, based on existing and proven solutions. However, the REPowerEU strategy is not currently accompanied by additional and stable financial resources that are commensurate with its objectives. Its financial component is limited to the re-use of funds not yet disbursed from the NextGenerationEU European recovery plan and to the limited earmarking of revenue from the European carbon market, the additionality of which compared to the previous situation is not guaranteed. Investors therefore continue to depend on a patchwork of essentially national schemes, which remain dependent on possible reversals linked to political changes.

The response of EU economic actors and public authorities has led to a significant reduction in gas imported from Russia by pipeline to only 16% of European gas consumption in 2022, before reducing further in 2023.2 Nevertheless, the pace of installation of renewable energy and electrification in buildings, transport and some industrial uses needs to be further accelerated. To do this, additional actions are needed to secure the transformations, to put in place the energy infrastructures adapted to this change of model and to support households and companies in this transition. Even though the adjustment to the energy crisis is nevertheless taking place painfully, with significant production cuts in certain European industrial sectors and a price increase that is weighing on the budgets of households, businesses and States. The response to the energy crisis has not been as coordinated in terms of the economic support provided to households and businesses, over which the Member States have sovereignty. They have thus put in place different measures to mitigate the rise in energy costs, such as tax reductions, the introduction of maximum prices on regulated prices, subsidies to gas-fired electricity producers or direct aid to businesses to pay their energy bills. To finance these actions, some states have used windfall profits from the sale of contracted renewable energy generation or introduced levies on the profits of energy companies.

These measures are justified to mitigate the effect of the crisis on the poorest households and companies affected by the crisis or exposed to international competition. However, not all Member States have the same financial and political means to implement them, which may increase tensions within the EU. For example, the amounts of aid to companies approved by the Commission since March and the establishment of the Temporary Crisis Framework on State Aid speak for themselves: more than half comes from applications from Germany, 24% from France, and the rest from the other 25 Member States.3 These policies can also contradict the objectives of reducing energy demand when they reduce the price of energy for actors who have the capacity to adjust their consumption, in response, without restriction on their part. They are potentially costly4 for public finances, which may therefore reduce the public funds available for other public policies necessary for the energy transition, at a time when security concerns are pushing European states to significantly increase their defense budgets.

These scattered interventions have added to the differences in the exposure of European states to Russian hydrocarbons, resulting in a very mixed macroeconomic picture across the EU. As far as the level of inflation is concerned, it peaked at 11.5% in October 2022, with large regional differences. On the one hand, countries such as Spain and France, which have put in place strong measures to limit energy inflation, are experiencing annual inflation of less than 7%. On the other hand, Italy and some Eastern European countries, which are more dependent on Russian gas and have done less to limit the rise in energy costs, are experiencing double-digit inflation levels.

Four priorities for European energy policy

Gas prices are expected to remain at high levels in the coming years, despite their ongoing decline, with liquefied natural gas structurally traded at a higher level than gas imported by pipeline from Russia. In this context, it seems important to go beyond the approach of protecting economic effects and to restore the economic incentive to reduce energy consumption for those European households that can do it. Redirecting the financial means devoted to tariff shields towards supporting investment in long-term solutions, such as energy renovation or electrification of transport and heating, and strengthening direct payments for the most vulnerable consumers, seems essential.

Secondly, Europeans must better coordinate their energy mix while respecting national choices. This concerns the deployment of renewable and nuclear energy supply and the strategies for exiting from fossil fuels, but also the discussion which began in 2022 on the coordination of energy consumption reduction targets. Limited in time to gas and electricity, these discussions should continue for the implementation of the REPowerEU strategy and lead to a strengthening of energy efficiency and sufficiency in European energy policy. The past year has reminded Europeans that they share a common energy system and that any action taken in one state affects the availability and competitiveness of energy beyond their borders. There is therefore a clear benefit in greater coordination to moderate Europeans' energy demand and an opportunity to build on this last 12-month experience.

It is also necessary to move away from a purely national approach to support for economic players–dependent on the financial and political capacities of the various Member States–towards a common and coordinated approach at European level to overcome the crisis, based on a long-term financing plan to support the European energy transition, from the deployment of energy production to the production of low-carbon materials or clean mobility. This approach should also aim to reduce the risk of internal tensions, which could arise from the development of new activities, concentrated in certain Member States only. The idea put forward by the President of the European Commission of a new European sovereignty fund could be an opportunity to ensure this rebalancing, provided that it contains substantial and stable additional financial resources earmarked for the development of low-carbon industry, and that it ensures that deployment takes place in a balanced manner throughout the EU. Mastering green technologies is a necessity for European sovereignty and the respect of climate pledges, but also a great opportunity for the European economy to build its competitiveness for the coming decades.

Finally, Europeans have much to gain by better aligning their external diplomacy in the energy field. They can do so by combining responsible access to the resources needed for transition (such as copper or lithium) with technological and financial support for the development of low-carbon energy models, considering the interests of developing countries. Beyond this year's blatant misunderstandings, between European actors seeking fossil gas in all markets of the planet and injunctions not to invest in new hydrocarbon projects in developing countries, Europeans must find a way to speak with one voice to build solid partnerships with countries that share the values and objectives of sustainable development.

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