3 reasons why Europe’s energy problem is far from over

Leaders at the World Economic Forum in #Davos are convening to discuss the transformation of global energy systems to deal with the challenges of security and affordability, in the context of climate change.

Europe, in particular, is experiencing an energy crunch that threatens to unsettle its industrial base and derail progress toward next-gen energy goals. The continent’s energy landscape was transformed by Russia’s invasion of Ukraine in February 2022, prompting countries to focus on building reserves while planning for rolling blackouts and rationing. Last year was marked by record-high gas prices and much-reduced pipeline flows, which left Europe in a fragile economic position.

Barclays Research believe the situation remains very delicate. Three major factors explain why Europe’s energy problem is far from over.?

1. Temperature swings lead to volatility in demand patterns and inventory levels

Unusual weather patterns have become more common due to climate change, but recent shifts have had dramatic effects on energy demand across Europe. Milder-than-normal temperatures in the autumn led to seasonally low demand for home and industrial heating, which helped the continent build gas inventories. In December, however, a spell of freezing weather tipped the balance toward high gas consumption: European countries saw usage volumes rise above the seasonal average for the first time since June. As a result, stocks were drawn down quickly across Europe, highlighting the risks of unexpected cold spells. As such, disruption from unpredictable weather patterns in 2023 cannot be ruled out.

Cold December weather triggered greater consumption of gas (Figure 1), which emptied inventories more rapidly (Figure 2).

2. The end of China’s zero-COVID policy will likely intensify competition for energy

For much of last year, while China pursued very strict measures to contain the spread of COVID, its demand for energy dropped accordingly. Imports of liquefied natural gas fell by more than one-fifth during the first 10 months of 2022, allowing supplies to be routed instead to Europe, to fill gaps left by reduced supplies from Russia.

Beijing’s abrupt shift toward the end of the year changed the picture. We expect a rebound in Chinese demand for energy in 2023, which should intensify the bidding for spot LNG cargos and could drive up energy costs for Europe, complicating the path to energy independence from Russia.

3. Elevated energy prices will weigh on Europe’s industrial performance

The loss of Russia as a steady and dependable supplier of energy has taken a toll on Europe’s industrial base, which had become accustomed to relatively cheap and abundant energy. Before the start of the Russia-Ukraine conflict, the EU received roughly half of its natural gas and close to one quarter of its petroleum oil from Russia. Current gas pricing in Europe is three times pre-COVID levels. Now that the bloc has cut ties with its largest supplier, higher prices in the years ahead seem inevitable.

Already, more expensive energy has curtailed the continent’s post-pandemic recovery and caused its manufacturing sector to underperform the rest of the world. Some European companies have made moves to relocate production to cheaper locations outside of Europe. Such shifts could be permanent, resulting in drops in overall manufacturing output.

Before the war, the EU was highly dependent on Russia for gas (Figure 3) and oil (Figure 4).

A short-term energy squeeze for Europe looks inevitable, despite developed economies’ efforts to lower their dependence on fossil fuels. The recent gas price-cap agreement between EU leaders should help to mitigate the effects of the crisis. However, additional measures – such as joint gas purchases and more streamlined procedures for deploying renewable energy – could be necessary to ease potential pain in the months ahead.

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