PoV #9: Europe's Energy Quandary - From Crisis to Opportunity

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In the autumn of 2022, Russia disrupted a significant portion of its gas pipelines to Europe in response to the EU's support for Ukraine. This disruption caused a sharp increase in wholesale gas prices, with some countries experiencing prices more than 22 times higher than those in 2019. Simultaneously, oil prices remained high, and policymakers issued warnings about potential fuel rationing and rolling blackouts as winter approached.

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This move left EU nations in a precarious position, with low gas storage levels and limited alternatives to replace a crucial energy source. They prepared for potential energy rationing, skyrocketing electricity and fuel costs, and the looming threat of an economic downturn.

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Luckily, Europe's economy performed better than expected in 2022, with Germany, for example, achieving 1.9% inflation-adjusted GDP growth over 2021. Today, Europe stands in a significantly more comfortable position regarding its gas supply, with ample gas arriving from sources such as Norway, the shale fields of Texas, and Qatar. Gas prices have plummeted below their pre-invasion levels and continue to decline almost daily, while oil prices remain relatively stable. The imminent threat of rationing is no longer a topic of discussion.

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However, Europe's energy landscape grapples with underlying structural issues, primarily driven by the transition from economical Russian gas to pricier liquefied natural gas (LNG) imports. While gas supply is a critical concern, Europe's vulnerability due to dependence on a few suppliers for vital resources and the urgent imperative to slash CO2 emissions by 55% by 2030 compound the complexity of the situation.

Immediate actions to optimize energy usage and cost-cutting are important but insufficient to tackle Europe's structural energy challenges. Industry and government must collaborate on ambitious, long-term solutions that leverage green markets and technologies to address energy supply, carbon impact, and international competitiveness.

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Proactive Playbook

The EU's proactive approach was characterized by conservation efforts, substantial investments in diversifying energy sources, and a willingness to temporarily deviate from long-standing energy strategies. As a result, EU countries emerged from the winter of 2022-2023 with natural gas storage levels at their highest in years, fuel prices returning to pre-invasion levels, and a milder economic impact than initially anticipated. This success, however, came at a considerable cost to other regions, where energy scarcity and rising fuel prices posed significant challenges. The focus shifted away from the green transition as energy reliability and affordability took precedence over environmental concerns.

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Abundant Gas Reserves: As Germany and Europe approach the 2023/2024 heating season, they are much better equipped and more confident than the previous year. They have diversified their sources of supply and filled storage facilities earlier. Additionally, favorable weather conditions may once again play a role, with an increasing likelihood of a mild winter according to the EU's Copernicus Climate Change Service.

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The capacity for importing liquefied natural gas (LNG) has been expanded in Germany and other European countries, with plans to add more floating LNG import terminals this winter. German gas storage facilities were nearly 95% full at the beginning of October. However, various factors could still significantly affect the supply situation, as cautioned by the grid agency's (BNetzA) weekly gas status report. In the event of extremely cold weather, consumption could spike, and the possibility of partial or complete failures in natural gas pipelines cannot be entirely ruled out. As of October 2023, the "alert level" for gas supply, which is the second level in Germany's three-step emergency gas plan triggered in June 2022, remains in effect.

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Concerns in the Gas Markets: Germany has conducted test runs to prepare for a potential gas supply crisis, aiming to simulate what would occur if rationing were necessary. The grid agency's head, Klaus Müller, stated that the country is much better prepared for this winter compared to the previous year but emphasized that it's still too early to declare an all-clear. The economy ministry has also updated its "Natural Gas Emergency Plan" based on the lessons learned last year.

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Coal as a Backup: To ensure a secure electricity supply and save gas during the heating period, Germany decided to allow ignite power plants that had been in reserve to re-enter the market. This policy will continue this winter. Other European countries took similar precautions to enhance their supply security. For example, France extended the operation of its two remaining coal-fired power stations until the end of 2024.

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The German government has assured that reactivating coal plants from the reserve will not impact the country's coal phase-out, which is scheduled to be brought forward to 2030, if possible, from its originally planned 2038 date. However, some state governments in eastern Germany have expressed concerns about the feasibility of the earlier exit date given the new threats to supply security.

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Economy Minister Robert Habeck announced in mid-October that the reactivated plants from the reserve capacity would be permanently decommissioned in 2024. By that time, Germany is expected to have sufficient LNG import capacity to handle lower pipeline-based gas supplies. These coal plants will serve as a "safety net" for any unlikely supply shortfalls.

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After the winter, the German government plans to evaluate whether the measure has led to additional greenhouse gas emissions and, if so, propose ways to offset them. An analysis by consultancy Energy Brainpool in early 2023 found that the intensive use of coal plants during the energy crisis led to nearly 16 million tonnes of additional CO2 emissions compared to a scenario without it.

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Concerns for Industry and Economic Growth: The energy price surge not only strained household budgets but also had a significant impact on Germany's industrial sector and the overall economy. Many industrial companies, especially energy-intensive ones like chemical and steel producers, had relied on cheap Russian pipeline gas. The energy crisis, exacerbated by supply chain challenges, hit these companies at a crucial stage of their transition away from fossil fuels. While the costs of industrial decarbonization added to their challenges, many acknowledged that reducing dependence on fossil fuels and improving energy efficiency would ultimately lead to more affordable and secure energy.

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Although concerns about the imminent deindustrialization of Germany proved unfounded, economic growth remained significantly subdued throughout 2023. The government revised its growth projections in the autumn, forecasting a slower recovery from the recession and lower growth in 2024 than initially anticipated. Some industries, like construction, experienced the worst business climate in decades due to rising interest rates and a more challenging investment environment, leading the government to relax energy efficiency standards.

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Germany is currently debating whether to subsidize electricity for heavy industry to maintain competitiveness. The economy and climate ministry are considering a plan to lower power prices for energy-intensive companies in exchange for decarbonization commitments and staying in the country. Economy Minister Habeck even suggested that Germany should consider lifting restrictions on new state debt, given the high costs of industrial decarbonization during an economic downturn. However, many economists oppose these plans, fearing they could become permanent subsidies that delay necessary structural changes.

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The government emphasized that the EU as a whole faces pressure to respond to industry subsidy schemes implemented in other parts of the world, particularly in China and the U.S. Chancellor Scholz emphasized that effective climate action in Germany and Europe requires economic growth to demonstrate that it does not undermine prosperity and that it paves the way for industrial success in the future. Together with French President Emmanuel Macron, Scholz committed to closer cooperation to strengthen a robust and sustainable industry and create new industrial leaders, as both countries represent a significant portion of the EU's economic output.

Europe at Crossroads: Facing the Crisis and Paving a Green Path Forward

The current energy situation presents an unprecedented challenge, but Europe's industry has weathered past crises. A green transformation can turn this impending disaster into an opportunity, making proactive action imperative.

It would be a mistake to assume that energy prices will return to pre-crisis levels. To compensate for reduced gas supplies from Russia, Europe, especially Germany, will heavily rely on LNG, resulting in a substantial increase in imports. LNG is expected to set European gas prices for the foreseeable future, and Germany faces a significant competitive disadvantage compared to other regions, not only in the near term but also through 2030.

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Industry players in Germany appear to underestimate the impact, with many expecting smaller increases in natural gas prices than what scenarios suggest. This energy price disadvantage will significantly affect the competitiveness of major European industries throughout the value chain, from process industries to end products.

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Adding further pressure, the US is bolstering its green energy advantage through initiatives like the Inflation Reduction Act (IRA), while the EU historically focused on demand-side incentives. Europe needs to level the playing field and seek new sources of competitive advantage.

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A Real Opportunity

Europe's opportunities lie in green markets and technologies, where it already demonstrates capabilities. The growing number of companies with ambitious emissions-reduction targets creates demand for green products. However, there is a gap between downstream players committed to decarbonization and upstream players providing low-carbon materials.

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While Europe may face cost disadvantages in fossil fuels, it is competitive in renewable alternatives compared to the pre-IRA US and China. For companies aiming to remain competitive in Europe, the green transformation is now a strategic necessity.

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The Way Forward for Industry

European companies must take bold steps to succeed in green markets. Rather than waiting for the market to mature, they should accelerate their net-zero transformations and develop portfolios of green products. The good news is that most companies are already prioritizing green solutions, recognizing the importance of sustainability.

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In conclusion, the lessons learned from the EU's response to the energy crisis following the Ukraine war provide valuable insights into how nations can navigate future energy challenges. These lessons emphasize the need for resilience, diversification, adaptability, and a focus on sustainability in energy systems and policies. The energy crisis also presents an opportunity for Europe to accelerate its transition to green energy and enhance its long-term competitiveness in the global market.

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