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It’s no secret that Europe is in the midst of a full-blown energy crisis right now. Since the beginning of 2022 — when tension between Russia and Ukraine began to escalate —natural gas prices have spiked, causing major challenges for European households and businesses alike. As well as heating homes and generating electricity, gas is used to fuel a range of industrial processes, such as forging steel to make cars, so the higher prices are a real problem. Thankfully, the price of gas has pulled back a little recently, providing much needed relief for many. However, prices are expected to remain elevated for a while yet, and this could have big implications for the economy.
The green ambition created an energy disaster
Paradoxically, Europe's energy crisis is linked to the region’s ambition to shift from fossil fuel energy to renewable energy. Europe has ambitious clean energy targets, and policy makers were under the impression that Russian natural gas — which was cheap and convenient in the past — could bridge the continent's energy needs until clean energy is readily available throughout the continent.
Europe has certainly made progress on the clean energy front in recent years. Yet, due to challenges associated with availability and storage of this form of energy, renewable energy is not going to completely replace fossil fuel energy any time soon. Therefore, Europe is still heavily reliant today on natural gas from Russia for its energy needs.
The problem is, as a result of the war between Russia and Ukraine, Russia has choked off the supplies of natural gas that Europe depended on. Due to the shutdown of the Nord Stream 1 pipeline – which stretches 1,200km under the Baltic Sea from the Russian coast near St. Petersburg to north-eastern Germany — Russian gas shipments to Europe have fallen significantly this year. This has left the continent vulnerable on a number of levels. Without gas, Europe may struggle to run factories, generate electricity, and heat homes this winter.
What is Europe doing to deal with the crisis?
On the back of the gas shortage, Europe has reverted to traditional forms of energy such as oil and coal. For example, Germany is keeping coal plants that it planned to shut down (to reduce emissions) open for now. This fossil fuel energy can serve a purpose in the short term. However, it is far more polluting than renewable energy, meaning that it is not helping Europe progress towards its clean energy goals.
Europe has also increasingly been importing liquefied natural gas (LNG). For instance, several cargo ships of US LNG originally destined for China have been re-sold to Europe this year, according to Bloomberg, and China National Offshore Oil Corporation (CNOOC) has offered up an LNG cargo from Australia’s North West Shelf for delivery in November. This has helped to boost gas storage. However, LNG is much more expensive than pipeline gas, and will, therefore, increase European electricity bills.
Wood is another source of energy that is being embraced as a result of the gas shortage. In Germany, for example, people have been buying wood-burning stoves and stockpiling firewood to ensure they will be able to heat their homes this winter. Using wood for energy raises environmental issues, however. Trees do not replenish quickly and are, therefore, not available long-term replacement for oil and gas. Fumes from the burning of wood can also contain toxic chemicals.
Aside from turning to wood, there are many other ways consumers are trying to reduce their energy costs. Strategies include cutting back on showering, turning the home thermostat down, and changing to energy-efficient light bulbs.
It is worth noting that in her State of the Union speech on September 14, President of the European Commission Ursula von der Leyen proposed an ‘emergency intervention’ in Europe's energy markets to tackle the current crisis. Noting that the EU is experiencing a “severe mismatch” between energy demand and supply (due largely to the continued weaponisation by Russia of its energy resources), she unveiled a set of proposals designed to ease the pressure on European households and businesses, including:
Energy savings: Member states have been asked to reduce their electricity consumption by 5% during peak hours. They have also been asked to aim to reduce overall electricity demand by at least 10% until March 31, 2023.
A temporary revenue cap on non-fossil fuel energy companies such as solar, wind, hydro power, and nuclear businesses: The Commission has proposed setting a cap of €180/MWh for these companies. This will allow producers to cover their investment and operating costs without impairing investment in new capacities in line with Europe’s 2030 and 2050 energy and climate goals. Revenues above the cap will be collected by member state governments and be used to help energy consumers reduce their bills.
Taxes on fossil fuel companies: The EU is proposing to apply additional taxes to fossil fuel suppliers since the current crisis has pushed up their profits significantly. This will be collected by member states on 2022 profits that are more than a 20% increase on the average profits of the previous three years.
Investment in hydrogen: The Commission is proposing €3 billion in funds to facilitate hydrogen development in order to switch from a niche market to a mass market product.
The International Energy Agency (IEA) has also offered Europe a 10-point plan to reduce its reliance on Russian gas. The plan suggests replacing Russian gas supplies with gas from countries such as Norway and Azerbaijan, using LNG, introducing minimum gas storage obligations to minimise disruption, accelerating wind and solar projects, accelerating energy efficiency in buildings, and more.
A tough winter ahead
In August, inflation in the euro area hit 9.1%, up from 8.9% in July. However, when discussing inflation, it is worth distinguishing between headline inflation and core inflation. Headline inflation is the number you tend to see in the media (i.e., the 9.1% here). This measures price rises across a whole basket of goods. In contrast, core inflation strips out food and energy prices — two components of inflation that central banks can’t control with monetary policy.
Looking at inflation numbers in the EU right now, there is a big difference between these two types of inflation. While headline inflation was 9.1% in August, core inflation was just 5.2%. The European Central Bank is currently increasing interest rates in an effort to reduce inflation. However, we can see that a large percentage of inflation in the European Union is coming from energy prices. In other words, the European citizen is being hit twice — once by sharply higher energy prices, and then again by higher borrowing rates. Putting this all together, it is likely to be a challenging winter for the European consumer.
