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3 Challenges and Opportunities Presented by the EU Energy Crisis

Leaders should focus on finding long-term solutions

Source: www.pexels.com

In this article, I discuss the key facts surrounding the European energy crisis and the associated risks for the environment while also arguing that the current situation presents an opportunity to take bold steps toward reaching net-zero faster and more sustainably.

The origin of the latest energy crisis

Russia, a major global oil and gas exporter, began its invasion of Ukraine on February 24, 2022, causing worldwide outrage and a series of harsh economic sanctions levied against Russia by the West. Due to the tragic events, millions of people in Ukraine became refugees or were displaced in their own country. Sadly, many have been injured or lost their loved ones.

Despite the unfortunate humanitarian crisis in Ukraine, the world, and especially Europe, faces two additional challenges:

  • Soaring inflation affecting middle and lower-income people through higher food and energy prices.
  • An Environmental crisis caused directly by the pollution from the use of military equipment, for example, bombings of buildings and oil reserves, and indirectly via supply chain disruptions. To mitigate supply chain disruptions, country leaders may supplement or substitute supplies with imports, thus increasing the use of fossil fuels for transportation and hence their carbon footprint.

Key Facts

A. Significant dependency on Russia for energy supplies

According to data for 2019 from Eurostat, Russia is Europe’s main supplier of oil (27%), gas (41%), and coal (47%).

Source: Eurostat
Source: Eurostat
Source: Eurostat

The supply dependency issue is exacerbated when looking at individual energy consumption patterns by country within Europe.

“More than 80 % of energy imports are petroleum products in Cyprus, Malta, Greece and Sweden and more than a third is gas in Hungary, Italy, Austria and Slovakia. Around 20 % of energy imports are solid fuels in Poland and Slovakia.”

B. Dependency on Russia and Ukraine for grains supplies

“Russia and Ukraine together provide a third of global wheat exports and 75% of sunflower oil exports. Russia is also a major fertilizer supplier.”

However, the grain supply dependency for Europe is not as critical as the energy supply dependency. Europe is a major producer of agricultural products in its own right and, therefore, largely self-sufficient.

But Europe, like most of the world, is not immune to rising food prices. Food inflation reduces the buying power of households, forcing them to spend disproportionately more to cover their basic food needs. Furthermore, secondary effects can kick in when inflation becomes embedded into European economies, thus pushing the European Central Bank to increase interest rates to fight off inflation. Higher interest rates will inevitably lead to higher borrowing costs for households and companies, thus harming European economic growth prospects.

C. Adherence to the EU Green Deal

Presented by the European Commission in December 2019, the European Green Deal represents Europe’s ambition to become the first climate-neutral continent in the world. As an interim goal, Europe aims to cut emissions by at least 55% by 2030 before achieving net zero by 2050.

It’s worth noting that one of the five pillars of this green agenda is to ‘reduce external energy dependency’.

Source: European Commission

Therefore, there was already an explicit goal for increasing European energy security by reducing external energy dependency even before the Ukraine war broke out.

The following analysis is based on the International Energy Agency (IEA) report on reducing Europe’s dependency on Russian gas’.

So here are the three challenges posed by the Ukraine crisis in the transition to net-zero.

1. Do not renew gas supply contracts with Russia

According to the IEA, gas contracts mandating more than 15 billion cubic meters (bcm) per year from Russia to Europe are set to expire by the end of 2022, representing approximately 12% of Russian gas imported into Europe for the entire 2021. Overall, contracts with Gazprom covering close to 40 bcm per year will expire by the end of this decade. Therefore, slowly retiring long-term contracts with Russia will allow for a steady diversification of energy supplies and possibly a full substitution by 2030.

The challenge here is that Ukraine has been pressing European policymakers for harsher sanctions against Russia, including putting a full ban on oil and gas imports. The European Commission has recently put forward a plan for a complete ban on coal imports from Russia by August.

Since Europe is already relying on Russia for nearly half of its coal imports, trying to cut-off gas at the same time in the near term would potentially pose a significant risk for Europe’s energy security. Last but not least, for whatever it’s worth, and should it ever be challenged in international courts, Russia could demand that Europe pays hefty penalties for terminating unilaterally gas contracts that hadn’t expired.

2. Replace Russian gas with supplies from other sources

Non-Russian pipelines could be utilized to import gas to Europe, including from Azerbaijan and Norway, or even from Algeria. However, pipeline capacity utilization cannot be increased immediately, and will also depend on pipeline maintenance schedules and production quotas being revised upwards.

Another option is to import liquefied natural gas (LNG). Because this doesn’t require pipelines, it is possible to transport LNG from regions not geographically close to Europe, such as the United States. According to the report by the IEA:

“The EU could theoretically increase near-term LNG inflows by some 60 bcm, compared with the average levels in 2021. However, all importers are fishing in the same pool for supply, so (in the absence of weather-related or other factors that limit import demand in other regions) this would mean exceptionally tight LNG markets and very high prices.”

High energy prices will inevitably lead to an increase in corporate bankruptcies, as some firms might not be able to operate with such high energy costs. Similarly, some vulnerable customers may not be in a position to cover the higher gas bills, possibly leading to a humanitarian crisis for the poorer classes and thus exacerbating social inequality and unrest. In this case, European policymakers will face the challenge of striking the right balance between redistributing income to those who need it most while avoiding a vicious circle of increasing inflation in their economies as an unintended side effect of trying to fix the problem of higher prices.

Being forced to pay a considerable premium on LNG purchases, which eventually burdens the budget of businesses and households, is only one side of the story. An additional challenge would be that transporting LNG from far away regions to Europe is by itself a high carbon-emitting activity and one that contradicts the entire philosophy of Europe’s Green Deal on reducing carbon emissions.

3. Store more gas

Gas storage is a key component of European energy security. Maintaining adequate reserves will help meet seasonal and unexpected demand shifts, especially at a time of major geopolitical tensions.

According to the IEA

“…fill levels of at least 90% of working storage capacity by 1 October are necessary to provide an adequate buffer for the European gas market through the heating season. Given the depleted levels of storage today, gas injection in 2022 needs to be around 18 bcm higher than in 2021.”

In practice, reaching a high percentage of gas storage capacity is much more challenging. Given the current tight market conditions for energy, there aren’t enough incentives to boost storage well ahead of the next heating season. Intervention and coordination by authorities at the EU level will likely be needed to achieve this.

And here are the three opportunities posed by the Ukraine crisis in the transition to net-zero.

1. Accelerate deployment of sustainable energy sources such as wind and solar

What better way to diversify away from Russian fossil fuel dependency than investing more aggressively in renewable energy capacities such as wind power and solar photovoltaic (PV) modules? It’s almost like having the cake and eating it too! This is essentially the prime target of the EU Green Deal — achieving net-zero by 2050 via reducing carbon emissions. The current situation, despite all the challenges, presents a unique opportunity for our leader to fast-track us in the right direction — seek to achieve energy security by prioritizing sustainability rather than simply looking to completely substitute polluting fossil fuels from Russia with imports from other countries.

To fully act on this opportunity, policymakers should take into account these steps:

  • Clarify and simplify processes and responsibilities for the various license issuing bodies
  • Build and strengthen administrative capacity, and allow for applications for new investments in renewables via digital platforms to boost productivity and efficiency in granting permits
  • Consider subsidizing a portion of the cost for rooftop solar PV systems installations. This can add to energy security while significantly reducing bills for customers.

On another note, bioenergy is another field that deserves proper attention from policymakers. According to the report by IEA:

“The large fleet of bioenergy power plants in the EU operated at about 50% of its total capacity in 2021. These plants could generate up to 50 TWh more electricity in 2022 if appropriate incentives and sustainable supplies of bioenergy are put in place.”

2. Accelerate energy efficiency programs for buildings and industrial facilities.

Another way to reduce dependency on Russian fossil fuels and get to net-zero faster is to consume less energy.

A non-trivial way to go about this is to appeal to people’s environmental consciousness by advocating to reduce energy consumption. Education programs and other campaigns already underway are instrumental in changing behaviors such as setting the heating to operate at a lower temperature and using bicycles to commute instead of cars.

Delivering energy efficiency programs, including upgrades to older and less energy-efficient buildings, is an additional key factor in conserving energy and reducing reliance on fossil fuels.

The following steps should be considered to take advantage of this opportunity:

  • Increase standardized upgrades of older homes and other non-residential buildings, primarily via improved insulation.
  • Speed up and encourage the widespread installation of heat pumps. Heat pumps offer a much more efficient and cost-effective way to heat buildings than gas or oil-powered boilers.
  • Increase incentives through subsidies for installing smart heating controls (smart thermostats) to reduce energy bills and improve home comfort.
  • Help small businesses (SMEs) by offering a subsidized consulting service to become more energy efficient in their operation.

3. Keep existing nuclear energy capacity

Although a controversial issue regarding its sustainability status, nuclear power is the largest source of low carbon emissions energy in Europe. Provided nuclear reactors are properly maintained and checked for safety, nuclear power generation capacity can be increased going forward.

Furthermore, a temporary delay of planned nuclear reactor closures, conducted in a way that assures the plants’ safe operation, could reduce to a greater extent reliance on fossil fuels.

To sum it up

The recent energy crisis in Europe, triggered by the Ukraine war, poses both challenges and opportunities for policymakers.

Europe has to carefully navigate a fine line of both reducing its dependency on Russian fossil fuel imports while at the same time ensuring its energy security and ultimately protecting European consumers and the economy.

Frans Timmermans, Executive Vice-President for the European Green Deal, captured the most important points discussed in this article when he mentioned that:

“It is time we tackle our vulnerabilities and rapidly become more independent in our energy choices. Let’s dash into renewable energy at lightning speed. Renewables are a cheap, clean, and potentially endless source of energy and instead of funding the fossil fuel industry elsewhere, they create jobs here. Putin’s war in Ukraine demonstrates the urgency of accelerating our clean energy transition.”

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Spyros Ierides, CFA

Spyros Ierides, CFA

Sharing thoughts on financial markets, personal investing and self development.