The Russian invasion of Ukraine, launched on 24 February 2022, has been a watershed moment in many ways. Not only it has brought large-scale conventional war back to European soil after decades of peace, but it has also disrupted a large number of trends on a continental and global scale. Among the domains worst affected by the conflict, energy – and the energy transition – features prominently, with two diverging effects. On the one hand, the war and its threat to gas and oil supplies on a global level show once again the importance of fossil fuels in today’s energy mix and the limits of the transition towards renewables. The recently approved partial embargo on Russian oil and the pledge to progressively phase out Russian gas from the EU energy mix will have a considerable impact on households and enterprises in the short and medium-term. On the other hand, the conflict has highlighted how fossil fuels are affected by geopolitical tensions and has stressed the outsized role played by countries endowed with ample reserves of hydrocarbons. The conflict has therefore effectively created a short-term problem while strengthening the case for a long-term solution based on renewables and clean energy sources. In fact, the energy transition is not merely an environmental issue, but also – as the Ukraine conflict dramatically shows – a matter of security and strategic autonomy. The EU has been severely impacted by the conflict: a sharp increase in energy prices coupled with a reduction of imports from Russia is forcing the EU to find alternative suppliers and may lead to an increase in fossil fuel consumption, at least in the short term. This is especially at odds with the model envisioned by the European Green Deal the initiative to reduce greenhouse gas emissions and decouple EU economic growth from fossil fuels.
A broad and ambitious plan for global leadership on climate
Despite having been badly affected first by the Covid-19 pandemic, and then by the Russo-Ukrainian war, the European Green deal actually predates both. The EU Commission proposed it in December 2019, with the aim of becoming global leader in the energy transition and the fight against climate change. The ambitious plan was meant to boost the European economy, restructure continental society and production, and overcome the link between the use of resources (including fossil fuels) and economic growth. In short, it has always been much more than a climate plan. With the spread of the pandemic and the subsequent economic crisis, the EU Green Deal (together with the EU Recovery Plan) has developed into a tool to facilitate the economic recovery of the Union and provide instruments to jump-start the European economy, detaching it progressively from greenhouse gas emissions and other forms of pollution. The commitment of the Von der Leyen Commission to the environment has been significant from the very start and has been favoured by the presence within the G20 of several climate-sceptic leaders that made the EU the de facto leader of the “green camp”.
The European Green Deal and its follow-up measures, the Fit-for-55 package and the REPowerEU plan, constitute a comprehensive approach that ranges from efficiency to sustainable mobility and includes clean energy and carbon adjustment mechanisms both within and outside of the Union.
The main area to be directly affected by the ongoing conflict in Ukraine is undoubtedly energy, where immediate risks arise. A rapid reduction of imports from Russia, as outlined in the Commission plans (REPowerEU aims at reducing the demand for Russian gas by two-thirds in 2022 and the coming oil embargo should be put in place within the same deadline) presents two main challenges: a short-term increase in the use of fossil fuels and a faster deployment of renewables in the medium to long term. Contrary to the International Energy Agency’s proposal to reduce dependency on Russia, the European Commission does not intend to increase the consumption of coal (or other fossil sources), although some countries might decide to postpone the phase-out. The main contribution in the future would come from a larger use of renewables, primarily solar and wind power. As for solar energy, the Commission plans to simplify rules regarding the installation of solar panels and achieve 15tWh of additional capacity by the end of the year, with a 2025 target of 320 GW, and almost 600 GW by 2030, effectively doubling today’s figures. Wind energy capacity, the other key renewable component of EU clean energy, should be increased by 480GW by 2030, contributing to a significant reduction in gas demand for energy purposes. In the REPowerEU plan unveiled in May 2022, the Commission aims at reaching 1236 GW of renewable energy generation by 2030, increasing the previous 40% target of the Renewable Energy Directive to 45%. The increased role of renewables, however, requires major updates to the EU energy grid, improving connections and adapting a network largely conceived for stable fossil fuels to accommodate an extensive use of intermittent sources. In order to reach the 40% renewables target set by the Commission, significant storage capacity needs to be created: according to the European Association for Storage for Energy (EASE), by 2030 the EU would need 108GW of electricity storage, up from the 40GW capacity available in 2020. The domain of batteries is characterised by several challenges that go well beyond the current high research costs and the limited technology available to store large amounts of electricity in relatively small batteries. These include the necessity to build industrial production capacity and to ensure a steady supply of the critical rare earths required. Conscious of these issues, in the latest EU Industrial Strategy, Brussels has strengthened the European Battery Alliance, established in 2017 to bring together industrial actors throughout the value chain of battery production, from research to production. This is a key step in reinforcing a critical industry for the future and reducing external vulnerabilities, although it would be unrealistic to imagine a fully autonomous EU in this regard: international cooperation with friendly partners remains the most effective tool to build a secure supply.
Not all economic sectors, though, can be electrified with the same ease. Hard-to-abate sectors and the most energy-intensive ones that are already facing the brunt of the effects of the war are of particular concern. Here, hydrogen – and especially green hydrogen – has been chosen as the main pathway towards decarbonisation. The already ambitious Hydrogen Strategy of 2020 has been further reinforced by REPowerEU, which quadruples the target for green hydrogen supply and plans to use a large part of the energy potential provided by renewables to produce green hydrogen. The plan aims to add 15 million tonnes of green hydrogen production by the end of 2023, up from the 5.6 million tonnes initially planned. The move, although bold, builds upon the European Hydrogen Accelerator Centre and the Commission’s intention to reform energy markets and speed up the procedures related to hydrogen infrastructures, primarily storage. Yet, such high targets for green hydrogen production mean that a significant part of new renewables capacity would be dedicated to this task, requiring policymakers and stakeholders to accurately plan new energy facilities within the EU. The REPowerEU Plan aims to reach 20 million tonnes of green hydrogen in the EU (half internally produced, half imported), a goal that requires massive investments in infrastructures. The three main axes are the Mediterranean corridor, which exploits the great potential of North African countries to produce green hydrogen, the North Sea area and Ukraine, although this last option would heavily depend on the evolution of the conflict. However, the establishment of hydrogen-capable pipelines would require a significant overhaul of existing equipment, with expected costs averaging between 28-38 billion euros for EU pipelines and an additional 6-11 billion for storage systems. Financing those plans, however, would be challenging. Furthermore, the establishment of a functioning import infrastructure relies heavily on economic and political stability on the Southern Coast of the Mediterranean. An additional challenge stems from the fact that hydrogen, despite its high potential, can hardly be considered decarbonisation: its deployment would therefore be most effective if concentrated on hard-to-abate sectors, avoiding excessive use in areas where electrification could provide an easier option.
A shift towards more sustainable, greener mobility would play a key role in reducing greenhouse gas emissions and limiting the carbon footprint of the EU: transport accounts for almost a quarter (24.6%) of total EU carbon emissions, with road transport accounting for 71.7% of all transport sector emissions. While REPowerEU has only a marginal focus on transport (increased [clean] energy production being required for a larger fleet of EVs in EU countries), sustainable mobility is crucial to reducing dependency on Russia and fostering the transition towards a net-zero economy. In 2020, almost a third (29%) of crude oil imported by the EU came from Russia, and road transport accounts for a significant share of oil demand. Even though EVs alone are unlikely to make a major contribution to reducing Russian oil imports in the EU, a faster than planned switch to electric mobility could create a win-win scenario where both the demand for Russian oil and CO2 emissions would decrease. The backbone of the Commission’s action plan for transport is the Sustainable and Smart Mobility Strategy approved in December 2020, which sets out the steps to reduce carbon emissions from transport by 2050, as mandated by the EU Green Deal. The strategy builds on available technologies and future developments: while most of the emission reduction in road and railway transport would come from electrification, in the domain of air and waterborne transport, the bulk of decarbonisation would require cleaner fuels as well as new net-zero propulsion systems. Fuel cell technologies, especially based on hydrogen, are already being deployed within the Union and are included in most national Recovery and Resilience plans. The Strategy plans to reach 30 million zero-emission cars and 80,000 lorries by 2030, with a view to reaching complete net-zero for all road transport by 2050 if possible. The objectives related to aircraft and ships – especially larger ocean-going vessels – are much more distant in time, and aim to have market-ready options by 2030 for sea transport and 2035 for aircraft. In this regard, it is remarkable that the International Air Transport Association (IATA) has pledged to render aviation net-zero by 2050, roughly in line with the EU’s roadmap. According to IATA, 65% of the cut in emissions would come from Sustainable Aviation Fuels (SAFs), obtained largely from feedstock, and only 13% from hydrogen or electrification technologies.
The transformation of the EU into a net-zero economy would require massive investments, both from the public and the private sector. The most recent estimates by the Commission put the investment gap at around 520 billion euros per year, while other analyses put the total cost as high as 855 billion annually. There is a consensus that the Ukraine war has further increased costs. Higher than expected inflation and the need for government interventions to cushion citizens and businesses from skyrocketing food and energy prices is further eroding the fiscal space of public institutions. To help channel private investment towards green and sustainable projects, the European Commission has elaborated a taxonomy providing a clearer picture of what would be considered compliant with ESG standards (Environmental, Social and Governance). The most recent integration, adopted in March 2022, includes – under strict conditions – nuclear energy and gas as transitional sources that could help reduce the use of more polluting fossil fuels like oil and coal. Despite the role of the taxonomy being largely limited to the finance sector, considering that it does not mandate any kind of investment, it remains a crucial element of EU strategy: the required disclosure would put pressure on larger businesses and help reduce the risks of greenwashing. The combined effect of these measures, added to the required reporting compliance for both financial and non-financial undertakings, would show which areas of a company’s activities are aligned to the ESG framework. Additionally, the impact of the EU taxonomy is likely to extend far beyond the Union’s borders, since all investors offering products within the Single Market would be required to align to it, and to provide all relevant information to any investor based in the EU. This could provide an additional “Brussels effect”, where countries follow the rules set by the EU due to the timing and importance of a common market. However, the particular context of its adoption, together with the difficulty of reaching compromises and diverging global preferences for green investments could limit this potential.
Despite the potential positive impact of the taxonomy, however, the financial challenge remains the most pressing one for the EU: the war in Ukraine has significantly constrained economic growth in Europe and growing public debt poses a risk for several Member States in a scenario of interest rate hikes. The limited fiscal space and the need to sustain the post-pandemic recovery are hardly compatible with massively increased green investments. To pursue its energy transformation and stay on track to reach its net-zero objectives, the EU needs additional financing tools and greater private investor involvement. According to the Renner Institute, to reach its decarbonisation objectives, the EU would need between 11,670 and 16,320 billion euros of investments, a huge amount of resources that would require a system of public guarantees and de-risking mechanisms to attract private investors. The approach of using public resources to mobilise private capital is already being pursued by the European Commission and there is an additional possibility for Member States and stakeholders to issue green bonds to finance sustainable projects within a framework that would benefit from the taxonomy. The Commission itself estimates that in the aftermath of the Ukrainian war, the EU will have to spend additional 225 billion euros to diversify energy sources and phase out Russian oil&gas. In order to reduce energy revenues for the Kremlin, Brussels has devised an embargo on Russian seaborne crude oil, effective from December 5th 2022. While oil could be easily substituted, despite global production not increasing after the latest OPEC+ meeting, gas presents a different set of challenges and high gas prices remain the main culprit for the hike in European energy bills. To counter higher energy costs for firms and consumers, the main proposal being debated at a European level is a price-cap mechanism. Such a tool would impose a limit on the price of either energy or single energy sources. A price cap on all gas entering the Union would be unlikely, given that the Commission has expressed fears that such a measure might discourage LNG suppliers to deliver to Europe and this could prove counterproductive in a moment when Russian gas flows to the UE are lower than 1000 cubic meters per week. Alternatively, the EU could decide to set up a cap on energy prices for end users (households and firms) following the example of Spain and Portugal; however, such an option would be extremely expensive, requiring public resources to compensate wholesale energy producers for selling at a loss. Nonetheless, while energy prices largely depend on the price of gas - being it often the readily available marginal source - production costs vary significantly depending on the source. According to the International Renewable Energy Agency (IRENA), in 2021 global costs for newly installed renewables have declined compared to 2020 (-15% for onshore wind, -13% for solar PV, -13% for offshore wind), continuing a decade-long trend. In such a scenario, energy sellers not using gas have gained extensive profits from the hike in gas prices; hence, the Commission is proposing to adopt a temporary cap on inframarginal energy producers, set at 180 euros per MWh, with excess revenue to be collected by Member States and directed to reduce energy bills for consumers. Compared to the other price-cap options, such a solution would not result in higher public spending nor would it disrupt excessively the markets; however the cap should be set at a high enough level to encourage investments in renewables, which remain crucial to decouple the EU from Russian energy.
Before such a decoupling, however, the most pressing issue for Brussels remains to find a solution to withstand additional curbs on Russian gas supplies before the next winter sets in. After the Nord-Stream 1’s temporary closure and the dispute over turbine repairs, Moscow’s use of lower energy transfers as blackmail to incite a softer attitude towards Russia among European countries has become evident. To escape such a trap and reduce the Kremlin’s political leverage, the Commission and the Council have devised a plan to withstand the worst-case scenario whereby Russia would completely cut off gas supplies: under a potentially mandatory scheme, Member States would have to reduce their gas consumption by 15% this upcoming winter.
The European green transition would have a significant impact even beyond the borders of the EU, not only because the fight against climate change is indeed a global one, but also because of crucial concerns related to the delocalisation of CO2 emissions outside of the EU. In a way not dissimilar from what happens with industries that set up new plants where production costs are cheaper, European businesses could delocalise their most polluting activities to third countries to avoid having to pay ETS or to comply with higher EU standards. The Carbon Border Adjustment Mechanism (CBAM) is a necessary element to fight this trend, and to ensure – as far as possible – a level playing field that will not discriminate against EU producers. This measure, currently being finalised by the Council of the EU, would create a border tax for carbon-intensive products entering the Single Market, essentially through an import levy, within the “Fit-for-55” package. The CBAM would thus encourage foreign producers to reduce the carbon footprint of their exports even in the absence of national regulations in order to remain competitive on the EU market. While this could act as an extremely powerful incentive for businesses that rely on European customers, it would also create a certain degree of trade diversion, redirecting exports towards other markets that have not applied similar measures. At the time being, only the EU is planning to implement such rules, while debate on the issue is still ongoing in the US.
The CBAM in itself is only part of a wider package of initiatives aimed at strengthening the external dimension of EU climate action. Parallel to this and to ongoing negotiations at a multilateral level, the European Commission has provided a significant boost to its support for sustainable infrastructure through the Global Gateway initiative. This strategy, presented shortly after Glasgow’s COP26, would operate at the core of the global challenge for energy transition infrastructures, with a key focus on emerging countries. Global Gateway would thus unify the numerous – and often fragmented – European programmes and plans to finance sustainable connectivity abroad, recognising the need for more urgent and more cohesive action. The war in Ukraine not only renders this initiative even more necessary, given the EU’s need to build new energy relationships and reduce its dependence on Russia, but also increases its geopolitical significance. Global Gateway goes, in fact, far beyond climate actions and aims at countering other global initiatives to support infrastructure financing, particularly the Chinese Belt and Road Initiative, with a view to setting future global standards for financial and environmental sustainability.
The ongoing conflict, while reducing available resources, strengthens the case for additional investments in renewables and green infrastructures. With rising inflation, lower growth projections and a recovery that appears increasingly fragile, the only path to growth is the one based upon sustainability.