Today, Europe finds itself in the midst of a perfect storm. From its onset, the war in Ukraine laid bare the structural weaknesses of the European energy market, and although the conflict served to highlight these problems, they had long existed in the EU’s energy scenario. The energy trilemma revolves around three main pivots: energy price, energy security, and sustainability. The core priority around which European energy policy has been based over the last twenty years has been ensuring energy supplies, particularly gas, at as low a price as possible. For much of this time, the key supplier providing inexpensive gas has been the Russian Federation, which in 2021 accounted for 45% of all European gas exports – a total of 155 billion cubic meters – and for 40% of European gas consumption. Russia’s preponderant role as a gas supplier was also accompanied by reduced gas production within the EU, which dropped from 24% of total gas consumption in 2015 to 9% in 2021. Additionally, investments in renewable energy to sustain the energy transition have not keep pace with the increase in energy demand, driven in part by post-pandemic economic recovery, and more importantly, they have not adequately made up for the reduction in planned investments in fossil fuels, resulting in a growing gap between demand and supply.
How Russia changed European energy security
The Russian invasion of Ukraine that began on February 24, 2022 was a turning point in many ways. Among the sectors most affected by the conflict, energy and the energy transition occupy a key role, with two divergent effects. On the one hand, the war and the consequent threats to global gas and oil supplies demonstrate once again the importance of fossil fuels in the current energy mix and lay bare the limits of the slow pace of the energy transition towards renewables. The partial embargo on Russian oil, which accounted for about 29% of total European oil imports, and the commitment to gradually eliminating Russian gas from the EU’s energy mix are having a significant impact on businesses and families in the short and medium run. Indeed, the conflict has highlighted how fossil fuels are influenced by geopolitical tensions, and has underscored the central role played by countries endowed with ample fossil fuel reserves. Since the beginning of the war in Ukraine, Russia has gradually reduced its gas flows to Europe while also increasing its profits by adding a surcharge of over € 200/Mwh, earning as much as € 800 million a day in March 2022. Nevertheless, since the beginning of October the profit margin has come down to about € 130 million a day, due mostly to a marked reduction in Russian gas flows to Europe, which now only account for about 7% of total European gas imports. Gas flows fell steeply in early September after Gazprom’s announcement that the Nord Stream pipeline would be shut down indefinitely and after the undersea explosions that ruptured the Nord Stream 1 and 2 pipelines in the Baltic Sea, releasing large quantities of methane into the atmosphere. Additionally, Nord Stream is not the only inactive pipeline: the Yamal pipeline linking gas fields in northwestern Siberia to Germany via Belarus and Poland has also been shut. The two pipelines that remain active are the one that runs through Ukraine and Turkstream, which links Russia and Turkey and from there runs to southeastern and central Europe.
Short-term measures
In order to tackle the energy emergency, on September 30 the European Council agreed to a voluntary overall reduction target of 10% of gross electricity consumption and a mandatory reduction target of 5% the electricity consumption in peak hours. In addition, it agreed to cap the market revenues for electricity generators that do not use gas to produce electricity, relying instead on solar power, nuclear power, hydroelectric energy and lignite. The cap was set at € 180/Mwh. The member states will collect all surplus revenues. Finally, a solidarity mechanism has been introduced consisting of a levy calculated as a percentage of taxable profits earned by fossil fuel companies (petroleum, gas, coal and refineries). Authorities may introduce a 33% tax on the profits earned by these companies during the 2022 fiscal year, but only if said profits are above a 20% increase of average profits since 2018. The proceeds from the second and third instruments will be used to provide financial supports to struggling households and businesses in the form of subsidies, reduced fees, or income support. In such a framework, the member states that have already adopted similar solutions at the national level will be able to continue their programmes if they pursue the same goal as the EU package.
The above seems to provide implicit authorisation to Germany’s € 200 billion plan to cap electricity and gas prices through subsidies for household and businesses, which would also help contain the inflation spiral. Nevertheless, it is crucial that the actions of individual countries, especially those with greater room for fiscal manoeuvre such as Germany, do not create unfavourable circumstances for other countries, leading to a fragmentation of the European single market. Indeed, financial supports to households and businesses through a reduction in energy prices inevitably translate into incentives to consume energy.
Instead, it would be crucial – and more rational from an economic standpoint – to provide subsidies to low-income households and incentives to families and households to reduce energy consumption compared to the previous year. The proposal to introduce a price cap on all imported gas, supported by fifteen countries including France, Italy, and Spain, is still being examined by the Commission. Nevertheless, there are fears that the maximum cap may lead to conflict with suppliers (who could retaliate by interrupting supply), and jeopardise the security of EU supplies while incentivising gas consumption at a time when gas savings have become crucial. In particular, a cap on the use of gas in electricity generation may require significant public funding, which would also create an incentive to increase electricity demands, leading to increased gas consumption. Finally, a cap on Russian gas only would have a limited impact now: given the reduction in gas supplies from Moscow, such a cap would only lead to marginal reductions in overall costs. Additionally, it is quite likely that it would lead to Russia shutting down supply for good.
Again, with an eye towards reducing consumption, the European Commission introduced the Save Gas for a Safe Winter plan in July 2022, which plan was approved by the Council on August 5. The plan calls for a 15% voluntary reduction in natural gas demand between August 1, 2022 and March 31, 2023 compared to average consumption in the last five years. Additionally, the regulation gives the Council the possibility to declare a “Union alert” on security of supply, in which case a reduction in gas demand would become mandatory. The Union also introduced new legislation requiring EU underground gas storage to be filled to 80% capacity by November 1, 2022 to ensure supply for the winter. As of now, Italy and the EU are at 90% capacity. Finally, the Commission has set up the EU Energy Platform to aggregate energy demand at the regional level and facilitate future joint purchasing of gas and green hydrogen, ensuring the optimal use of infrastructure so that gas flows to where it is most needed.
Finally, in October the European Council adopted several measures paving the way for a rationalisation of the European gas market. For the first time, starting next year EU member states will be obligated to jointly purchase 15% of their gas stocks (however, such gas stocks only cover 30% of winter gas demand). Furthermore, a new complementary reference parameter for gas prices will have to be developed that considers the increasingly important role of LNG. Additionally, proposals have been made to create a dynamic price corridor to reduce the volatility of gas prices, and the possibility has been introduced to consider temporary price caps on gas used for electricity generation. Finally, solidarity measures between European countries will have to be strengthened for cases in which an individual member state may find itself in an energy emergency.
These European measures and the reduced supply from Russia are starting to have noticeable effects. In mid-November 2022, 45.5% of EU has imports from LNG, 34% from Norway, 8% from Algeria and just 7.9% from Russia.
Another obstacle to greater diversification comes from the French veto on the MidCat gas pipeline, which would boost links between Spain and France and potential increase west-to-east gas flows. Gas flows in the two existing interconnections were augmented at the end of September, with an increase of 1.5 billion cubic meters, which amount to an 18% increase in Spain’s gas exports via pipeline, and to 6% of French natural gas consumption. On October 20, during a trilateral summit between France, Portugal and Spain, the MidCat project was jettisoned in favour of a new green undersea pipeline between Marseilles and Barcelona. The BarMed pipeline is destined to carry green hydrogen, but it will temporarily be allowed to transport small quantities of natural gas. This is a major step forward in the middle term to improve the integration of the European energy market while pursing decarbonisation goals. It also represents a victory for France, which sees upheld its position as a European energy power.
Italy’s numbers are not entirely in keeping with the general European data, thanks to the Draghi government’s efforts to pursue diversification with a Mediterranean focus, with agreements to increase supplies from Algeria and Azerbaijan via pipeline and also with additional contracts for LNG with countries such as Qatar, Egypt, Angola, Congo and Mozambique. As of late November, Italy was importing 41% of its gas from Algeria, 28.1% via LNG (from Qatar, the United States, Nigeria and other African countries), 18.5% via Azerbaijan through the TAP pipeline, 7.3% from Libya and only 1.6% from Russia, with gas flows from the latter country practically reduced to zero. The LNG share is destined to increase even more as soon as the regasification floating unit in Piombino becomes operational. Nevertheless, in the short term it will be very difficult to completely replace gas flows from Russia while also meeting demand for gas: for this reason, a reduction in consumption is one of the cornerstones of the European and Italian strategies to get through the winter without sudden interruptions in gas supplies to households and businesses. The effects of the prolonged increase in gas and electricity prices are leading to significant increases in energy bills in all European countries. Energy expenses as a share of GDP are expected to increase to 13% in 2022, compared to an average of 5% in 2019-21. In Germany, this share increased from 3.7% in 2019-21 to 9.5%. The situation is similar in France, where energy spending is expected to increase to 9.5% of GDP in 2022, versus an average of 3.5% in 2019-21.
REPowerEU, the green transition and decoupling from Russian gas
A rapid reduction in gas import from Russia, as indicated in the Commission’s plans (REPowerEU aims to cut the demand for Russian gas by two-thirds in 2022) poses two key challenges: a short-term increase in the use of fossil fuels, and speeding up the diffusion of renewable energy in the mid- to long term. Contrary to the International Energy Agency’s proposal to reduce dependence on Russia, the European Commission does not intend to increase the use of coal (or other fossil fuels), even though some countries may decide to postpone plans to abandon these sources altogether. The largest share under the Plan – amounting to two-thirds of the total reduction in demand – comes from a greater reliance on renewables and from improving energy efficiency. The Commission’s REPowerEU Plan aims to achieve 1236 GW of energy generation from renewables by 2030, increasing the previous goal of 40% in the Renewable Energy Directive to 45%. The increased role of renewable energy, however, requires major upgrades in the EU’s energy network, improving interconnections and adapting a network designed largely for continuous generation and centralised to accommodate the widespread use of intermittent and scattered sources. Additionally, in order to achieve the goal of 45% of energy from renewable sources set by the Commission, it is necessary to significantly increase stockage capacity: according to the European Association for Storage of Energy (EASE), by 2030 the EU will need an electricity storage capacity of 108 GW, versus the 40 GW available in 2020. However, not all economic sectors can be electrified with the same ease. In hard-to-abate sectors and in the most energy-intensive industries, hydrogen will have to play a key role to ensure their decarbonisation. The 2020 EU Hydrogen Strategy, which was already ambitious enough on its own, has been further strengthened by REPowerEU, which has quadrupled the green hydrogen supply target and plans to use much of the energy potential supplied by renewables to produce it. The REPowerEU plan has set a goal of 20 million tonnes of green hydrogen in the EU (half produced domestically and the other half imported), which requires massive investments in infrastructure to achieve it. Nevertheless, such ambitious goals for the production of green hydrogen imply that a significant proportion of the new renewable energy capacity must be set aside for this goal, which means that policy makers and other interested parties must carefully plan new power plants within the EU.
The necessary resources for the transition
Turning the EU into a zero-emission economy, as envisaged by the EU Climate Law, will require massive investments on the part of both the public and private sectors. According to the most recent estimates by the Commission, the investment gap currently amounts to about € 520 billion per year, while other analyses estimate total costs of € 855 billion per year. Stronger-than-expected inflation and the need for government interventions to protect citizens and businesses from the spike in energy prices are further eroding the fiscal space within which public institutions can invest in decarbonisation. In order to help channel private investments towards green and sustainable projects, the European Commission has developed a taxonomy that provides a clearer picture of what investments can be considered in compliance with ESG (Environmental, Social and Governance) standards. The latest update, adopted in March 2022, includes nuclear energy and gas – provided rigorous conditions are met – as energy sources that can help reduce the use of the most polluting fossil fuels, such as coal and petroleum, during the energy transition. To mobilise private capital in support of public investments, the Commission has also made it possible for member states and other institutions to issue green bonds for investments identified as sustainable according to the taxonomy. Such private funds are essential in a context that sees an acceleration in green investments – in its REPowerEU Plan, the Commission estimates that because of the war in Ukraine the EU will have to spend an additional € 210 billion to diversify its energy sources and abandon Russian gas and oil – and limited room for manoeuvre for public budgets.
Indeed, the energy transition is not just an environmental issue: as shown dramatically by the conflict in Ukraine, it is also a matter of security and strategic autonomy. The EU has been hit hard by the conflict: the spike in energy prices, combined with reduced imports from Russia, is forcing the Union to find alternative suppliers and may lead to a temporary increase in fossil fuel consumption. Thus, in the short run one of the three pillars of the energy trilemma – sustainability – seems destined to be sidelined in favour of energy security and diversification. In fact, it is already necessary to accelerate investments in renewable energy and support research into nuclear power for the future, since these are crucial for the European Union’s true energy security and a reduction in energy prices.
With the support of the European Commission's Representation in Italy.
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