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20 July 2022

Europe risking lives with lack of imminent energy reforms

This coming winter will stretch Europe’s energy resources more than any time in living memory and threatens to destabilize geopolitics across the continent. The European Commission’s upcoming strategy must focus on short-term efficiency measures before an unrelenting push towards onshore renewables.

As much of Europe sits in record breaking heat, it seems almost impossible to fathom the chaos that a cold winter will bring. But it is in fact this very volatility in temperature – an undeniable consequence of climate change – that threatens Europe’s energy system.

The cause is the worsening stranglehold that Russian President, Vladimir Putin, is taking on Europe’s supply. Russian energy has historically been crucial to keep things turning in Europe, while revenues from exports plays a vital part in Russia’s economy. In 2022, it is expected that taxes from such revenues will account for 45% of the government’s annual budget.

Europe may hold more clout when halting the purchase of oil from Russia, with oil exports accounting for over 10% the country’s GDP over the past five years. But gas is where Russia holds its ace. It accounts for just 2% of GDP but has recently provided Europe with 42% of its total gas supply.

Russia will therefore survive without its gas exports. Europe will struggle. The current hot spell will only make things worse. Gas fields in Norway have been shuttered due to hot weather. Electricity demand for air conditioning has risen to maximum levels, causing an upswing in natural gas being used for power generation. While coal and oil distribution can be relatively easily redirected, replacing and reconfiguring gas infrastructure can take years and billions of dollars of capital investment.

Meanwhile, Nord Stream 1, which can provide over a quarter of Europe’s gas from Russia, had been running at 40% of its normal levels. Following a spell of undergoing maintenance, which shut the pipeline off completely, the European Commission stated that it does not expect Gazprom, the operator of the pipeline, to turn the taps back on at all. Russia, as should have been expected, is using the pipeline as a political weapon against the broad range of EU sanctions. It has chosen not to increase supply via alternative pipelines that pass through Ukraine.

Europe, which had pledged to reduce its dependence on Russian gas by two-thirds by the end of the year, had been doing relatively well in its endeavor until this hot spell. Harnessing LNG imports from the US and Middle East, gas reserves have been filled from low levels of 26% in March to nearly 60%. This would be on track to reach the 80% that would be required to get Europe through winter.

With a complete Russian shut off looking increasingly likely, political tensions across Europe are rising. Industrial firms are facing extortionate gas prices at best, as they are forced to buy from the spot market rather than through pre-agreed contracts. At worst, they may be forced into reduced purchase volumes. This winter will see the less financially equipped go bust, with worries of a broader financial meltdown.

The IMF said this week that a full embargo of Russian gas would lead to severe recessions if countries around the world start hoarding their own gas supplies. Economic contractions of over 5% could be seen in Czech Republic, Hungary, Slovakia, and Italy over the next year.

This risk will provide a strong test of the mettle of Europe’s cohesion, potentially more than the Euro crisis of 2010. Countries that are particularly dependent on Russian gas or have failed to fill up their storage reserves – including Hungary, Bulgaria, and Romania – may want to ease off on sanctions to keep their gas supplies steady. Others will want to remain in solidarity with Ukraine, until Putin backs off its invasion. He has shown little sign of doing so.

The UK, now outside of the EU, has also warned that it will have to prioritize its own supply for domestic consumption if it faces a shortfall this winter. Countries like Norway and the Netherlands could make similar moves.

This will compound the disparity in gas prices between markets and warns of a breakdown in the single market. Prices for delivery this winter are at €183 per MWh for natural gas – marking a seven-fold increase on historic levels. Prices for delivery in the winter of 2023 and 2024 are four times the normal level. Many are worried that the economic impacts of this will prompt default on national debts.

The European Commission will present a plan to tackle this at an emergency meeting on July 26th, where it will have to address a non-Russian boost to supply, as well as a reduction in demand. Begrudgingly, it may need to include both the UK and Norway in discussions – as well as the USA ideally – as alternatively suppliers, and should also push for more LNG imports. Gas fields that are scheduled to close, such as the Groningen facility in the Netherlands, should be kept running until 2023.

There will need to be a distributed approach to who has to ration their gas use, with state-backed companies at the top of the list, while storage capacity should be filled and shared across the bloc.

But most importantly, changes should be made that will help the bloc’s ambitions in the long run, reducing dependency on natural gas as a whole – not just gas from Russia. While medium-term plans have been outlined for more nuclear and offshore wind capacity, more emphasis should be placed on projects with shorter lead times. If solar and onshore wind projects were approved now, many could be online to help out next winter.

On the demand side, measures can be implemented that will have a material impact this winter. Insulation measures could reduce natural gas demand by over 10% in many markets.

Such measures are unpopular politically. By reducing regular consumption of natural gas, they can have an artificially negative impact on GDP. But such approaches are essential in tackling the triple threat of Russian imports, climate change, and rocketing power prices. Europe must come together to create a coherent and efficiency energy infrastructure by accelerating the imperative shift towards green energy.