Bracing for a Bleak Winter: Unravelling the EU Energy Crisis

Europeans are gearing up for what could be a long, cold and expensive winter. Rising energy costs have shot up fuel bills and increased the price of many daily purchases, including food. The continent is dealing with the worst energy crisis in decades, with exorbitant costs of gas and electricity causing inflation amid looming fears of an ugly economic recession. The reasons behind the energy crisis are all but straightforward and give an insight into how complex and interconnected the global energy market is.

While the crisis is global with China and African countries facing the brunt as well, Europe is grappling with more aggravating factors that could make the crisis more severe.

The start of the crisis can be traced back to the winter of 2021, when colder-than-expected temperatures led to higher-than-usual electricity demand to warm up buildings. This triggered a glaring decrease in gas reserves, which reached a worrisome 30% by March 2022. With time, the vaccination campaign started to gain traction around Europe, businesses started reopening, and customers were eager to spend after a huge hiatus. This economic recovery generated a new wave of energy demand, which further increased during the summer when sweltering temperatures, a consequence of global warming, forced people to use more air conditioning and cooling systems than before. However, the growing demand for energy was not met with a fitting supply.

Unlike a popular notion, major gas-supplying countries like Russia, Norway and Algeria have not really supplied more gas to Europe, despite the marked increase in prices. And this is strange because, in the case of spare capacity, the supplier can easily benefit from the price rise. With no increased supply, prices continued to rise and were breaking records by August. Rising gas prices have increased the price of electricity by over 230%. When reserves should have generally been high at this time of the year, when gas is cheaper and it is profitable to hold up huge reserves in lieu of winter, there is next to no stock. This is very much an ominous sign for the coming months.

The connection between gas and electricity prices is based on the rules of the EU energy market. Today, the EU’s electricity market works on the basis of marginal pricing, which is also called a "pay-as-clear market." Under this system, all electricity producers – from fossil fuels to wind and solar – bid and offer energy depending on their production costs. Since most countries still rely on fossil fuels to meet all their energy demands, the final price of electricity is inevitably set by the price of coal or natural gas. Therefore, if gas becomes more expensive, electricity bills go up, even if cleaner and cheaper sources are available. This "coupling" of electricity and gas prices has been criticised by several member states, especially France and Spain, who argue that this system fails to tap into the benefits of transitioning to green energy.

Additionally, the surprising lack of new supplies from Russia, which is the EU's leading gas exporter, is raising fears that Russia wants to leverage the crisis to make a case in favour of the contentious Nord Stream 2 pipeline. The 1,230-kilometre pipeline directly linking Russia and Germany is now complete, but operations have not begun due to bureaucratic hurdles. The project has drawn ire inside and outside the EU for perpetuating the bloc's dependence on fossil fuels and furthering President Putin's geopolitical influence. Moreover, the shutting of Nord Stream 1 has also added to fears of supply getting curtailed for an indefinite period, further deepening the crisis.

On the economic front, the euro is grappling with a strong dollar. Fears of a full-blown recession have made the European Central Bank hesitant about raising interest rates to combat ongoing inflation. Inflation is also in the picture now because of the post-pandemic growth fuelled by COVID-19 stimulus policies and consumer saving rates.

The recent chain of crises (from the COVID-19 pandemic to the Russia-Ukraine war) is a strong reminder that ambitious and long-term climate goals cannot be achieved if energy security and affordability are not acted upon. The EU’s extremely high dependency rates, at 95% for oil and at 85% for gas, are dire enough to look for sustainable sources and to diversify supply. Paradoxically, short-term measures to quickly limit the rise in oil prices could also delay the transition to decarbonised transportation.

As a positive step in the transition to green energy, the European Green Deal was unveiled at the beginning of the pandemic. More recently, in July 2021, the European Commission launched the Fit for 55 Package. The Fit for 55 Package includes measures that directly address oil consumption and road transportation, and includes the development of a new emission trading system, the development of alternative fuel infrastructure, and the ban of internal combustion engine vehicles by 2035. Additionally, the REPowerEU plan unveiled by the European Commission on March 8th mentions the option to strengthen the Fit for 55 proposals with higher or earlier targets, but so far, the only short-term measure that positively impacts the climate is an incentive to turn down the thermostat for heating buildings by 1°C. Since most EU members have already implemented short-term measures to shield consumers from the rising prices, some of which include direct support or subsidies to fossil fuels, there will be a delay in the transition to alternative fuels.

In their efforts to brace themselves for a bleak and drawn-out winter, European governments have spent trillions of euros in order to cushion consumers and companies from soaring energy prices and many have unveiled ambitious plans and packages to counteract the devastating impacts. From windfall taxes, price ceilings to circuit breakers, the EU and the governments are clambering to try and lessen the severity of the crisis. All in all, what has become evident is that times of uncertainty do not favour major structural changes. Moreover, since solar panels and hydrogen trucks cannot be massively deployed overnight, recent crises can only boost decarbonisation ‘plans’ in the long term, as is evident from the defensive response of EU member states. All eyes are on Europe to see how its harshest winter so far pans out for the continent.

References:

  1. The ‘Fit For 55’ package at a glance. (2022, April 5). European Climate Foundation. https://europeanclimate.org/stories/the-fit-for-55-package-at-a-glance/

  2. Gumbau, A. (2022, May 12). Energy price crisis: Is the EU’s power market design to blame? Energy Monitor. https://www.energymonitor.ai/policy/market-design/energy-price-crisis-is-the-eus-power-market-design-to-blame

  3. Lu, C. (2022, July 26). The Energy Crisis Is Fueling Global Turmoil. Foreign Policy. https://foreignpolicy.com/2022/07/22/global-energy-crisis-natural-gas-fuel-shortage-power-cut/

  4. REPowerEU: affordable, secure and sustainable energy for Europe. (2022). European Commission. https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal/repowereu-affordable-secure-and-sustainable-energy-europe_en

  5. What is behind soaring energy prices and what happens next? – Analysis. (2022). IEA. https://www.iea.org/commentaries/what-is-behind-soaring-energy-prices-and-what-happens-next

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