The The The

The EU’s unwise energy policy

CD
Christopher Dembik

Head of Macro Analysis

The EU’s energy crisis has been years in the making. The year 2021 ended with a month of record prices. Natural gas in Europe is now more expensive than oil. Instead of COP26 resulting in a phasing down of coal, the sad reality of the green transition in the EU is that coal is growing (see our Q4 outlook for a detailed analysis of the EU green transformation). With better weather conditions from March/April onwards, energy prices will likely move downward, but the crisis is not over yet. Expect energy prices to increase again next winter. The EU’s energy goals were to consume less, pay less at the end and pollute less. The outcome so far has been to consume the same, pay much more and pollute more.

A policy failure

Over the past years, the EU has actively promoted intermittent renewables, which cannot provide a constant supply of energy source, while pushing for the closure of nuclear reactors—one of the low-carbon baseload backbones of the EU. These are the two original sins of the EU’s green transition policy, and this is why consumers are now paying a much higher energy bill. Instead of getting away from fossil fuels, Europe is increasingly dependent on natural gas imports, keeping up coal plants and nowhere close to decarbonising. The chart below shows the evolution of electricity production by source in the EU between 2016 and 2021. Natural gas (+120 TWh) has replaced coal and lignite (-170 TWh) while wind power has increased by 100 TWh. But nuclear and hydro energy have remained constant. So far, natural gas is the main winner of the green transition introduced by the EU. Several countries are even happy about it: think Belgium, Germany and Poland. 

Source: ENTSOE

Case studies

Germany and Belgium are the perfect examples of what not to do. Around 20 years ago, Germany agreed on phasing out its nuclear plans. The Fukushima catastrophe (March 2011) accelerated the process with quite a knee-jerk reaction, suspending lifetime extensions for the seven oldest reactors. The closure of nuclear plans has forced Germany to rely increasingly on fossil energy, including dirty brown coal. To avoid an energy shortage, Germany will have no choice but to build a large number of gas power plants by 2030. The lowest estimate is based on building at least 50 new gas plants; the highest is 140. This is a hard-to-reach goal and is, of course, incompatible with the objective of achieving carbon neutrality by 2045. Belgium is in a league of its own in the EU. This is the only EU country to plan to increase the share of fossil fuels in its electricity mix. The Belgian government opposes nuclear power for ideological reasons. It plans to close all of the country’s nuclear reactors—which provide almost half of the electricity supply—by 2025. To compensate for this closure, the government is counting on the opening of new gas-fired power stations (even though it will take years before they are operational), and on an increase in electricity imports. All of this will cause a sharp increase in greenhouse gas emissions and a risk of supply shortages. This is a total nonsense.

Some hope

While the situation is critical, all is not lost. During the Christmas break the European Commission released its proposed taxonomy, a classification system that establishes a list of environmentally sustainable economic activities. Both fossil gas and nuclear are included as green electricity sources, with conditions. It is a wise decision to include nuclear, of course. Now, the European Parliament and the Council will have four months to scrutinise it and object to it, should they find it necessary. Anti-nuclear countries (Austria, Germany and the Netherlands) have protested against nuclear inclusion but they don’t have a qualified majority to reject it in the Council; that requires at least 20 member states representing at least 65 percent of the European population. An objection from the Parliament is perhaps more likely since it requires only a simple majority. We should have an answer by July; hopefully, nuclear will remain a part of the taxonomy. 

Macro implications

The energy component (9.5 percent of the headline HICP) has been one of the main drivers behind the increase in inflation in 2021. The EU’s misleading green transformation, low spare production capacity and the lack of investment in fossil energy infrastructures partially explain it. In recent weeks, energy prices (particularly natural gas) have fallen. But the demonstrations in Kazakhstan—a net gas exporter (15 bcm in 2020)—could have an impact on local production and push European gas prices higher again in the short term. We expect the energy component to ease from March/April onwards with better weather conditions. That being said, we believe inflation in the eurozone will remain uncomfortably high on average this year. In our view the risk of a new energy crunch next winter is high. 

Geopolitical implications

The EU is already structurally dependent on Russia for its energy supply. It now imports nearly 40 percent of its natural gas from Russia, for instance, and things will only get worse. When Norway, the EU’s second largest supplier, reaches its peak gas extraction by the end of the decade, this dependence will be even more pronounced. It is unlikely that Algeria, the third largest supplier, will be able to substantially increase its production in the coming years. This will leave the EU at the mercy of the Russian president’s wiles. Europe will remain a political dwarf on the world stage and will have little influence beyond its borders (i.e., in Ukraine or Belarus).

Political implications

EU citizens won’t be happy in the coming months when they receive their inflated energy bills. Several member states have already introduced temporary measures to mitigate the impact on consumers.  For instance, France has announced inflation indemnity of €100 to citizens earning less than €2,000 per month, while Spain has brought in a temporary reduction of VAT for electricity; others are discussing measures. The new German coalition government is mulling heating compensation to ease the pain of energy prices via energy vouchers or lower taxation. Overall, more than 36 million Europeans who belong to the poorest quintile are affected the most by the energy crunch. All these measures are helpful in the short term, but not necessarily in the long term. If the energy crisis lasts, as we believe it might, it will have deep political implications too. The risk of the Yellow Vest Movement spreading over Europe is low. Very few European countries have a protest tradition like France. But anger over energy prices and declining standards of living could fuel populism, abstention from voting, political extremism and further distrust towards the EU and the political elite, amongst other things. Ultimately, this leads to a more divided society. 

In our view, the closure of nuclear plants in the EU was a serious historical mistake. In Asia and Africa, there are over 150 projects in the works between now and 2030. The EU is lost at this point; consumers will now pay the bills for ill-advised policy choices. Including nuclear as a green investment in the taxonomy was the best decision to take. But building nuclear plants take years—more than 6 years on average. In the interim, energy prices will remain elevated, there will be more pollution from fossil energy and Europe will get poorer. 

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