Europe Needs a Grand Bargain on Energy

Europe finds itself in the middle of a perfect energy storm. Over the last several months, multiple shocks have converged, pushing the continent into what increasingly looks like the worst energy crisis it has ever experienced. The effects of COVID-19, Russia’s invasion of Ukraine, and unexpected problems with domestic electricity production have upended Europe’s energy market. As a result, Europe might not have enough energy to meet anticipated demand this winter. Several European countries might need to significantly curtail their use of gas in the industrial sector to keep households warm.

This energy crisis represents Europe’s greatest systemic risk right now, both economically and politically—more so even than a potential recession, which is also driven mainly by the disruption to energy markets. A European energy crisis would lead not only to a spiral of economic turmoil and social tensions but also to renewed calls for protectionism. Countries could stop sharing their scarce energy supplies, compromising the functioning of the European energy market and creating an emergency for countries that have few options for finding new energy sources. The resulting lack of trust among European countries would ultimately weaken their unity, including their strong stance against Russia’s invasion of Ukraine.

Russian President Vladimir Putin’s strategy to weaken European support for Ukraine by weaponizing energy is now clear to all. Putin has routinely cut gas supplies to European countries when they refused to comply with the Kremlin’s demand that Russian gas be paid for in rubles or when they voiced support for Ukraine. When the leaders of France, Germany, and Italy traveled to Kyiv in June, for example, Putin responded by slashing gas deliveries through Nord Stream 1, Europe’s last major access to Russian gas.

To resist Russian pressure, European leaders must rapidly prepare a counteroffensive for what will be a difficult winter. The choices they make now about how to manage a limited energy supply will shape the future of Europe. Populist parties are likely to push for energy protectionism, which might damage Europe’s political unity. But if European leaders agree to better coordinate energy policy and invest more in alternative energy sources, they could prevent Putin from leaving the continent in the cold this winter. Even better, such steps would accelerate Europe’s transition toward cleaner and more affordable energy—allowing the continent to finally free itself from the whims of the Kremlin.

THE SHOCKS

The ongoing effects of the COVID-19 pandemic continue to disrupt Europe’s energy market. During the peak of the pandemic, in 2020 and 2021, oil and gas investments declined as global energy demand plummeted during lockdowns. Reduced oil and gas production then led to a profound imbalance between supply and demand once global energy demand bounced back as economies reopened. Today’s high demand exceeds current supplies, causing high prices in fuel markets around the world. The lack of spare production capacities has made energy markets especially sensitive to changes in demand. In the past several months, for example, global oil prices have fluctuated wildly as China imposed and then lifted its pandemic lockdowns.

Next came the Russian shock, which started well before the February invasion of Ukraine. Russia has been manipulating European natural gas markets since the summer of 2021, when it substantially reduced exports and chose not to refill storage sites in the EU. These moves were initially considered part of Russia’s strategy to force Germany to open the newly built but controversial Nord Stream 2 pipeline that was supposed to bring gas directly from Russia to Germany, circumventing Ukraine. Once the war began, however, it became clear that drying out European markets was part of Russia’s larger strategy to exploit Europe’s dependence on Russian gas; in 2021, the EU imported 40 percent of its gas from Russia. By turning off the spigot, Russia could exert massive political pressure on European countries to abandon their support for Ukraine.

Since the spring, Russia has used its gas and oil supplies as a geopolitical weapon to divide Europe. It has done so most notably by reneging on long-term supply contracts that European countries considered sacred. After cutting off Bulgaria and Poland in April, Russia’s state-owned natural gas giant Gazprom stopped supplying a dozen European countries in May. In June, it finally reduced flows to its main markets, Germany and Italy. By the beginning of July, Russia was sending only one-third the volume of gas it had previously agreed to supply to European countries. As a result, gas prices in the EU have risen more than tenfold, and governments are nervously trying to protect consumers by handing out billions of euros in subsidies. Europe is compensating for the reduced Russian supplies by importing record levels of liquified natural gas, mostly from the United States. European companies have also signed several new gas deals with alternate suppliers. Additional supplies are expected to come online over the next few years.

Weather and other unforeseen problems have worsened Europe’s already tight energy situation. France can now run only half its nuclear power plants after inspections found that pipes in several of its reactors were corroding, and the facilities were shut down for repairs. With low nuclear output, France needs more gas for power generation. At the same time, severe drought has drained Europe’s rivers and lakes to extremely low levels, compromising not only the generation of hydropower but also the cooling required by thermal plants, as well as coal-fired power plants that rely on waterways to deliver coal. The situation deteriorated further in July, as Europe experienced a historic heat wave, which intensified the drought and increased energy demand in southern Europe.

GREATER THAN THE SUM OF ITS PARTS

Given this perfect storm, Europe must act quickly to ensure its energy security in the coming months, especially since the demand for gas will increase this winter. EU countries may be tempted to go it alone, but this is a challenge that is best overcome together. Europe needs a grand energy bargain in which every country brings something to the table. One country might increase its domestic gas production, for example, while another might ramp up its use of coal to spare using gas in electricity generation. Yet another might limit the use of gas in certain energy-intensive industries that make products that can easily be imported, such as glass bottles or ammonia. Such a grand bargain could be formalized as an agreement between the EU heads of state at the next meeting of the European Council, scheduled for October. 

Pooling resources is the right move, but it will require painful political compromises. Postponing the closure of Germany’s nuclear power plants would help reduce Europe’s dependency on Russia for gas, but it would also reverse Germany’s long-standing plan to stop using nuclear power. Boosting production in Dutch gas fields would increase gas supplies, but it would upend the Dutch government’s commitment to decrease gas extraction in the northern region of Groningen, which has suffered from hundreds of microearthquakes caused by the drilling. Temporarily lowering pollution standards for large industrial installations all across Europe would save gas by allowing the use of coal or oil, but it would take a toll in terms of environmental and public health.

Moreover, European countries cannot let perfection be the enemy of the good. They must deploy all possible solutions to safeguard energy security, even those that pollute and contribute to global warming, such as ramping up production in power plants that run on lignite, a combustible rock also known as “brown coal.” But these less attractive options will be needed for only a short period, and they should be accompanied by an acceleration of the development of clean energy sources. Making progress on both fronts simultaneously would allow Europe to emerge from its energy crisis greener and more resilient.

Populist parties are likely to push for energy protectionism.

Agreeing to jointly procure gas on international markets could also reduce the risk that EU unity falls apart as member states compete with one another for limited supplies. Such an idea was proposed in 2014 by Donald Tusk, then the president of the European Council, after Russia annexed Crimea, but it failed to take off because Germany and other countries worried they would lose their preferential access to Russian energy. Now, in the midst of an energy crisis, EU member states might have more of an appetite for the initiative. Moreover, joint procurement improves the bargaining power of Europe vis-à-vis external suppliers and might, therefore, lower the financial and political costs for gas. Jointly procured gas supplies could be used to serve the most vulnerable consumers in Europe.

A grand bargain on energy needs to address not just supply but demand. All EU member states should make honest and comprehensive efforts to reduce demand whenever possible. On July 26, EU countries made the historic decision to coordinate a voluntary 15 percent reduction in the demand for gas, compared with their average gas consumption over the last five years. If they follow through on this initiative, Europe could save 1.6 trillion cubic feet of gas between August 1, 2022, and March 31, 2023—equivalent to a third of Russia’s gas exports to the EU in 2021. To deliver on this target, European governments will need to carry out a thoughtful and straightforward communication campaign, explaining to their populations why these sacrifices are needed. Policymakers must convince citizens to reduce their household energy consumption in exchange for the preservation of jobs and peace. As part of this effort, they will need to ensure that consumers are incentivized to reduce consumption. For instance, households might receive a tax credit based on the amount of energy saved compared with last year’s consumption.

European leaders should agree to stop directly subsidizing energy consumption as they have in the past—with administrative price caps and energy-cost compensation schemes, for example—and instead subsidize energy reduction. New regulations, such as temporarily allowing lower temperatures in rental houses, need to be put in place ahead of the winter.

THE NEEDIEST CASES

A grand bargain is necessary so that all European countries benefit from supporting one another in this crisis. The European Union should create a fund that could help compensate the countries that are making energy tradeoffs to help their neighbors.

For example, people living near the large Groningen gas field in the Netherlands should be compensated for the heightened risk of earthquakes that will arise from ramping up gas production. The Dutch government will have little incentive to pay the bill, because the increased production will mainly benefit other countries, specifically those most dependent on Russian gas, such as Germany. Algeria might be able to redirect gas flows currently going to Spain, which can easily turn to sources of liquefied natural gas if needed, and send them to Italy, which is far more dependent on Russian gas. But Spain might agree to foregoing cheaper Algerian gas only if it is compensated for having to buy more expensive liquified natural gas. Such a fund might also compensate gas-consumers in southern Europe for reducing their demand. That is, Italian industries could be paid to reduce their demand for gas, and the saved gas could be shipped to consumers in Austria or Slovakia, where it is needed more. Countries that are most responsible for the current crisis by having excessively relied on preferential access to Russian gas should contribute the most to such a fund.

Of course, any effort to stave off the European energy crisis cannot ignore the poorest in society, who are most exposed to energy poverty and more vulnerable than ever to price shocks. To protect this segment of the population, European governments should provide lump-sum transfers to vulnerable families that are struggling to cope with high energy prices.

A grand bargain on energy needs to address not just supply but demand.

Finally, short-term imperatives must not prevent European countries from enacting long-term solutions to reducing fossil fuel consumption. Although it may be difficult to admit, Europe will have to deploy all possible options to secure its energy supplies over the next several months, including the use of polluting coal. Adopting energy sources that accelerate climate change could be made more acceptable if European governments also ramped up the deployment of green energy solutions. They should, for example, fast track the permitting process for renewable energy projects, an undertaking that sometimes takes decades. Crucial domestic and cross-border transmission links should also be fast tracked. And Europe-wide energy-system monitoring and planning should be massively scaled up to detect and address bottlenecks that might hinder a more efficient development of renewable energy across Europe.

Should these steps be taken, Europe has a real chance to emerge from this historic energy crisis on a more sustainable pathway than before. In ten years, the 2022 energy crisis might be remembered as the great accelerator of Europe’s decarbonization and of its move toward energy independence. It is up to European governments to make it happen.