With the European Union battling a crippling economic crisis, Europe’s high energy and electricity costs have become politically and financially untenable and have sapped support for costly, environmentally friendly policies in many member countries. Reflecting this situation, the European Commission in mid-January unveiled its new energy and environment strategy through 2030, which softened Brussels’ longstanding push for the development of renewable energy sources while maintaining binding targets for carbon emissions. However, the impact of this particular EU policy change will be limited, particularly compared with the broader trends that govern energy markets in Europe.
Early drafts of the policy cited statistics showing that average industrial electricity prices in the European Union are more than double those in the United States, while industrial natural gas prices reach up to four times that figure. However, they remain competitive compared to Taiwan, South Korea and Japan. The comparative advantage gap between Europe and the United States, its main industrial competitor in the developed world, has been steadily growing because the United States has benefited from a domestic energy production revival in the past few years, engendering relatively industry-friendly government policies that have kept costs for industrial energy consumers low.
Industry leaders in the European Union hoped that the target for greenhouse gas emission reductions would be tempered, but the commission kept the binding goal on the higher end, at 40 percent lower greenhouse gas emissions compared to 1990. Beyond renewables and emissions, the commission’s new non-binding policies on shale gas development essentially give carte blanche to its members to regulate this new industry as they see fit – a move the United Kingdom lobbied for heavily.
The largest change in the commission’s paper indicates that renewable energy targets for 2030 will not be binding on a nation-to-nation basis but on an EU-wide basis. This provision makes direct enforcement much more difficult by relying on a nebulous concept of “harmonization” for countries to move away from fossil fuel energy generation. The push for renewable energy has its roots in the years of financial security before the crisis, when the main threat in the energy sphere was Europe’s dependence on Russian imports and the popular demand for cleaner energy production. In less than 10 years, EU member states more than doubled the share of renewable energy in their total energy mix.
The picture began to shift dramatically after 2008. Europe’s leaders have been completely preoccupied by the economic crisis and its political and social consequences. Surprisingly, Germany has become the cautionary tale as its trailblazing emphasis on renewables has driven electricity prices up and placed an uncomfortably heavy subsidy burden on Europe’s largest economy, where the current subsidy scheme is estimated to cost businesses and consumers $32 billion per year. Barring major technological breakthroughs or a markedly improved economic outlook for Europe, widespread and economically sound renewable energy seems to be off the table for the time being.
The consequences of the commission’s policy shift, which will still need to be approved by EU members, should not be overstated. The fact that emission targets were not cut underscores that the majority of European countries will remain politically committed to relatively low emission levels. EU members will delay the implementation of renewables but will also continue to move away from high-polluting, coal-fired power plants — favoring the middle ground offered by natural gas and, to a lesser degree, clean coal technology for power generation, particularly because of the relatively low costs for both commodities.
The internal readjustment of self-inflicted high energy and electricity cost premiums due to renewable subsidies may help halt the European Union’s decline in competitive advantage, but it will be nowhere near enough to get the struggling European economy back on its feet. Europe’s longstanding high industrial electricity and energy costs are primarily driven by broader questions of imports sourcing and pricing – which will become the focus of European policy at the national and supranational level as the Continent’s leadership faces escalating political pressure due to Europe’s stagnating growth and high unemployment.
Within this context, Europe’s energy future will depend on the evolution of some key trends, domestic and international, which Stratfor has followed for several years. In this analysis, we will focus nearly exclusively on natural gas, given the global and relatively transparent nature of crude oil trading and the overwhelming importance of natural gas to Europe, since it accounts for well over a quarter of the total energy consumption on the Continent.
Indigenous reserves of conventional natural gas (and oil) are slated to continue declining in Europe, despite Norway’s limited but notable success in periodically finding replacement reserves. Much attention has been directed at Europe’s attempts to replicate the United States’ success in unconventional natural gas production. The European Commission report included a weak first attempt at an EU-wide strategy for shale development, a mostly irrelevant provision since the obstacles to unconventional natural gas production have mainly been unique to each country. We expect bureaucratic red tape and strong opposing interest groups (some rumored to be connected with Moscow) to continue delaying progress in Central Europe – as has clearly been the case so far in Poland and Romania. Concurrently, we are also extremely pessimistic on a reversal of social opposition to shale gas production in continental Western Europe -pressure that has not abated in either France or Germany.
The second developing trend to keep watching is the growing integration of European natural gas markets through EU-level policy and physical interconnection. A more integrated and clearly regulated pan-European market helps avoid major import price discrepancies between member states and, in the future, will give the bloc major negotiating leverage against Moscow when it comes to negotiating contracts with its largest consumer market — resulting in broadly lower average prices in the medium to long term. While Russia will attempt to diversify its customer base by expanding its energy exports to East Asia, existing field and infrastructure logistics will ensure that Moscow will remain deeply beholden to the European market.
A third dynamic that will have an influence on the energy sector in Europe will be the development of natural gas sources beyond Russia and Europe proper — a key imperative for policymakers who see the strategic danger of replacing declining indigenous production with more Russian imports to meet the expected stable demand.
Due to several factors – the low availability of investment capital in recession-stricken Europe, the strength of Russia’s competing South Stream pipeline project, Moscow’s strong leverage in Turkmenistan and the political risk still associated with Iran – we do not see a high-volume pipeline route from the natural gas-rich Eastern Caspian to Europe emerging in the next few decades. The only project that will materialize, the Trans-Adriatic Pipeline, will be limited in volume and geographic range.
We also do not expect North Africa to significantly ramp up natural gas exports to Europe in the medium to long term for two reasons. First, domestic consumption in North Africa is rising steadily, limiting the availability of natural gas for expanded exports. This trend is compounded by years of lagging production. While Algeria is moving toward a gradual opening of its significant conventional and unconventional natural gas reserves to foreign investors, the country is experiencing its own political transition and will proceed cautiously given how critical energy revenues are for managing the complex balance of power in Algiers. Egypt and Libya, the region’s other natural gas exporters, are likely to remain mired in political instability that will make production and export increases unlikely over the next decade.
Shipments of liquefied natural gas from around the world provide a coherent alternative for Europe in terms of supply stability and diversification, but it remains a toss-up price-wise. Buoyed by rapidly growing demand, the East Asian natural gas market is likely to continue commanding high prices in the short to medium term on the spot market, even as large Australian and North American projects come online in the second half of the decade, with East African projects joining the fray after 2020. In the medium to long term, the picture becomes more complicated as large volumes of liquefied natural gas will create more homogeneous (but not necessarily lower) prices for the commodity around the world.
Finally, another trend is the decline of nuclear power. Following the Fukushima Daiichi nuclear power plant disaster, a host of countries in continental Europe (with the notable exception of France) completely shut down their nuclear power programs. Despite a tepid resurgence, it remains unlikely that nuclear power will become a much more significant chunk of the European energy mix. The main barrier for large-scale development of nuclear energy in Europe, even outside of Germany, will continue to be the high upfront costs that are economically untenable when compared to relatively low fossil fuel costs.
Ultimately, the reality is that Europe will be hard-pressed to find cost-effective alternatives to natural gas from Russia, the world’s largest producer and the only consistent supplier of cost-competitive, high volumes of the commodity in the region. The European Union will place a greater emphasis on its collective bargaining and enforcement power to negotiate lower prices from Russia across the board for all of its members, and the development of liquefied natural gas import facilities will continue apace with the expectation that global liquefied natural gas prices will drop by the next decade. But as the economic crisis continues to blight Europe and the low energy price lobby grows stronger on the Continent, political leaders in Europe will focus on cost-effective solutions – even if they have to concede some of their current policies that make sense on a strategic level, in particular the construction of expensive diversification projects.