Near-term prospects of the European energy market

MOSCOW, 04 Oct 2021, RUSSTRAT Institute.

Current events in the European energy market strongly indicate the development of a systemic crisis there. The mechanism of providing the economy with energy that developed during the 20th century shows signs of increasing breakdown. The traditional instruments that self-regulate it have lost their practical effectiveness. And most importantly, the political leadership of the European Union demonstrates a persistent misunderstanding of the essence and causes of what is happening, continuing to consider it certainly as unpleasant and economically destructive phenomenon, but in fact strictly a short-term one.

According to the statement of the European Commissioner for the Internal Market, Thierry Breton, “the difficult situation in the energy sector” arose due to a tragic, that is, unpredictable in advance (hence completely random) coincidence of a number of negative factors. The key ones among them are a sharp and very high increase in gas prices, a reduction in energy supply due to the closure of oil and gas wells, the consequences of the COVID-19 pandemic and increased geopolitical tensions.

The latter serves as a reason to shift the blame for what is happening to Russia, which refuses to increase gas supplies to Europe. Thus, Moscow is allegedly trying to increase political pressure on the European authorities to lift the restrictions of the Third EU Energy Package in relation to the Nord Stream 2 gas pipeline.

However, the real reasons for what is happening are different. Wishing to move the European economy to zero CO2 emissions by 2050 at a faster pace, and also striving to fully transfer its energy sector to the principles of the free market as quickly as possible, the EU leadership has implemented solutions that practically paralyse not only the energy industry, but also the economy of Europe as a whole.

The first destabilising factor is the desire to maximise the scale of renewable energy sources (RES) in the total energy balance. According to the “Carbon Border Adjustment Mechanism” and the “Renewable Energy Directive” adopted by the European Commission in 2017, the share of wind and solar energy in total energy generation should be increased from 19.7% in 2019 to 32% in 2030 and up to 40% by 2040. Generation should not be confused with consumption of electricity, 40% of which RES is supposed to providе by 2030, and 60% – by 2040.

Even without in-depth analysis, it is clear that these figures are poorly combined with each other. This indicates the lack of a holistic system in energy and structural economic planning. At the forefront of which is a completely idealistic desire to reduce CO2 emissions by 55% by 2030 without any consideration of the associated economic and structural consequences.

The race for renewable energy for the sake of renewable energy in 2020 led to the commissioning of 15 GW of installed capacity, bringing its total volume to 220 GW. This led to a situation where, during 2020, 40% of Europe’s consumed electricity  was “taken” from renewable energy sources, and 34% accounted for generation that consumes fossil fuels.

Not because renewable energy is somehow better, it’s just that investors “in green energy”, before the implementation of projects, received state guarantees about the unconditional priority of purchases of “green energy” over all other sources. Thus, during the formation of surpluses, traditional power plants stopped. Moreover, “green energy” still had the right to sell electricity at a price 4-5 times higher than “traditional” one.

Until the share of non-market methods in the overall scale of the energy system remained insignificant, the “conflict of prices and interests” was relatively successfully smoothed out by the existing mechanism. However, the shock increase in the rate of growth in renewable energy generation brought its share to values that the traditional system was no longer able to smooth out.

The second destabilising factor should be considered the reckless, largely populist and overly politicised desire to achieve a 55% reduction in carbon emissions in Europe by 2030. It was believed that the introduction of so-called “green certificates” would become an effective mechanism for the “soft” stimulation of the energy industry “towards a green energy transition”. However, in practice, they have turned into a classic exchange commodity.

Already in 2019, the Paris Institute for the Economics of Climate Change in its Global Carbon Account review noted that as of May 1, 2019, there were 25 greenhouse gas emission taxation schemes and 26 emissions trading schemes (ETS) in operation worldwide. In total, the jurisdictions in which the carbon price is applied account for about 60% of global GDP.

In 2016, European CO2 emitters paid €22 billion for “emissions”. In 2017, this figure rose to 32 billion, and in 2018 it increased to 40 billion. In the European Emissions Trading Scheme (EU ETS), the price “per tonne of CO2” has increased from the originally established €8.8 to 22.2. In the summer of 2020, the “green certificate” was already sold for €40, and by now the price has reached €60 per ton of CO2 emissions.

As Thierry Breton noted in his speech, the shortage of electricity in Europe arose due to the fact that in the second half of 2021 there was an abnormal decrease in the “amount of wind”, which caused a twofold drop in the power generation of wind farms.

Technically, this is true. However, the European Commissioner did not mention that the owners of the “green certificates” who received them at the base price, but unspent, were actively selling them on the stock exchange. Thus, on the one hand, generating additional income for the renewable energy segment, and on the other hand, practically killing the profitability of classical, primarily coal generation. Because of this, by now more than 20% of coal capacities have been on the verge of bankruptcy, and another 34% have been forced to drastically reduce production volumes. Thereby further increasing the scale of the deficit.

However, the European Commissioner’s selectivity can be understood. Based on the “anti-crisis measures to save the European economy” adopted at the beginning of 2021, a quarter of all “carbon charges” now go directly to the budget of the European Commission, thereby reducing its dependence on voluntary contributions from EU member states.

The appearance in Brussels of its “own money” significantly expands its authority  to strengthen the power of the central bodies of the European Union. In addition, another 2.5% of the total fees goes to the maintenance of the EU ETS bureaucracy.

It follows that in the near future, the European authorities will not abandon the continuation of the current policy in the field of “reducing emissions”. On the contrary, they will try to use the crisis to adopt new programs to expand it.

The third destabilising factor is the EU’s stubborn desire for the widest and fastest possible transfer of the energy market to the principles of “free trade”.

Until 2014-2015, the price of gas was formed with reference to the price of oil, and was adjusted according to the average value of the oil quote for the past six-month period. By the end of 2019, the European Commission managed to include spot quotes on European gas hubs in the calculation formula, increase their share to 25%, and reduce the duration of the “oil averaging” to three months.

While oil and gas prices, due to the formed oversupply of hydrocarbons, as well as the abnormally warm and short heating season of 2020/2021, were at extremely low levels, around $1.9 per million British thermal units (MBTU), the result of the EC’s actions seemed successful.

However, the heat wave that followed did not reduce the demand for electricity, and political measures to block Nord Stream 2, coinciding with a decrease in production from other suppliers, led to the fact that the destroyed price binding “to oil” began to push the price of gas up. With less than $140 per thousand cubic meters, it exceeded 800 today, and for a short time, during the week, it even reached $1,000 per thousand cubic meters at its peak.

As a result, a generation deficit began to form in European countries, resulting in an increase in direct electricity prices. If in March of this year the average cost of a kilowatt-hour in Europe fluctuated around 18 euro cents, then in the third week of September it exceeded 60 euro cents. And this is not the limit, since the heating season in Europe has not yet begun, and only 72% of the required volume of gas has been accumulated there. This directly indicates negative prospects, since usually by the fourth week of September they were filled by 90-94%.

Moreover, the growth of gas prices in Europe continues to lag significantly behind their level in Asia, thereby preventing the market mechanism from “turning on”. The vast majority of producing countries, including the United States, prefer to continue shipments to Asian markets. And so far there are no significant reasons for a radical change in the current situation.

The fourth influencing factor is the continuation of the EU policy on accelerated decommissioning of coal-fired power generation, as “unacceptably highly polluting the atmosphere of the planet.”

In particular, the Court of the European Union in Luxembourg sentenced Poland to pay a daily fine of €500,000 until coal mining at the Turov mine is stopped. Warsaw’s arguments that coal plants provide almost 70% of the country’s energy generation, and shutting them down will plunge the Polish economy into collapse, were ignored.

There is a paradoxical situation with coal in Europe in general. Due to the rise in the cost of “green certificates”, rising prices for energy coals, as well as due to other strict restrictive measures, the cost of coal generation is growing critically, bringing it closer to the threshold of direct loss.

But due to the rise in electricity prices, as well as due to a drop in production in the renewable energy segment, during January – July 2021, the share of coal generation in Germany slowed down the decline and even increased by 7 percentage points (to 26.1%) compared to the same period last year.

Roughly speaking, the EU’s “anti-coal” position actually leads to an accelerated consumption of the technical and financial resources available in the “coal segment”. The owners of coal plants are in a hurry to squeeze the maximum out of the equipment, completely stopping investments not only in modernisation and expansion of capacities, but even in their current routine maintenance.

Consequently, by the end of 2022, we can expect the start of mass closure of facilities due to their reaching the limit on technical wear. That the energy deficit in the EU will increase even more.

It is already clear that all of the above has the effect of “a scrap stuck in a thin working mechanism.” The most energy-intensive sector of the European economy – industrial chemistry – has reached the unprofitability milestone.

One of the largest producers of fertilisers, the American company CF Industries Holdings announced the shutdown of two of its production complexes in Britain, which are the largest in the industry in the United Kingdom. This signalled a reduction in production volumes at other similar enterprises in Germany, Belgium, the Netherlands and Southern Europe.

For the next couple of months, the available stocks of chemical products to support the vital activity of connected economic chains will still be enough, but in the spring of 2022, a significant shortage of mineral fertilisers is expected in the EU, threatening to fall in agricultural production in Europe as a whole in the autumn.

However, problems with food are expected this year. In particular, manufacturers of bakery and pasta products started to warn the authorities about the threat of the inevitability of price increases of approximately 40%.

Since electricity is widely used in their production cycle, and it is also required to maintain a stable temperature regime in the premises, previously provided by gas heating. A sharp rise in prices for both in the near future will force manufacturers to radically revise their pricing policy under the threat of ruin.

Of course, this is not yet a harbinger of famine, but similar signals from the meat and dairy and processing industries say that if the situation with energy prices does not change for the better in the coming months, in the timeframe of one or two years, the European Union may move from the status of a net exporter of food to the category of its net importers.

However, the European authorities do not draw systemic conclusions from what is happening, preferring to “fix everything” with momentary administrative measures. As it became known to The Times, Spain, at a meeting of EU transport and energy ministers held in Slovenia, submitted a “secret plan” to the European Commission.

According to Madrid, Moscow is “to blame” for the rise in European gas prices in Europe, using “temporary difficulties” to destabilise the EU, undermine the European economy and destroy the unity of the European position on the issue of the subordination of the Nord Stream gas pipeline to the norms of the Third Energy Package. It is proposed to combat this through the introduction of directive-set marginal gas prices in the European Union, the observance of which should become mandatory on the territory of all countries of a United Europe.

At first glance, it is clearly utopian. For example, the Spaniards propose to urgently form buffer gas reserves in the European Union, with the help of which Brussels will have to stop price fluctuations. And it does not matter that this goes directly against the European policy of expanding free market pricing for energy carriers.

However, there are already reasons to expect that at the next EU profile summit in October, the Spanish “idea” will begin to pour out into official “pan-European” documents. Winter is coming, for which the European Union is showing a clear total unpreparedness. Germany is threatening to completely stop gas supplies to inter-sectoral enterprises, and Brussels is already recommending to residents of Croatia to start massive firewood harvesting for heating housing.

This leads to a logical conclusion that the current crisis in the European energy sector is not of a momentary temporary, but of a long-term fundamentally systemic nature. The 2021/2022 heating season and further consequences in the spring and early summer of 2022 will be a serious test of the European economy for stability, and the European authorities for overall adequacy.

Of course, it is premature to expect a complete economic collapse of the EU, but in the current conditions, three likely general scenarios for further developments are being viewed. Analysts of the British oil giant BP call them: “Net Zero”, “Rapid, and “Business-as-usual”.

The “Net Zero” option proceeds from the assumption that the authorities of Europe (more broadly, the entire collective West, including the United States) will try to use the emerging circumstances to decisively break the traditional energy model in order to maximise the acceleration of the “energy transition to hydrogen”.

New energy will be very expensive, and the process of building it will be extremely painful. But there is no other way, since the gradual iterative transfer of the economy to “green hydrogen” is currently critically hampered by numerous factors of the “inertia of the old system”. This includes the disagreement of ordinary consumers to lower their standard of living “during the transition period” caused by the destruction of the existing economic chains at the stage of their transformation.

However, if to pass it “quickly”, the new “hydrogen economy” will work before the level of social discontent in society reaches a critical level.

In addition, the subsequent economic transformation will create convenient conditions for the complete reorganisation of the European Union from the current federation of still fairly independent countries into a single centralised supranational state, with the final concentration of power and money in the hands of Brussels (i.e. the European Parliament and the European Commission). Including securing for them the right to their own budget and to collect direct taxes from the entire territory of the United Europe.

The development of events under the “Net Zero” scenario promises a radical increase in the cost of “green certificates” to €220-250 per ton of CO2 in “developed” countries and to at least €175 in “developing” countries.

In the future, up to 2050, such measures will reduce the demand for oil by 80-85% and for gas by 60% relative to the level of their consumption in 2019. The European economy as a whole will go through a devastating stage of a complete shutdown of a number of major industries, including chemical, metallurgical and, to a large extent, food. The material standard of living of European households, in the framework of the next 5-8 years, may decrease by 40-50%.

However, a large-scale expansion of capital investments in the construction of a new “hydrogen infrastructure” and the associated “hydrogen economy” should create a sufficiently large-scale basis for maintaining economic growth in new industries, which will ensure a serious reduction in the level of negative factors, and by 2030 will form a new stable trend of long-term sustainable positive development. Approximately as it was observed during the recovery of the European economy after the Second World War.

In contrast to the “radical” option, “Business-as-usual” is “conservative”. It proceeds from the expectation that the European authorities will be able to “come to their senses”, that is, to abandon idealistic radicalism in favour of practical adequacy. All the global goals and objectives of the EU, including the transition to a “hydrogen economy”, will remain unchanged in it, but their achievement will be carried out in a multi-stage step-by-step iterative way.

In particular, this will mean a temporary relaxation of the norms of the EU Energy Charter and the Third Energy Package, as well as delay the introduction of “carbon taxes”, as well as drastically reduce their target values. The price of the “green certificate” per ton of CO2 emissions by 2050 is expected to be €80 for “developed countries” and €65-68 for “developing”.

Thus, in general, it will be “difficult” for the transforming economy, but the level of problems will remain solvable, and the transformation process will go “along the path of least resistance”, leaving the opportunity to manage to transform decaying elements without a radical drop in living standards.

In this scenario, the consumption of hydrocarbons will certainly continue to decline, but the rate of decline will not exceed 2% per year, with an overall reduction of 10-15% by 2050.

The “Rapid” option is considered to be an intermediate between the two above. It proceeds from the fact that the line of formation of events will be determined by the balance between the energy of the stubbornness of idealistic reformers and the extent of the “resistance” of the current energy and economic system, as well as the ability of the EU monetary authorities to generate a sufficient amount of monetary liquidity without collapsing into hyperinflation.

In this scenario, a ton of CO2 emissions by 2050 will reach €120-140 per ton for “developed” countries, and up to €90 for “developing” countries. The demand for oil will fall by approximately 50-60%, and gas consumption, although it will decrease by 40%, will still remain a significant part of the European energy balance.

At the same time, the overall economic situation will be in a long transformational crisis, which will drag on until 2035-2037.

Which of the above scenarios will be the most likely will be shown by the results of Europe’s passage through the 2021/2022 heating season. But in any case, Russia should prepare to strengthen its opposition to gas supplies, and increase pressure to force Moscow to agree to follow the Western “green agenda”. Including the consent to “voluntarily” pay the “carbon tax” on the terms of the EU and the USA.

This trend should be stopped by maintaining the current strategy of “strict compliance with Gazprom’s contractual obligations”, without increasing the volume of energy supplies “for the sake of saving the European economy”. And also by accelerating the “turn to the East”, with a reduction in the share of foreign trade with the EU in Russia’s total foreign trade turnover, in favour of its expansion in other directions (Asia, the Middle East, Africa).

It is also necessary to develop effective mechanisms for accepting economic migrants from Europe who have the qualifications and practical experience necessary for us, who want to integrate into Russian society and work for the benefit of the Russian economy.

Against the background of the collapse of the traditional “European way of life”, Russia has every chance to become a very attractive “island of stability” and understandable “normal” values. This will serve as a very strong incentive “to change one’s place of residence”. Let the volume of such “Europeans” be small, but even 5-7% of the total current population of the EU can create an influx of 20 to 30 million “new citizens”, quite strongly motivated to work actively “in a new place”.

Institute for International Political and Economic Strategies – RUSSTRAT


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