How Europe Invited Its Energy Crisis

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The historian Barbara Tuchman famously compared European civilization before the First World War to a “proud tower” but showed how that tower was more rickety than those at its summit imagined. The pride was overdone, the hubris all too real.

If Europe today can be symbolized by a similarly proud tower, one candidate might be a giant North Sea wind turbine in September 2021, its blades barely turning thanks to winds that had dropped, unexpectedly, for weeks. This unproductive calm had led to a scramble for other sources of power to remedy the shortfall. But the price of one obvious alternative, natural gas, was already soaring (the European benchmark, Dutch front-month gas, was around five times as high as it had been two years before).

In part, this was due to the post-pandemic surge in demand, but something else was going on too. From the middle of 2021 Russia had declined to boost sales of gas to satisfy Europe’s growing need. That mattered. The EU imported roughly 40 percent of its gas from Russia, and looking elsewhere wasn’t straightforward. With the notable exception of Norway, Western Europe’s gas production has been declining for years. This owes something to dwindling reserves and something to fossil-fuel companies’ reluctance to spend the money required to find new ones, for reasons that include the disapproval of a climate establishment that now includes major investors.

Various explanations for Russia’s behavior were circulating last fall. We’ll never know for sure, but the best guess now must be that it was mainly designed as a demonstration of Russia’s clout, the first act in an attempt to use the leverage its gas had given it to force Europe to accept Moscow’s expansionist ambitions. In mid December 2021, with its troops massing on Ukraine’s border, Russia set out demands that would, if agreed to, have consigned Ukraine to Moscow’s sphere of influence and raised unsettling questions over what Eastern European membership in NATO really meant. That all this helped take European gas prices to levels some four times as high as they had been at the beginning of September would not have escaped Vladimir Putin.

It made some sense for Moscow to assume that merely brandishing its energy weapon would limit the European response to an attack on Ukraine. Both NATO and the EU included member states known for their less-than-robust approach to defense, or for attitudes toward Russia that ranged from the naïve to the not unsympathetic. A “reminder” to those most dependent on Russia for their energy requirements (Russia had also supplied some 35 percent of the EU’s oil and about 20 percent of its coal in 2020) would surely persuade them — to the extent that they needed persuading — to stay on the sidelines in the event of a “special military operation.”

Germany, the most important of NATO’s weaker links, would have weighed heavily in such thinking. Since the opening of the Nord Stream 1 pipelines in 2011 and 2012 it had become even more reliant on Russian gas (in 2021, 55 percent of Germany’s gas came from Russia), and yet was intent on deepening that dependence with Nord Stream 2, a project agreed to after the first invasion of Ukraine and annexation of Crimea (only now has it been abandoned). Russia also provided one-third of Germany’s oil and about 50 percent of its hard coal. Germany’s vulnerability to Russian coercion had only been increased by the destructive impact of its Energiewende (energy transition) on its energy resilience. Starting in 2010, this featured hugely expensive and poorly planned investment in renewables driven by climate fears, and a re-acceleration away from nuclear energy driven by almost superstitious dread. Germany’s last three nuclear-power stations were due to be shut down at the end of this year, but two of them will now be kept open on a standby basis for a little longer. In another shift, Germany has now chartered five floating terminals to import liquefied natural gas (LNG), two of which should be ready this year. Previously, the country had none, floating or fixed. With so much gas coming from its reliable Russian partners, why bother?

Germany may have been an extreme case, but to varying degrees, its mistakes were repeated across much of Europe by a governing class convinced both that its climate policies would be an example that the world would follow and that the march toward a rules-based international order (where the EU would be setting many of the rules) was irreversible. Europe’s “race to net zero” greenhouse-gas emissions would, it was claimed, be accomplished not only (relatively) painlessly, but rapidly. These claims bear scant resemblance to what is achievable — central planners are like that. The “race” — and the malinvestment that preceded it — embedded the energy insecurity that may have helped Russia believe that it could get away with the major European war that, to many Western Europeans, was an impossibility in the rules-based 21st century of their collective imagination.

That said, seven months since that war began, it’s evident that the Kremlin has underestimated Europeans’ willingness (so far) to stick with Ukraine even if it meant losing access to Russia’s energy resources, a willingness underlined by their decision to phase out most Russian oil imports by year’s end.

Bans on Russian coal imports are already in full effect. For its part, Russia has been steadily decreasing its gas exports to Europe, calculating that the resulting economic pain — and the political turmoil and social disorder that it might provoke — would erode European support for Ukraine. That would be worth more to Moscow than export revenues forgone. Some European countries have had their supplies cut off altogether. And gas no longer flows through Nord Stream 1 (which was used to transport some 35 percent of Russian gas exports to the EU last year), although Russian gas continues to reach Europe through two other pipelines (at, naturally, a reduced rate), but for how long?

Energy providers have been badly hit. Some, denied the cheaper gas they were due from Gazprom, the Russian state-controlled energy company, have had to turn to the spot market to buy the gas they had to deliver to their customers at (much lower) contractual rates, a mismatch that has bankrupted some and led to bailouts or the nationalization of others. A large number failed in the U.K. after the spot price shot past the legal maximum (which until August was changed only semiannually) they could charge their clients. Other utilities are running or may run into liquidity problems arising out of hedging operations in the derivatives markets. The observation by Finland’s energy minister that this could be “the energy sector’s version of [the] Lehman Brothers” moment may have been exaggerated, but Sweden’s prime minister also talked of risks to financial stability. Measures to support utilities have been introduced in Finland, Sweden, and elsewhere, and they are unlikely to be the last.  

The pricing of European electricity is another twist of the knife. Typically it is aligned with the cost of the most expensively generated power required to satisfy demand. Thus the current gas price is pulling the price of electricity far above the overall cost of its generation. Strange as it may seem, this marginal-pricing regime encourages efficient production and consumption. Nevertheless, it looks set to be replaced, quite possibly de facto rather than de jure, by the proposed price cap on low-carbon producers mentioned below.

Mounting economic troubles could easily lead to conflict within the EU and NATO, a long-term Kremlin objective. Even if we disregard Hungary, a perennial outlier (true to form, it recently struck a deal that will increase the amount of gas it receives from Russia), there is plenty of potential for division, not least over the willingness to share energy across borders in the event of a supply crunch. This could be peculiarly treacherous territory for Brexit Britain, outside the Brussels laager. Even though gas — about half of which is imported — accounted for roughly 40 percent of the U.K.’s energy use in 2021 and heated some 80 percent of its homes, Britain has little gas storage and a growing dependence on interconnectors to import electricity from European neighbors that may now be facing shortages themselves.

With 2022 being what it is, France, which in 2021 supplied around half of Britain’s imported electricity, is grappling with major problems in its ageing and under-maintained nuclear-power stations. Nuclear energy normally provides approximately 70 percent of France’s electricity, but more than half of its reactors have had, temporarily, to close. The first of these should start restarting shortly, with the others joining in time for winter. All the same, businesses will soon have to explain how they can reduce their electricity consumption by 10 percent. Other users too will be expected to show that they understand that France has entered, to use President Macron’s term, an era of energy “sobriété.” The City of Light will dim this winter.

Signs of damage already inflicted by higher energy costs are hard to miss. They have contributed to inflation (annual euro-zone inflation stood at 9.1 percent in August), and central bankers are hiking rates in response, a painful necessity. Manufacturers, particularly in energy-intensive sectors, are cutting production, unable to pass on enough of their increased costs to their customers. According to Eurometaux, 50 percent of the EU’s aluminum and zinc capacity has been “forced offline.” Other shutdowns include fertilizer manufacturers, cement-makers, and steelmakers. Most are described as temporary. We’ll see. Unsurprisingly, both U.K. and euro-zone consumer-confidence levels are at their lowest since records began.

Measures taken or under way to protect households and businesses from running into further difficulty will cost European governments an estimated $500 billion (including price caps in the U.K.), a number that doesn’t include the cost of sorting out the embattled energy providers. And there will almost certainly be more spending to come. Some of this will likely be funded, if the EU Commission (its administrative arm) gets its way, by windfall taxes or, to use the Brussels euphemism, “solidarity contributions” on fossil-fuel companies and revenue caps on low-carbon generators. Adding to the pressure for relief, many energy buyers have been sheltered from surging prices by longer-term contracts, but, as time passes, those expire.

Price-driven demand destruction for gas (not an encouraging economic indicator), complemented by voluntary (for now) efforts within the EU to reduce consumption by 15 percent and some success in finding other sources of supply (or replacing gas with substitutes such as, cough, cough, coal), has, along with buying programs, some of which are now mandatory up to a certain level under EU law, led to storage facilities that are over 85 percent full, above average for this time of year. This offers some hope that the worst result — rationing — can be avoided this winter, although without the prospect of much in the way of top-ups, “above average” may well not be sufficient, especially if it’s colder than usual. Optimists will note that the benchmark price for gas has fallen a long way since a spike in mid August, the first sustained reversal for months, although it is still over three times as high as it was in late September 2021. But that hasn’t stopped the EU Commission from eyeing electricity demand and proposing a mix of compulsory and voluntary curbs this winter. Around 18 percent of Europe’s electricity was generated in gas-fired power plants in 2021. Meanwhile, the Baltic states are bracing for disconnection from the Russian grid, which would bring blackouts in its wake, although they should be able to plug into the European network within hours.

Quite how far Europe’s economy will fall is unknowable. Predictions of a mild recession, let alone any growth, are being torn up. Deutsche Bank is now forecasting a 3 percent drop in the euro-zone’s GDP (a number that will, of course, vary from country to country) between the middle of this year and mid 2023, and (wisely) won’t rule out “an even sharper winter downturn.” Much will depend on how far any rationing has to reach and where it bites deepest. Germany is, in many respects, Europe’s manufacturing hub: Prolonged shutdowns there could have devastating knock-on effects across the continent. And the steeper the slump, the harder the knock to support for Ukraine. Voters will probably put up with darkened shop windows, unilluminated monuments, and colder offices, but their patience will be put to a harsh test by disappearing jobs, blackouts, and interruptions in the heating of their homes. There’s also the question of whether a slump could trigger the renewed euro-zone crisis that has, with Italy on investors’ minds, been brewing for a while now.

Even if Europeans weather the winter, they will not be home free. It’s hard to imagine that Russia’s gas will be turned back on anytime soon, let alone that it could reestablish itself as a trustworthy supplier. Filling the gap left by Russian energy resources will take quite some time. Energy costs will remain high for a while. And so will the spending by governments defraying the worst of the consequences. The Europe that eventually emerges from this ordeal will be more heavily indebted, more heavily taxed, more heavily regulated, and considerably less competitive. More immediately, 2022–23 will be only the first of several tricky winters: To start with, there will be no Russian gas to refill storage facilities left depleted by the end of the winter that is almost upon us.

There is no quick fix. Traditional suppliers such as Norway don’t have enough additional capacity to make a material difference to the effort to replace Russian gas. To be sure, LNG has already been helpful and will mean more supplies coming from farther afield. But LNG is a global product, and Europeans will, as they did this year, have to battle with Asian buyers to secure a supply until more export capacity is built. That will take years, not months, and on the European side more import capacity should be added too. And, yes, there is currently a shortage of LNG tankers.

French and British plans to build a series of new nuclear-power stations (including the quicker-to-build small modular reactors) are welcome (and might assist in a wider nuclear renaissance) but will take years to come to fruition. Renewables can be built out more quickly but by themselves are too unreliable to solve Europe’s energy conundrum. The backstop they need has been gravely weakened by overenthusiastic decarbonization. But European fossil-fuel companies, for the reasons referred to above, will hesitate to invest in the new development projects that ought to be part of the solution, even if gas has recently been designated by the EU as a green “transitional” fuel for financing purposes. The fact that even the prospect of increased LNG exports to Europe raises objections from some climate activists sends a clear signal.

This is perversely appropriate. Europe’s rushed and reckless moves toward decarbonization destabilized its energy system and handed Moscow an opportunity it should never have been given. Undeterred, the EU’s leadership claims that this catastrophe only strengthens the case for moving away from fossil fuels, which must, they argue, proceed apace. As Blackadder’s Anthony Melchett, a somewhat unfair caricature of a British general in the First World War, put it: 

“If nothing else works, a total pig-headed unwillingness to look facts in the face will see us through.”