Global Counsel Germany launches in Berlin. Learn more

Date
Climate, energy and net-zero

Reform or revolution? Europe’s energy choices in 2023

By
Author
 
First name
Jasbir
 
Basi
Body

This week’s EU energy council comes at an inflection point in the energy crisis. It will be a moment to take stock of progress on short-term challenges:  the new gas storage regulation means underground gas storage is above 95%; demand-side measures for gas and electricity have reduced gas consumption by 15% since August; and LNG supplies hit a new record of 109 bcm by the end of October, up from 80 bcm in the whole of 2021. 

Analysis of legislation in 2022 (See Annex A) highlights the EU’s willingness and ability to overcome differences over short-term crisis management. But Brussels often struggles to apply the same political will to medium-term challenges. What should we expect over the next 12 months? 

Industrial competitiveness 

The first challenge is maintaining industrial competitiveness. With the global LNG market likely to remain tight until 2024 at the earliest, any expectation of wholesale prices normalising in 2023 seems overly optimistic. This means higher input prices for industry, eroding margins and potentially even the viability of energy-intensive industries such as chemicals, steel, ceramics, and fertiliser, potentially with factories closing for long periods.  

Assessments of this “demand destruction” vary. Business Europe estimates 70% of Europe’s fertiliser production has been shut or slowed down, and that 50% of aluminium capacity has been lost. In Germany, a survey by credit information provider CRIF found that 10% of companies, particularly those in energy-intensive sectors are at risk of insolvency over the next year as a result of energy and wider inflationary pressures.  

Figure 2

Figure 1

The Commission’s recent adoption of the second amendment to the State Aid Temporary Crisis Framework demonstrates its recognition of the need to expand business support. The latest extension until 31 December 2023 will enable member states to recapitalise companies facing solvency issues and provides enhanced energy price compensation for energy-intensive sectors with a high intensity of trade with third countries and emissions intensity (e.g., steel, paper and textile manufacturing).  

While the Commission will continue to explore innovative ways to optimize energy consumption, it alongside Member States faces a stark political choice. Risk the relocation of energy-intensive industries out of Europe permanently, increasing strategic dependency on third countries and loss of jobs and competitiveness? Or rather, embrace low-carbon technologies offered by decarbonisation as an opportunity to boost the competitiveness of European industrial sectors? The recently unveiled “decarbonisation pact” by President Macron in France for industrial sectors, partly in response to the introduction of the US Inflation Reduction Act and wider competitiveness pressures offers a promising test case. Energy-intensive industries will receive increased financial support in exchange for submitting new decarbonisation roadmaps and projects to the French Government.  

Electricity market reform 

There is widespread consensus across Europe’s political leadership that reforms to sever the link between electricity and high gas prices should proceed. Commission President Ursula von der Leyen has been a leading advocate, adding that the EU’s electricity market is “no longer fit for purpose” and needs “[urgent] reform to address the crisis”.  

The Commission has promised “deep and comprehensive reform” of the EU electricity market, with a legislative proposal expected to follow early next year. It has begun to reveal some of its thinking in a recent non-paper, proposing the creation of contracts for differences between renewable and other types of inframarginal generators (e.g., nuclear), to be awarded by tendering.  

But the Commission faces key fundamental choices in its approach to electricity market design. Will it use market design as a tool to achieve wider decarbonisation objectives, or as a political end goal in itself? Will it pursue efforts at all costs to preserve the current merit order, or sever the link between electricity and gas prices, in order to encourage flexible, low-carbon generation? The latter dilemma reflects in the strategic ambivalence shown by European governments to lock in long-term LNG contracts (e.g., 15-20 years) typically favoured by producers. 

These fundamental political choices will be key drivers of Europe’s response to the energy crisis over the next 12 months. Both will require EU policymakers to transition from crisis response to more multidimensional policymaking. Businesses and investors should continue to follow and engage with these policy developments closely as Europe’s energy crisis enters its next phase.  

Annex

    The views expressed in this research can be attributed to the named author(s) only.