The events in Europe over the past year, culminating in Russia's invasion of Ukraine last February, have put the so-called "energy trilemma" back at the center of public debate: how to guarantee security, sustainability, and competitiveness/affordability of energy at the same time? 

This is a key issue for the future of our continent, which, in the short term, faces the difficult, but the unavoidable challenge of ensuring cheap and secure energy for its businesses and people, and diversifying supply sources. 

In the medium-long term, the need is to achieve its decarbonization objectives, from those envisaged by Fit for 55 in 2030 (-55% of carbon dioxide emissions compared to 1990) up to net zero carbon dioxide emissions by 2050.

At the same time, it will be necessary to combat the growing phenomenon of energy poverty, which already afflicted around 10% of the population of the European Union before the current crisis and which is now increasingly widespread in the light of the unprecedented rise in gas and electricity prices over the last year. 

A theme, that of pricesalso penalizes the competitiveness of European companies, which have found themselves paying for gas even ten times more than their American peers – and are now looking to relocate their business across the Atlantic.

 

In the Midst of "Energy Chaos"

The crisis we are experiencing has upset balances consolidated for decades in the energy geopolitics and the entire energy sector. We have now slipped into an "energy chaos", in which energy producing countries that had been "marginalized" in recent years have now returned strategic. 

At the same time, gas flows that we had considered "secure" and once arrived mainly via pipe, especially in Europe, will now arrive more and more in liquid form, but will require a price-competitive framework to ensure they are not diverted elsewhere (ex. China and the Far-East). 

This is radically changing the geography of relations between countries and between operators, triggering new competition between States and continents, relocations and reconsiderations of investment choices, new wealth, and new poverty to be combated. The events of the last twelve months have shown above. all how important energy security is. 

Energy Security

Despite being one of the pillars on which European integration stands, as stated in Article 194 of the Treaty on the Functioning of the Union (TFEU), it has for too long been taken for granted, no longer part of risk management assessments and strategic assessments. 

Security of supply – especially natural gas – in our continent is the short-term priority: in particular, it is necessary to strengthen the diversification of sources and routes, not only to reduce dependence on a single country but also with a view to greater market liquidity, to find a necessary balance and achieve a progressive reduction in prices, for the benefit of businesses and citizens. 

Strategies 

To tackle this challenge, the main European countries have equipped themselves with new rules and new agreements to guarantee full storage at the beginning of the winter season, to maximize the use of existing import routes, and, especially in the case of Germany, Italy, and the Netherlands, to increase regasification capacity, also using new Floating Storage and Regasification Units (FSRU). 

At the same time, new solidarity mechanisms between States have been identified at the European level, and initiatives have been launched to contain consumption. Several countries have revised their energy policies considering the changing scenarios. 

Finally, the European Union, born in the 50s of the last centuries to share the choices and uses of coal and steel (the basis of the heavy, including military, industry at the time), has undertaken more incisive energy programs than in the past. However, it has yet to manage to cancel some divisions between countries.

 

The High Road to Diversification

In addition to the diversification of gas routes, the game for greater European energy security also implies thatin the short and medium-long term, the acceleration of the development of electric renewables (solar and wind) and energy efficiency, both through public policies and with a "gentle push" that leads to greater consumer awareness. 

We are learning that energy, like water, is a scarce resource, and in any case not infinite, and must be used in the best way, giving it a correct value. In particular, the crisis we are experiencing has brought to the fore the value of energy efficiency in the short and medium to long term. 

With the RePowerEU plan, Europe has set itself the goal of being completely independent of Russian gas by 2030, Germany and Italy even a few years in advance. According to a recent elaboration by the Energy Transitions Commission, in 2023, Europe could replace between 48% and 66% of Russian gas imports through diversification of sources, diversification of electricity production, and actions on the demand side. 

The road is not easy but is somehow forced by events. Looking ahead, the pursuit of Europe's energy security could restore the centrality of the Mediterranean, making Italy increasingly a continental gas hub, thanks to the increase in import capacity from Algeria, Libya, Azerbaijan (TAP) and new regasification plants and, at the same time, to the increase in export capacity by reversing the direction of flows (reverse flow) towards North and Eastern Europe. 

However, in the short term, the search for sufficient energy availability to meet demand also leads to choices in contrast to the fight against climate change, such as the increase in coal-fired electricity generation, nullifying part of the results achieved in recent years.

On one hand, the combination of the energy price crisis that began with rising gas and electricity prices in 2021, coupled with the security of the fossil-fuel supply crisis following the Russian invasion of Ukraine, has dramatically changed the EU's energy policy. 

Of the objectives of energy trilemma (environment sustainability, security of supply, and affordability of energy), the two crises have led to more attention to security and affordability and less to sustainability. This implies a detour on the path to net zero as emissions rise (with coal temporarily replacing gas in the power sector of many European countries) and governments struggle financially to deal with the other two objectives and the wider macroeconomic consequences. 

Energy Transition

On the other hand, the new emphasis on security confirms an under-appreciated benefit of the energy transition in Europe—greater energy independence stemming from reduced reliance on imported fossil fuels—and offers an opportunity to underscore and support its acceleration.

Climate change has always been a concern to the security establishment, especially due to its impact on geopolitical instability. However, the energy security challenge now posed by Russia strengthens the appeal of the energy transition to the security lobby in Europe.

To be clear, fossil fuels will continue to be part of the European energy mix for many years. However, the energy transition means that vastly expanded amounts of green electric power generation and consumption will replace current fossil-fuel production and consumption. 

Energy security will increasingly depend on the central role that electricity will play in the decarbonized energy system. To avoid or mitigate potential future problems concerning the reliability of electric power supply will require in-depth thinking on redesigning current electricity markets.

This will be needed to elicit necessary private sector investment in renewables generation capacity, power storage technology, electrification, smart grids, and various other technologies, including those that increase the potential for energy demand-side management. 

In the meantime, it is essential to avoid policy decisions that will slow the energy transition or increase its costs, and equally important to secure the support of consumers for the energy transition and their active participation in it.

Security and Sustainability

For this reason, looking at the medium term, the challenge must increasingly be to reconcile energy security with environmental sustainability with a "win-win" approach. In this sense, oil and gas price volatility accelerates the time to make new low or zero-carbon technologies such as biomethane, hydrogen, and carbon dioxide capture and storage (CCS) competitive. 

These technologies, together with others that are not fully mature or not fully known today, will be essential to enable us to achieve decarbonization objectives, particularly in the so-called hard-to-abate sectors, from energy-intensive industries to heavy transport. Renewable electricity alone, while indispensable, will not be enough. 

As the International Atomic Energy Agency (IAEA) reminded us last year in its net zero report, "electrons" will be able to cover about 50% of the world's net-zero emission energy needs by 2050. It is hoped that even more can be done, but the rest of the energy mix will still be entrusted to "molecules", even if decarbonized. Already by 2030 the contribution of new technologies will be tangible. 

Looking at Italy, according to the latest joint Snam-Terna scenarios, the European objectives of reducing carbon dioxide emissions by 55% compared to 1990 will be achieved with a strong development of renewable electricity sources.

It will cover more than 65% of national demand – and green gases, which thanks to the production of biomethane and the contribution of green hydrogen will represent about 11% of gas demand. It is also planned as early as 2030 to use Carbon dioxide Capture and Storage (CCS) technologies to start the path of progressive decarbonization of the hard-to-abate sectors. 

At the continental level, the RePowerEU scenario foresees a biomethane production of 35 billion cubic meters (bcm) by 2030 (compared to 3 today) and a domestic production of green hydrogen of 10 million tons, associated with a similar number of imports. 

In this scenario, a consideration is essential: if it is true that for too long, we have taken energy security and the stability of the geopolitical context for granted, it is equally true that the transition to zero emissions will not be a deterministic phenomenon, but a transformation composed of many "micro-crises" of change, the results of which may lead to slowdowns, accelerations and the emergence of new technologies.

Therefore, we are not faced with a linear process to be drawn on a sheet of paper but a sort of "corridor" within which to build the infrastructural redundancies necessary to always guarantee security, not only in the geopolitical dimension but also in the satisfaction of demand at sustainable prices.

REPowerEU is the EU's strategic response to the above-mentioned double-crises. It proposes several measures to reduce dependence on Russia and fossil fuels and accelerate the energy transition.

The most important measures from the perspective of decarbonizing the energy system have to do with the penetration of renewable energy generation in the electricity sector, the electrification of demand, and the development of decarbonized gas, particularly green hydrogen. 

Electricity is certainly central to the transition. Today it accounts for 20-25% of energy demand in EU countries. By 2050, it will be responsible for more than 50% of demand, and in some scenarios, significantly more, especially where green hydrogen becomes an important part of the energy mix.

The challenge will be to adopt policies that facilitate and can accelerate the transition through a massive energy system transformation while ensuring energy supply security.

 

The Role Of Public Policies

To conclude, all the conditions are in place for current efforts to provide Europe with greater energy security in the future to accelerate, rather than slow down, the energy transition path toward carbon neutrality objectives.

However, it is necessary that public policies, also thanks to the impetus of recovery and resilience plans, go beyond the emergency phase and continue in this direction with structural actions that favor greater diversification of supplies and, at the same time, the development of electrification, green gases and energy efficiency.

All this, knowing that a fair degree of flexibility will be needed, with the consequent "redundancies", and ensuring a transition as fair as possible to protect industries and the weakest social classes, avoiding that they perceive energy security and sustainability as a threat rather than an opportunity. 

The current energy crisis has reinforced the case in Europe for an energy transition away from fossil fuels and towards electrification. However, the new decarbonized and decentralized electricity system raises its security of supply challenges. New market designs are needed to address those challenges and to incentivize the appropriate mix of investments.

The energy system of the future will be increasingly electric. Electrification and the integration of intermittent renewables will be central to ensuring that the new energy system provides security of supply. Active consumer participation will be essential to both.

Furthermore, while protecting the most vulnerable consumers, governments should avoid interventions in the short term that weaken the incentive for consumers to reduce energy demand and that increase investor perception of political risk.

Finally, citizen support and consumer participation are essential for the energy transition. Governments should offer targeted relief, such as transfers to lower-income households suffering most from higher energy bills. 

However, they should not shield most consumers from those prices. Instead, they should encourage energy saving and assist citizens in mitigating the impact of high energy prices while at the same time contributing to the energy transition. 

Market forces are always the central part of the energy system, but Governments are ultimately responsible for:

• Guaranteeing that everyone has access to energy
• Securing public goods of decarbonization and security of supply; and
• Demonstrating that markets work for all citizens

Resolving the energy trilemma, especially in the current complex context, therefore means consolidating a genuine standard European energy policy, respecting the specificities of individual States, and being increasingly aware that there can be no transition without energy security and social justice, acting consistently within a new order.

 

This article was contributed by our expert Alessandro Nanotti

Frequently Asked Questions Answered by Alessandro Nanotti

Q1. How is war in Ukraine affecting the energy transition in Europe? 

The notion that Europe would shift from fossil fuels, including natural gas, has, in the last 15 years, dampened interest from European policymakers and corporations to develop long-lived import infrastructures underpinned by long-term supply contracts for oil and gas. This perspective was actively reinforced by the energy transition policies and advanced by most of the countries in Western Europe. 

In Germany, the policy of Energiewende (energy transformation) aimed to facilitate economy-wide decarbonization. Low-cost natural gas from Russia was considered a bridge fuel that could help reach the goal, mainly since the German plan for the energy transition required the phasing out of the country’s nuclear fleet by the end of 2022. 

While Germany has been the most aggressive among all the European countries concerning its efforts to eliminate nuclear power, the attitudes of the other European countries have mainly been ambivalent. 

France, being very dependent on nuclear power for energy needs, has been proactively maintaining or rebuilding the nuclear power fleet in the current energy crisis.

Of course, the “wind drought” (Dunkelflaute) in the fall of 2021 stoked fears of the lack of sufficient redundancy in the European energy mix.

With Russia’s invasion of Ukraine, Russian President Vladimir Putin threw a boulder into the proverbial pond of European energy policy.

Energy security is currently crucial for most European policymakers and also the public. In March 2022, merely 2 weeks after the invasion, natural gas and nuclear energy were somewhat back in favor, declared “in line with EU climate and environmental objectives” by the European Commission Directorate‑General for Financial Stability, Financial Services, and Capital Markets Union.

In turn, an accelerated emphasis on increasing LNG import capacity online emerged. For the next 3-4 years, the focus will be on energy security rather than energy sustainability and transition. 

Refocusing on energy security rather than the energy transition needs the utmost attention. Europe should also take into account and assess the impact of its rushed measures on this dossier, given the fact that such solutions may jeopardize the 2030 goal of reduction in carbon emissions by at least 55% compared to 1990 levels, as set by the European Commission, and of attaining the net zero carbon emissions by 2050, under the European Green Deal. 

The rapid energy transition requires cooperation among EU countries. Signatory countries have committed themselves to reduce their dependence on the Russian energy supply and investing in renewable energy sources, like offshore wind power, for which the Baltic region promises enormous potential.

Eight EU members in Denmark attended the Baltic Sea Energy Security Summit on 30 August 2022, and the signing of the Marienborg Declaration were some important steps taken. 

Another effort to accelerate the energy transition is a cooperation between the EU and the African Union (AU). Europe’s increasing reliance on gas supplies from Algeria, Egypt, Angola, Congo, Nigeria, Senegal, or Mozambique may benefit the African countries in counterbalancing the immediate impacts of the Russia-Ukraine war on their economies, as seen with the increase in the cost of commodities.

However, the enhanced partnership between Europe and the AU should also feature sustainable collaboration through investments in renewable infrastructures in the African continent.

For example, Italy has already taken the necessary steps. Aligned with its decarbonization goals, Italy (through its state-controlled companies) is collaborating with some African countries, especially the Republic of Congo and Kenya, for the development of agri-feedstock and agri-hubs for biorefining. 

In August 2022, Italy’s Cassa Depositi e Prestiti (CDP) gave a loan of 100 million euros to the Africa Finance Corporation to be invested in the renewable energy infrastructures on the African continent. 

This project aims to promote sustainable development on the African continent and foster local growth by engaging local communities and creating new job opportunities. 

In Egypt, additional involvement has been observed in projects for developing wind and solar energy, hydrogen production, and Carbon Capture and Storage (CCS) projects. These projects seem to be effective, and they encourage Italy’s engagement in tackling the energy emergency and climate crisis by contributing to the diversification of energy sources while focusing on decarbonization.

Though the continent offers enormous untapped potential in terms of wind, solar, hydro, and geothermal energy, only 2% of the global investment in renewables has been made in Africa over the last two decades.

The hydroelectric potential is due to its major river basins: the Nile, Congo, Niger, and Zambesi. Whereas the onshore wind potential, studies have shown that its exploitation – notably in Algeria, but also in Mauritania, Mali, Egypt, Namibia, South Africa, Ethiopia, and Kenya – would satisfy Africa’s electricity demand 250 times over. 

It also offers enormous geothermal potential, mainly in the Great Rift Valley region of East Africa. Thanks to its progress in this area, Kenya now ranks among the world’s top ten geothermal power producers. Moreover, with its 9,000,000 square km extent, installing solar panels in the Sahara region could satisfy Africa’s demand for energy and Europe’s as well. 

In such a partnership, meeting Africa’s energy demand should be a priority, while exploiting Africa’s energy resources for the sole benefit of European countries should be deemed unacceptable.

Thus, a fruitful collaboration between the EU and the AU would benefit all involved. Undoubtedly, it would allow Africa to fulfill its potential for economic growth, thus favoring the development of the African economy.

At the same time, it would also lead to a dramatic reduction of global carbon emissions, as Africa and Europe would head towards achieving the net zero goal, an objective which can be reached by 2050 only if annual investment in renewable energy in developing economies grows to over seven times the current level. 

Significant issues such as climate change and the energy transition can be tackled by creating a united front among EU members while cooperating with other regional organizations. Since the Russian invasion of Ukraine, the EU has demonstrated enormous cohesion in responding to external threats. 

To date, the compactness of its member states and their alignment with decisions issued by Brussels has allowed Europe to cope with Russia’s attempts to splinter the Union to undermine its power through the weaponization of refugees, energy, and food supplies.

The cooperation amongst the EU, an enhanced partnership with the AU, and a move towards a more balanced energy mix may allow Europe to attain and maintain energy security. 

Q2. What are the main aims of the EU's energy policy? 

In December 2021, the European Commission released a series of legislative proposals as a continuation of the “Fit for 55” package announced in July 2021.

Aims

• Pave the way towards renewable and low-carbon fuels and create a hydrogen market. The package also contains provisions related to methane emissions, providing obligatory tracking and reduction of methane, which is released into the atmosphere from the energy sector
• They have set forth the principles around sustainable carbon cycles and for efficient and green mobility
• It also introduced another proposal that aims to foster the decarbonization of the building sector

These measures are another milestone in delivering the goals of the European green deal. Ahead of the implementation, the measures are expected to significantly accelerate the business transformation towards sustainability in the gas, agriculture, and transportation sectors.

European Green Deal

The European Green Deal is Europe's growth strategy that aims to:

• Improve the well-being and health of the citizens
• Make Europe climate-neutral by 2050
• Protect, conserve and enhance the EU's natural capital and biodiversity

The EU taxonomy aims to help improve money flow towards sustainable activities across the European Union. Enabling the investors to re-orient their investments towards more sustainable technologies and businesses will make Europe climate neutral by 2050.

The taxonomy is a science-based transparency tool for companies and investors. It also creates a common language that investors can use when investing in projects and economic activities that have a substantial positive impact on the climate and the environment.

It also introduces disclosure obligations on companies and financial market participants.

While the EU has a common climate and environmental targets, the national energy mix is a member state prerogative and varies from one member state to another, with some still heavily reliant on the high carbon-emitting coal.

The Taxonomy helps mobilize private investors toward climate objectives and covers energy activities that reflect different national situations and starting points.

Hydrogen and Gas Markets Decarbonization Package  

On 15 December 2021, the Commission published the Hydrogen and Gas Markets Decarbonization Package.

It proposes a set of amendments to the European Parliament (EP) and Council Directive 2009/73/EC of 13 July 2009 concerning the common rules for the internal market in natural gas and EP and Council Regulation (EC) No 715/2009 of 13 July 2009 on conditions for access to the natural gas transmission networks.

It is one of the first legislative initiatives in the European Union (EU) to set out detailed provisions for developing alternative energy carriers. The key decarbonized gases identified in the package include hydrogen, biogas, biomethane, ammonia, and methanol, which will gradually become substitutes for unabated fossil fuels.

The regulatory changes are intended to create a market, governance, and infrastructure architecture to transmit and distribute decarbonized gases in the EU. The package also envisages the expiration of long-term contracts for unabated fossil natural gas by 2049.

Regulation on Methane Emission Reduction in the Energy Sector

On 15 December 2021, the Commission published a proposal to track and reduce methane in the energy sector. The document recognizes methane as contributing to a quarter of current anthropogenic global warming.

The main objectives of the new regulation are to improve the accuracy of information regarding the main sources of emissions, increase reporting reliability and further effectively mitigate methane emissions. 

It also imposes mandatory leak detection and repair and a ban on venting and flaring. Importers of fossil energy into the EU will need to provide information on methane emissions and their mitigation across their value chains.

The rules may be amended by 2025 to introduce more stringent measures on fossil fuel imports once all data is available. Lastly, the EU intends to set up and manage a transparency database for fossil energy imported into the EU.

Sustainable Carbon Cycles

Also, on 15 December, the Commission published a communication on sustainable carbon cycles, outlining its vision for carbon farming, industrial carbon capture and use (CCU), and carbon capture and storage (CSS). According to the communication, carbon removals from forests and agriculture will play a crucial role in achieving climate neutrality by 2050.

The Commission has proposed how to increase carbon sequestration and scale-up carbon farming as a business practice. The Commission will foster innovative approaches through public funding to support carbon farming. This year, the Commission will propose a regulatory framework for transparent accounting and certifying carbon removals.

Revision of the Energy Performance of Buildings Directive (EPBD)

The European Commission published on 15 December the revision of the EPBD, which translates the 'Renovate Wave Strategy' into legislative action.

The EPBD sets the overall vision for new and existing buildings that applies across relevant provisions of the “Fit for 55” package and complements current legislation (e.g., Energy Labelling Regulation, Ecodesign Directive).

The proposal establishes a zero-emission target for all new buildings by 2030 and by 2027 for new buildings in the public sector. Concerning existing buildings, new energy performance standards would require the worst-performing 15% of the building stock of each Member State to be upgraded by 2027 for non-residential buildings and 2030 for residential buildings.

Other changes introduced in the proposal include:

• Energy Performance Certificates (EPC) - a more precise set of rules (and harmonized by 2025) is proposed for EPC, and the obligation to obtain an EPC has also been extended
• Integration between National Buildings Renovation Plans and National Energy Climate Plans – plans will also have to include roadmaps to phase out fossil fuels in heating and cooling by 2040
• Access to information and lower costs for consumers

Efficient and Green Mobility Package

On 14 December 2021, the Commission published four proposals that will serve to modernize the EU’s transport system:

• Revision of the TEN-T Regulation – TEN-T Network will be completed in three steps: 2030 for the core network and 2040 for the extended core network, which together forms the European Transport Corridors, and then 2050 for the comprehensive network
• Revision of Intelligent Transport Systems Directive – extends the scope of the Directive to encompass multimodal information, booking and ticketing services, and automated mobility
• New EU Urban Mobility Framework – guidance on how cities can cut down emissions and improve mobility, including Sustainable Urban Mobility Plans
• Action plan to boost long-distance and cross-border passenger rail - establishes a roadmap to help the EU meet its target of doubling high-speed rail traffic by 2030 and tripling it by 2050

Q3. How is the EU dealing with the energy crisis? 

Of the two main energy sources — gas and oil — the EU is most reliant on Russia as a source of natural gas, which makes up a steadily increasing share of the block’s energy mix (around 40%) as the continent draws down on coal.

Russia supplied 168 Bcm to Europe in 2021 (including Turkey), down from 191 Bcm in 2019 but still meeting around one-third of the demand. Volumes reaching Europe transiting via Ukraine have halved since 2019 but are still 40 Bcm a year – about 8% of total demand. Nord Stream 2, the final step in Russia’s plan to grow its exports to Europe while circumventing Ukraine, would have reduced volumes transiting through Ukraine even further. Germany is the biggest buyer of Russian gas (40 Bcm), but Italy, Austria, and Slovakia depend most on Ukraine transit gas.

Source  Data are taken from CEDIGAZ.
 Note bcm: billion cubic meters.

The disruption to Russian pipeline flows has left a massive supply gap in European gas markets. With Russia only exporting 25 billion cubic meters (bcm) of gas to the EU, down from 155 bcm, Europe has had to look for a new major supplier to fill the shortfall. It is a destination-flexible US LNG that has answered the call.

While floating storage and regasification units (FSRU) have been mobilized as near-term opportunities to bring more LNG into Germany and Italy, there is limited capacity along LNG supply chains to do more in the near term.

A lack of spare LNG liquefaction and tanker capacity has driven the LNG market into a very tight situation, so much so that large Asian buyers redirect cargoes to Europe and ration their own demands. Hence, Germany (and Europe more generally) is faced with the unavoidable outcome of using other fuels to sate its energy needs and/or ration its own gas demand, particularly industrial demand.

The disintegration of the EU crude oil and oil product market from Russia is also challenging. The EU is a large importer of crude oil and oil products. The re-routing of crude oil flows is well underway. The ban on oil product imports from Russia may be more problematic to digest for the world and NW European markets because of an anticipated shortage in ocean-going transportation capacity to carry the Russian oil products to markets beyond their traditional European market.

Many uncertainties also remain on the exact functioning of the oil price cap and may influence the volume of crude oil and oil products (particularly fuel oil, naphtha, and gas oil/diesel) available to world markets after the sanction dates (5 December 2022 for Russia crude oil and 5 February 2023 for Russian oil products).

The effects of Russia’s invasion of Ukraine did not impact EU member states to the same extent. Countries with a privileged partnership with Russia have evidently been the most affected (inter alia Germany and Italy). However, the EU has rapidly implemented a “burden-sharing” strategy to allow the most fragile members to cope with the harsh repercussions of the conflict. 

The EU promptly condemned Moscow’s breach of international law and introduced, as of November 2022, eight packages of sanctions against Russia, aiming to isolate it from global markets and weaken its economic power. In parallel, it implemented measures to support Ukraine by defending its territorial integrity, sovereignty, and independence and providing humanitarian aid to Ukrainians fleeing the country and internally displaced people.
 
When launching the special operation, Putin based his strategy on the expectation that NATO’s and Europe’s responses would be somehow in line with those undertaken in the recent past and thus weaker than they turned out to be.

Previous acts of aggression – such as the war waged against Georgia in 2008, the annexation of Crimea, and the conflict in Eastern Ukraine in 2014, alongside military exercises along the Ukrainian and Polish borders and in the Pacific Ocean – may have convinced Putin that NATO would not respond militarily to a new offensive and that the West’s military support to Ukraine would be more limited than it has proved to be.

Likewise, Putin could have expected the EU to impose sanctions, although he probably did not predict it would forge such a rapid, cohesive, and unprecedently harsh response. He may have hoped that a blitzkrieg invasion would create tensions among EU countries. Given their high dependence on Russia for critical raw materials, they would have been discouraged from implementing strict measures against Moscow that would damage their own economy too.

Evidently, norms of cohesion have trumped interests, as was suddenly made clear by Germany’s decision to suspend the Nord Stream 2 pipeline project right after Russia recognized the independence of the two eastern Ukrainian regions of Donetsk and Luhansk on 21 February 2022. Eventually, sanctions turned out to be much more comprehensive than those introduced in 2014 in response to the annexation of Crimea.

As far as gas is concerned, Putin was probably aware that if the EU reduced its reliance on Russia, his country would face economic repercussions, given that 70 percent of Russian pipeline gas exports went to the EU in 2021. However, he believed the Russian economy could sustain such repercussions by turning towards other commercial partners such as India and China. Indeed, over the last few months, Russia has become China’s biggest crude oil supplier. As of August 2022, the percentage of Russia’s oil exports to China has grown by approximately seven percent compared to the previous year.

EU’s sanctions and Putin’s countersanctions have also negatively affected the European energy sector and threatened its energy security, as President Putin hoped they would. Before the outbreak of war, Russia was the main supplier of crude oil, natural gas, and solid fossil fuels for many EU countries, notably Germany and Italy.

In December 2021, 40 percent of Italy’s overall gas imports came from Russia. Therefore, the decision to cut off reliance on Russian gas supplies led to shortages, causing a dramatic increase in energy prices, aggravated by speculation on energy markets.

In Italy, the effects of the radical reduction in Russian supply have been particularly pronounced due to the high percentage of gas in Italy’s energy supply (45 percent), combined with the country’s dependence on imports in the energy sector (75 percent in 2021), as it fails to take advantage of domestic resources. 
There are several reasons for this, such as Italy’s scarcity of gas fields, environmental concerns, and legal constraints that have hindered gas extraction in the past.

In 2021, gas production totaled 3.3 billion cubic meters, a small figure compared to the 8.6 billion produced in 2012, a quantity that has yet to be matched since.

Italy has turned towards other strategic partners to cope with the urge to diversify its supply sources. Eni and the Algerian state-owned company Sonatrach have agreed to increase Italy’s gas imports from Algeria through the Trans-Mediterranean pipeline by up to 9 billion cubic meters per year of additional gas flows by 2024. Moreover, there will be a notable increase in gas supplies from Egypt, Mozambique, Angola, and Congo.

Against this backdrop, Italy has also decided to pursue a parallel strategy to boost its domestic energy production, which consists in maximizing the production of six coal-fired power stations and one fuel-oil power station on its territory.

Regardless of the short-term objective of topping up the country’s gas reserves as quickly as possible in view of the winter season, the long-term consequences of such choices must also be taken into consideration, given that the coal combustion process produces 40–50 percent more carbon dioxide (CO2) emissions than natural gas. 

While Germany’s and Europe’s import capacity surges, the region’s gas consumption is in steep decline, and EU gas demand is estimated to decline by 25% in 2022 vs. 2021 levels, from 400 billion cubic meters (bcm) to 300 bcm. That reduction alone is the same capacity the Russian Nord Stream 1 and 2 pipeline systems could carry to Germany.

This means demand destruction alone has wiped out two-thirds of the 155 bcm of gas Russia sent to the EU in 2021, so the remaining 55 bcm have already been replaced mainly by LNG and alternative pipeline supply, especially from Norway.

What’s more, of Russia’s 155 bcm supplied in 2021, 15 bcm was Russian LNG which is still being supplied by private firms, so all in (lower demand, higher alternative supply), and Europe’s gas supply situation heading into 2023 doesn’t actually seem that bad anymore, with the big caveat that all this replacement will cost Europe hundreds of billions of euros in 2022 and 2023. This explains the recession but does inspire some hope that things could ease significantly post-2023 (but much depends on how cold this winter will be and what level gas storage will reach in March 2023).

The current energy crisis has prompted European investors and policy-makers to rethink fossil-fuel finance. What has emerged is a more measured approach that reflects the real-world constraints on financial institutions and corporates in making long-term financing and capital allocation decisions. 
The shift in approach reflects the complexity and the necessity of securing an orderly energy transition. The past year has made abundantly clear that energy supply and demand need to move in sync for economic stability and minimal price volatility.

Crucially, immediate divestment from fossil-fuel positions would only move financial-sector portfolio emissions elsewhere rather than achieve any significant real emission reductions. With this reset, the financial sector can drive tangible emission reductions and set the fossil fuel sector on a Paris Accords-aligned pathway.

Decarbonized electricity is at the heart of Europe’s energy transition.
Consequently, when EU energy policy was rewritten in the aftermath of Russia’s invasion of Ukraine, the sector’s ability to deliver was put firmly in the spotlight.

The scaling up of the hydrogen industry and its need for renewable energy supplies will pressure the industry to grow faster. The accelerated deployment of renewables (45% of energy by 2030, needing around 70% of power from renewables) will require substantially higher levels of investment in wind and solar. The objective is to support the industry’s ability to provide sustainable, reliable, and affordable energy for the long term.

Q4. How has the Ukraine war affected fuel prices?

After Russia’s invasion of Ukraine, energy security is at the top of mind for most European policymakers and the general public.

Europe is facing high natural gas and fuel prices and high uncertainty due to the substantial reduction in Russian imports (either voluntary or sanctioned) of natural gas, crude oil, and refined products. This winter is only the beginning, with next winter being even more complex to overcome and the oil and gas market balance remaining “precarious” throughout winter 2024-25.

Management of such a crisis will require fuel-switching (from gas to oil to coal), demand-rationing, and a concerted effort to bring new oil and gas supplies to Europe (mainly from the US, North Africa, and the Middle East), all while policymakers must thread the needle of keeping energy supplies affordable for the general public. 

This will generally mean that large industrial consumers will be the first to face interruption.

The impacts of reduced Russian natural gas, crude oil, and refined product supplies to Europe have spillover effects for the world. Continental Europe (with Italy and Germany at the forefront) relies heavily on natural gas for manufacturing — meaning these large economies have a large effect on gas availability and economic performance in the EU as a whole. Large industrial consumers are already feeling the effects. Consumption was reduced by almost 30% in October 2022 compared to the average in 2018-2021.

New Liquified Natural Gas (LNG) imports and additional pipeline supplies from other producing regions are not enough to make up for the almost 40% Russian market share in Germany and Italy — similar to the percentage in the EU as a whole. 

Recently, European LNG terminals have been operating at maximum capacity to fill storage for the coming winter, but cold weather and sanctions on importing crude oil and refined products will make energy prices and fuel prices spike greatly during the coming weeks and months.

European demand for LNG imports already forced LNG prices to unprecedented highs, driving a redirection of marketed volumes away from Asia to Europe. This starkly contrasts the status quo that generally persisted previously, in which Europe was viewed as a ‘market of last resort’ for global LNG volumes. A similar effect on fuel prices will be caused by the ban coming into play for crude oil in early December 2022 and refined products in Q1 2023.

The global market will be unable to adjust rapidly to make up for lost Russian oil and gas supplies in Europe due to infrastructure and logistical constraints.

Infrastructure projects like the Nord Stream 2 pipeline deterred investments into other sources of supply. Therefore, the historical reliance on Russian natural gas and oil has set the stage for difficulties to persist and possibly become even worse in 2023-24.

Firstly, global LNG supply cannot be increased quickly enough to offset lost imports of Russian pipeline volumes. It takes years to permit, build and commission new LNG export infrastructure and for the associated supply chains to deliver LNG to regasification locations. 

While FSRUs can serve as a near-term bridge for LNG imports, a casual reliance on FSRUs does not address the lack of sufficient global liquefaction capacity, the time to build new capacity or constraints on the current availability of FSRU capacity.

We already know that only about 6 million metric tons per year (mtpa), or 8.2 bcm/y, of new baseload LNG capacity, will enter global markets in 2023 (with 5.2 mtpa coming from Golden Pass in the U.S. and 0.4 mtpa coming from Congo-Brazzaville).

However, it is nowhere close to the amount of Russian pipeline gas that has been removed from the European market since the invasion of Ukraine.

Secondly, infrastructure and logistical constraints prevent the global market from adjusting rapidly to lose Russian gas volume into Europe. In particular, Russian gas cannot simply be redirected to other markets (e.g., China) due to the lack of alternative infrastructure. As such, there is no displacement opportunity whereby greater Russian pipeline volumes move into Asia and allow more LNG to be redirected from Asia to Europe. Hence, logistics and a lack of excess pipeline capacity prevent rapid adjustment.
In addition, by law, the EU’s natural gas storage must be filled to at least 90% by Nov 1, 2023. Some countries have set even more aggressive requirements; in Germany, storage must be filled to 95% by Nov1.

Such a legal imperative will result in removing supplies available to consumers during the non-heating season since they are instead being injected into storage, and rationing might be more severe during the summer. It is likely to tighten markets throughout the entire year.

Finally, significant volumes were still flowing to Europe from Russia for most of 2022, which helped countries to fill storage in anticipation of the coming winter heating season. In 2023, these volumes are very likely to remain unavailable. As such, while the near-term emphasis should be on meeting heating demands for winter 2022-23, winter 2023-24 may pose an even more difficult challenge.

The key takeaway of this situation is that modern society would not be possible without using pipelines to transport natural gas, crude oil, and finished products to demand centers. Investment in infrastructure is therefore essential to the good functioning of our economic and industrial environment.

High energy prices have many companies, like Germany-based BASF, considering relocation to countries like the U.S. and China. This does not bode well for the future of the German economy, nor, by extension, for Europe as a whole.