Europe rethinks energy policy amidst Russia’s war in Ukraine

Still a work in progress, the European Union and its member states are scrambling to replace Russian gas. With the economics increasingly favouring renewable energy, a faster energy transition is possible.

European energy policy is in the midst of a dramatic overhaul, sparked by Russia’s war in Ukraine. The proposed reforms, aimed at ramping down reliance on Russian gas, could see a massive increase in investment in LNG import terminals, gas storage, along with efficiency and renewable energy.

Top European officials are scrambling to find alternative sources of gas in the event of a supply cutoff from Russia. “But in the long run, it is our switch to renewables and hydrogen that will make us truly independent. We have to accelerate the green transition,” European Commission President Ursula von der Leyen said on March 1. “Because every kilowatt-hour of electricity Europe generates from solar, wind, hydropower or biomass reduces our dependency on Russian gas and other energy sources.”

She added that accelerating the deployment of clean energy serves a strategic purpose because “less dependency on Russian gas and other fossil fuel sources also means less money for the Kremlin’s war chest.”

Europe imports 90 percent of the natural gas it uses, and Russia accounts for about 40 percent of the total. That share is much higher for countries in central and eastern Europe. Germany, for instance, sources more than half of its gas from Russia.

Since the 2014 Russian annexation of Crimea, Europe has increased gas interconnections and LNG import capacity. But its reliance on Russia remained largely unchanged.

Moving away from Russian gas

The war in Ukraine is suddenly upending decades of defence and energy policy, and the impacts could be long lasting.

“It’s worth recalling though that the oil crisis in the 1970s triggered a wave of investment in alternatives, as well as a shift towards more efficient use of fuel,” Simon Evans, deputy editor of Carbon Brief, told Gas Outlook.

On February 27, a few days after scrapping the Nord Stream 2 pipeline, German Chancellor Olaf Scholz delivered a momentous speech, announcing a new direction for Germany, including a stepped up commitment on military spending to counter Russian aggression. He also proposed an array of new energy policies, including requiring utilities to build up reserves of natural gas and coal, and accelerating the construction of two LNG import terminals that had previously been sidelined. Scholz noted that the terminals may import LNG when they come online, but would be equipped to handle green hydrogen over the long run.

“The events of the last few days and weeks have shown us that a responsible, forward-looking energy policy is not only crucial for our economy and our climate. But also crucial for our security,” Scholz said. “We will change course in order to overcome our import dependency on individual energy suppliers.”

The German government is also weighing a delay in the shuttering of its remaining nuclear plants, a development that would have been unthinkable prior to Russia’s invasion. It remains an unlikely scenario, but demonstrates how drastically the Russian war has overturned long-held policy positions in Berlin.

Evans said he “wouldn’t be surprised” if there was increased interest in LNG import terminals in Germany as a way of diversification, but that the market is limited by global export capacity as well as by competition from buyers in Asia that snap up cargoes at relatively high prices.

Replacing the entirety of Russian gas in the short-term is technically possible, but difficult, according to a recent study by the Bruegel Institute. LNG terminals are not constructed overnight, and much of the trade is conducted under long-term fixed contracts, so Europe cannot simply turn to the LNG market and scoop up supplies.

A faster energy transition?

Germany also said it would target 100 percent renewable energy by 2035, compared to a previous goal of “well before 2040.” That will include an 80 percent share for solar and wind by 2030, requiring a substantial ramp up in installations going forward.

Germany’s new energy strategy will be augmented by a new communication set to be released by the European Union in the coming days. Originally intended to be released on March 2 in response to persistently high energy prices, the draft was delayed in light of the war and will now focus on breaking the bloc’s dependence on Russian gas.

Press reports suggest the document will call for minimum gas storage requirements ahead of next winter, and a focus on diversifying sources of imported gas.

But while conservation and some additional LNG cargoes are some of the short-term tools, the more important work in the medium- and long-term will be to accelerate the energy transition. The EU’s so-called New Energy Compact calls for more investments in renewable energy and swifter permitting in order to “frontload the security of supply benefits.” Revenues from Emissions Trading System, which have shot up because of soaring carbon prices, along with a windfall profits tax on energy companies, could help fund the stepped-up effort.

“Diversifying supplies, frontloading renewable energy and improving energy efficiency is the best insurance against price shocks,” the Commission said in the draft energy blueprint. “The EU and its member states should take resolute steps together.”

The good news is that there are tailwinds working in favour of the transition. Even before the war, the economics have been increasingly tilted in favour of solar, wind, and batteries, a dynamic that became even more stark in light of the global spike in crude oil and natural gas prices over the past 12 months.

Renewable energy had already been eating away at the coal’s market share in Europe’s electricity sector, but more than half of the new renewable capacity additions since 2019 have actually displaced natural gas, rather than coal, from the grid, according to a recent report from Ember, an energy and environmental think-tank.

Even before Russia’s war in Ukraine, the case for natural gas as a vital transition fuel looked “severely damaged” as a result of high prices, Ember said. The cost of gas used for electricity across the EU shot up to 255 euros per megawatt hour in December 2021, a sevenfold increase year-on-year. The price spike is expected to last beyond this year.

“Wind and solar power were already cheaper than fossil gas for electricity generation before the gas crisis hit and they have become even more cost-competitive since,” Ember concluded.

Does that mean that solar, wind and battery installations will grow at an even faster rate going forward?

“Short answer yes,” Charles Moore, an analyst with Ember and author of the recent report, told Gas Outlook. Even though commodity prices have increased the cost of manufacturing solar and wind equipment somewhat – prices for polysilicon and steel have increased for example – renewable energy has become “more competitive, not less,” Moore said. He added that “the shift in economics against gas is highly likely to accelerate the reduction of gas use in the European energy system.”

Those long-term economic trends are now reinforced by the urgent security crisis, potentially speeding up the drawdown of gas from the energy system.

In the U.S., the oil and gas industry and some of its supporters are calling for an increase in drilling to improve energy security. Because the industry has used that argument for decades, the messaging could find fertile ground in Washington. But in Europe, which lacks an enormous fracking industry and is much closer to the war, the need to diversify away from a petrostate – and fossil fuels more generally – is more obvious.

The call for increased drilling as a result of higher prices “doesn’t make any logical sense,” Moore said. “I don’t expect European policymakers to fall for that, it doesn’t pass the smell test.”

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