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How to overcome the energy crisis and keep the green transition on track

Policymakers need to keep their eye on the goal of decarbonising energy systems.

By Kristian Ruby

Climate change and the energy crisis share a common origin: for far too long our economies have relied on fossil fuels. When these fuels are imported from malevolent actors, like Russia in Europe’s case today, the consequences are severely felt across society. The solution is to break our dependence on imported fossil fuels by speeding up the energy transition. Clean and renewable electricity can cut Europe’s dependence on imported fossil fuels, decarbonise the economy and deliver energy savings via energy efficiency gains. Electrification is one of the cleanest and most cost-effective ways to reduce energy demand. Policymakers must remain focused on this even in the face of Russian aggression.  

The power sector is going through a perfect storm with soaring energy prices, lower generation capacities for clean energy because of recent extreme weather events, and liquidity strains. The Russia-induced energy crisis has triggered an explosion in gas prices. A seven-fold increase from 2021 levels is now crippling EU industrial output and driving inflation as high as 9.8 per cent this July. This year’s Power Barometer data report from Eurelectric – a European electricity industry association – shows that natural gas has pushed wholesale day-ahead electricity prices to record highs. They reached an average of €405 a megawatt hour in August 2022, more than five times higher than in 2021. 

Retail prices are also jumping, with new contracts in capital cities 84 per cent higher this summer than in January 2021; the previous year’s increase was 8.2 per cent. We must alleviate this burden on households and businesses in an efficient manner. This means reducing VAT, introducing energy vouchers for the most vulnerable and encouraging energy-efficiency. A revenue cap on electricity generators, as proposed by the European Commission, will have limited direct impact on consumers’ bills, but high risks for the markets.

Eighty per cent of the electricity we consume is sold in advance. Utilities must post collaterals, or guarantees, that the transaction will happen. Runaway energy prices mean collaterals have also grown exponentially, squeezing liquidity in the market. Otherwise healthy companies have had to resort to government credit lines to match collateral requirements and avoid bankruptcy. More flexible collateral standards and immediate credit lines are needed to mitigate the impact of a liquidity shortage on electricity generators and ensure they can continue to invest in decarbonised electricity sources. Without these measures, it will be extremely hard to achieve net zero ambitions.

Meanwhile, this summer’s heatwave has strained certain clean energy sources. With lower reservoir levels, hydropower generated 37 fewer terawatt-hours compared to 2021 levels, equivalent to a 22 per cent decrease. Extreme weather also increased river temperatures, lowering their ability to cool down nuclear reactors. Maintenance needs also forced several reactors to shut down, decreasing nuclear power generation by 33 terawatt-hours from 2021, an 11 per cent reduction.

We need to be able to rely on all available assets to keep the lights on and decarbonise the economy, and we need to build more assets. Safeguarding investor confidence is crucial to support the required investment rates in clean and renewable electrification. Investments in distribution grids and generation are critical to enable the needed scale-up in electrification. It is now more urgent than ever to reassure investors with clear investment signals. 

Yet the opposite is happening. New market interventions are increasing investor uncertainty. Price caps in the electricity market are an inefficient way to tackle the root cause of the crisis: gas prices. A better solution would be for policymakers to seek to address Russia’s deliberate efforts to disrupt the market by temporarily capping wholesale gas prices. This temporary measure should be complemented by encouraging energy sobriety behaviour across Europe. 

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Saving energy remains key to reducing gas demand and lowering energy prices, and electrification has an important role to play. Electric heat pumps and arc furnaces can reduce gas demand for hot water, space and process heating by up to 57 per cent. Heat pumps are four times more energy-efficient than gas boilers and are now increasingly competitive for households and industries. Electric vehicles are also growing in favour and have unparalleled potential to tackle fossil fuel dependence. Annual sales grew by 349 per cent between 2019 and 2021. Their take-off should now be matched by an 11-fold increase in evenly distributed public charging infrastructures to enable hassle-free driving across Europe. 

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Electrification offers a carbon-neutral, energy-independent future for Europe, but to achieve this policymakers need to remain focused on tackling the root causes of the crisis and not waste time on its symptoms.