While much of the EU economy has been stagnant and mired in the global financial crisis, its energy landscape has been undergoing rapid change. Renewables have grown considerably; from 2008 to 2011 their share in the total energy mix (excluding hydro-power) grew from 7% to 10%. This was mainly driven by the equally rapid increase in subsidies, which in 2011 these reached €39bn for renewables, with much of that met by consumers through higher energy bills. As much as €15bn went to support solar photovoltaics alone.

Europe’s fossil fuel use has also been changing. In 2011, the most recent year for which official data is available, demand for coal in the EU grew by 7%: more than the world average, and in stark contrast to other OECD regions including the United States and Japan, both of which that year saw coal use fall by over 4%. Gas demand in the EU collapsed in 2011 to levels last seen in 2000. CO2 emissions from the European energy sector are lower than they were a decade ago, but much of the drop occurred in the wake of the 2009 trough of the recession. The result is that the price of emissions in the EU Emissions Trading Scheme is very low and doesn’t provide a significant incentive for investment in lower-carbon technologies.

Looking forward to the end of this decade, the EU’s energy sector is at a crossroads: it can either act as an engine of recovery and growth for the economy, or it could act as a drag by increasing prices for consumers, weakening the competitiveness of export industries, and limiting opportunities for domestic businesses to innovate and expand.

One of the critical factors that will determine which of these possibilities comes to pass is the degree to which Europe is able to improve its energy efficiency. Its potential has been recognised by EU lawmakers who in 2008 made efficiency one of the three pillars of the Union’s “20/20/20” package, and more recently a new EU energy efficiency directive was adopted last October. Efficiency is particularly important now because many of the more worrying trends that have characterised the European energy system in the last years are set to continue and even worsen in the future.

“All these constraints mean that energy efficiency is going to be more important than ever for Europe. The good news is that Europe’s potential for increased energy efficiency is very significant”

Europe’s hydrocarbons production is in decline, with gas and oil output having both peaked before the turn of the century. And coal production has been falling for decades. There may be some opportunities, though, to slow down and perhaps reverse some of these trends. The U.S. is now enjoying a revolution in hydrocarbon production thanks to new technologies for unconventional oil and gas extraction. But the outlook for a similar transformation in Europe is bleak, at least for the foreseeable future.

Europe’s oil and gas resources are far less abundant than in North America but are nevertheless considerable. It is factors above the ground that are chiefly holding back development: High population densities mean that not all the resources can be exploited; regulatory frameworks for new extraction technologies take time to put in place; and strong political opposition has led to moratoria on exploration in several countries. The result is that continued growth in demand combined with decreasing production means Europe’s imports of oil, gas and coal will by 2035 grow to €490bn, up from €410bn in 2011.

Energy prices will also give continued cause for concern. EU consumers currently pay far more for their energy than in the U.S. or China. Under present policies, including those most recently announced, this situation is unlikely to change. By 2035, residential electricity prices in the EU will be 40% higher than in the U.S. and more than twice as high as in China. The major drivers of these differences are fuel prices, different investment costs for power plants, and CO2 pricing policies.

Renewables subsidies also play a part – by 2020 they will have added 15% to the average domestic European electricity bill. Low-cost coal in China and low-cost shale gas now coming into play in the U.S. mean that these regions will continue to enjoy a major competitive advantage against Europe. Domestic households there will have more buying power than will European consumers, and businesses will face lower energy costs. If unchecked, these trends will be a continual drain on Europe’s ability to compete in the global marketplace.

All these constraints mean that energy efficiency is going to be more important than ever for Europe. The good news is that Europe’s potential for increased energy efficiency is very significant, as we at the International Energy Agency pointed out in our World Energy Outlook for 2012. We considered in that what would happen if energy efficiency measures were to be significantly strengthened right across the whole European economy by measures that would include stringent codes for new buildings, retrofits for existing ones, the enhancement of energy performance standards for appliances, the use of best available technology in industry, use of the most efficient road vehicles and improved efficiency in the power sector. All these measures are economically viable with rather short payback periods, and feasible with existing technologies.

“The EU’s energy sector is at a crossroads: it can either act as an engine of recovery and growth for the economy, or it could act as a drag by increasing prices for consumers and weakening the competitiveness of export industries”

The costs of these measures in the EU would be some €1.7 trillion between now and 2035; a considerable investment, but the payback makes it well worthwhile. The resulting improvement in efficiency would lead to savings of €3.8 trillion for consumers by 2035, with further savings thereafter. The resources freed up by this reduced long-term spending on energy would help give a 1.1% boost to the EU’s GDP by 2035.

The reduction in Europe’s annual energy consumption by 2035 would be equivalent to 13% of its energy demand in 2010, and would lead to a 17% reduction in CO2 emissions in 2035. This in itself is not enough to put Europe onto a sustainable CO2 emissions trajectory, but it would certainly give a significant boost to decarbonising the European energy sector.

The energy efficiency directive adopted by the EU last year will certainly go some way towards realising these benefits, but it won’t come close to the scale of investments and consequent benefits set out in World Energy Outlook. Europe will need to go much further than that if it is to benefit fully from enhanced energy efficiency.

The further opportunities that European policy-makers should consider lie in several areas. Consumers and businesses can be better insulated from rising fuel prices through making buildings more efficient. In the EU, buildings stock is mature, so the emphasis should be on retrofits. To happen on a sufficiently large scale, retrofitting standards need to be high and the transaction costs low. One way of lowering transaction costs is to combine the financing and execution of retrofits into a “one-stop shop”, so that the owners or managers of buildings can deal with a single entity capable of both funding and carrying out the work.

Transportation represents the other major opportunity. The U.S. will have become almost energy independent in net terms by 2035, with half of this shift coming from increased oil and gas production, but the other half from the decline in oil demand arising from more stringent fuel efficiency standards in transport. Europe’s vehicle fleet is today more efficient than that of the U.S., but there is still enormous room for improvement. By 2035, the EU could reduce oil consumption by close to a million barrels a day, with almost three-quarters of the savings coming from road transport, evenly divided between cars and trucks.

The U.S. shale gas and oil revolution is such that without similar developments in Europe energy efficiency offers the chief opportunity for an EU energy boom. But this will happen if, and only if, Europe’s governments take the lead.