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The next 25 years are likely to see tougher global competition for hydro-carbon resources, rising real prices for fossil fuels and increased greenhouse-gas emissions. As a bloc whose import-dependency on fossil-fuels will increase over the next two or three decades, and which has invested much political capital in positioning itself as the world leader on climate change, the EU must therefore balance three key energy-policy considerations going forward – security of supply, economic competitiveness and environmental sustainability.

The EU’s prospects of remaining a serious economic, industrial and political player on the world stage will largely depend on whether it can balance these three considerations and secure its energy supplies at the lowest possible economic and environmental cost. And whether the EU can do this, will in turn depend largely on two factors: ensuring that its energy markets send the correct long-term price signals, and intensifying its energy efficiency efforts.

On price signals, there are a number of ways the EU’s energy markets should be improved. Two useful examples are the current dislocation between the price of energy and the price of capacity in the EU’s wholesale power markets, and the need for structural reform of the EU-ETS.

On the first of these points, customers are currently paying high unit prices for their power, but next to nothing for security of supply, and this needs to be tackled so investment can be encouraged so as to avoid a capacity crunch in a few years’ time. Wholesale power prices are the lowest for years, reflecting increases in renewables with low short-run marginal production (SRMC) costs. Renewables’ high long-run marginal costs (LRMC) are paid for in customers’ bills, but as these aren’t reflected in the wholesale price there’s little or no remuneration for back-up thermal capacity, and so no price signals to encourage investment in the reserve capacity needed to support the ever-increasing volume of intermittent energy from renewables. Quite the contrary, as the unambiguous signal that wholesale markets are sending at the moment is that much of the EU’s fossil-fuel capacity – especially the less CO2-intensive gas capacity – should be shut down. In other words, policymakers must either find a way to pay the right price for thermal power or risk the lights going out at some future point.

“With its indigenous fossil-fuel production in long-term decline, Europe will in future be competing ever more fiercely with other major energy importers like China and India for available energy resources”

The second example is the EU’s Emissions Trading Scheme, which needs structural reform and to be better aligned with energy efficiency and renewable policies. With the carbon price languishing at less than five euros a tonne, there is absolutely no incentive to invest in low-carbon energy infrastructure. Until investors have confidence that the carbon price will rise over the long term so that low-carbon technologies like nuclear and carbon-capture and storage (CCS) will become attractive, the EU risks losing all credibility on climate change.

Europe’s ETS is the only commodity market in the world where demand varies in real time but supply is fixed decades in advance. This explains why in response to the fall in demand caused by the economic downturn since 2009 prices have crashed. What is needed is structural reform that would allow for the modulation of the cap as demand varies. This would enable policymakers to respond to energy-efficiency improvements and reduce subsidies for renewable energies in a predictable way. In turn, this would help stabilise investments in clean-energy technologies.

As well as supply-side measures to fix problems with price signals in its energy markets, the EU needs to intensify its efforts on the demand side by making energy efficiency much more important to consumers. Although the EU is already one of the world’s most energy-efficient regions, out of its total primary-energy consumption of 1,700m tonnes of oil equivalent (mtoe) in 2011, over three-quarters was accounted for by fossil fuels and of that total 1,282mtoe, 930mtoe was imported. This gives serious cause for concern on the three considerations we referenced above.

First, consider security of supply. The EU’s import-dependency ratio in 2011 had risen to 55% from 43% in 1995, and for oil and gas, Europe’s import-dependency ratios were 85% and 67% respectively, up from 75% and 44% in 1995. With its indigenous fossil-fuel production in long-term decline, Europe will in future be competing ever more fiercely with other major energy importers like China and India for available energy resources.

Second, rising import dependency has serious implications for the EU’s economic competitiveness. As fossil-fuel prices have risen over the last decade, so too has the EU’s import bill. The volume of net EU imports of crude oil and petroleum products actually fell to 550mtoe (million tonnes of oil equivalent) in 2011 from 605mtoe in 2005, but the nominal cost of these imports increased to €340bn from €210bn in 2005. Rising import dependency will therefore be an increasingly significant drag on the EU’s competitiveness.

And third, to the extent that all of the EU’s energy imports are fossil-fuel based, the higher its energy imports, the less credible are the EU’s claims to environmental leadership. For example, Germany’s decision to phase out nuclear power following the Fukushima incident caused by Japan’s tsunami disaster has led to increased coal imports for power generation in place of CO2-free nuclear energy.

The benefits of energy-efficiency for all three key considerations should be self-evident: reducing the energy consumed per unit of output reduces reliance on imported fuels, saves money and reduces emissions. Accordingly, making Europe’s consumers more sensitive to the benefits of energy efficiency should be a priority for EU policymakers. Member states should as a first step transpose the 2012 Energy-Efficiency Directive (EED) into national law as soon as possible, and accelerate the timeframe for more ambitious energy-efficiency savings laid out in the European Commission’s 2050 Energy Roadmap.

“To the extent that all of the EU’s energy imports are fossil-fuel based, the higher its energy imports, the less credible are the EU’s claims to environmental leadership”

Now is also the time to consider going beyond the mandatory efficiency measures initially envisaged in the EED and implement mandatory efficiency targets. The Commission is due to assess the case for mandatory targets in mid-2014, and despite opposition from some member states it’s clear that the scale of the EU’s energy challenge strengthens the case for binding targets.

At the same time, of course, fully exploiting Europe’s indigenous energy resources in the coming decades will be essential, which means that not only renewables but also nuclear, CCS, and shale gas will all, to varying degrees, have an important role to play (nuclear power requires imported uranium as a fuel but the quantities involved are small and the strategic cost of import dependency therefore very low compared with the benefits provided by the reliable and low-carbon electricity it produces).

But supply-side measures to ensure energy markets generate coherent long-term price signals, along with demand-side measures to improve energy efficiency, are the two ways in which the EU can most effectively reduce its long term energy-import dependency and thus remain a leading economic, industrial and political actor in 2040 and beyond.

 

Photo credit: European Commission

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