The new energy mix: security, economics, and the green transition

The imperative of securing supplies: how the equation has changed

• The Russian invasion of Ukraine has made security the new energy imperative, adding to a necessary continued focus on sustainability and a growing concern on competitiveness. In 2020, the EU imported 57.5 per cent of the energy it consumed that year, including 83 per cent of its natural gas. Before the war, EU natural gas imports from Russia made up almost 50 per cent of the total, around 155bcm. After the Russian invasion of Ukraine, Russian gas imports fell to less than a quarter of all EU gas imports from January to November 2022. Key export routes for Russian gas such as Nord Stream 1 have become unavailable and Russian gas mainly flows through Ukrainian infrastructure and the Turk Stream pipeline. Securing supplies, with the national and economic security concerns as well as geopolitical reshuffling that comes with it, has become the new energy imperative.
• The sanctity of Long Term Contracts with Russia has been shattered. For the first time since the very inception of gas trade with Russia in the ’60s, the weaponization of energy contracts has been asserted and enacted by the Russian Government, contractual obligations have been violated and Russian presence in key European markets (and Russian ownership of critical infrastructure in Europe) has been frozen or overturned.
• The shortfall of Russian gas has substantially redefined energy relationships around the world. Countries like Norway and Algeria have significantly increased its volumes to the EU. Algeria, Africa’s largest gas exporter, saw its share of EU gas imports increase to 12% of the EU’s gas imports in 2022. LNG markets also provided necessary relief from Russian shortfalls, making the US the largest exporter of LNG in the world. The EU was the largest destination for US LNG exports, accounting for 56bcm or more than 52 percent of supplies. A scramble for resources has bolstered exporters, strengthened relationships and substantially redefined energy geopolitics. Two strategic priorities have therefore emerged: i. adapting to an LNG-intensive European gas market (focusing on imports from the US and from the Gulf); ii. bolstering and consolidating the pivot South of European energy relations, focusing on MENA and Sub Saharan Africa.
• The security imperative comes with more, and not less, attention to sustainability and access issues. High fuel prices account for 90% of the rise in the average costs of electricity generation worldwide, natural gas alone for more than 50%. As prices rise, for the first time in decades the number of people without access to electricity increased in 2022. Around 775 million people in the world live without electricity today. As securing supplies becomes vital for not only the energy security of Europe, but also the security and development of communities across the world, sustainability must be center stage. More than 260bcm of natural gas is wasted through flaring and methane leaks globally today. Its abatement is a key short-term priority that can help reduce potent greenhouse gas emissions while providing security and access benefits. New energy partnerships have to be designed, in order to combine increased availability of supplies and enhanced sustainability of productions.

The price conundrum: volatility as the chief enemy?

• Price concerns drive competitiveness issues. In Europe, TTF spot prices averaged at a record high EUR 120/MWh (USD 38/MBtu) in 2022 –almost eight times their five-year average during 2016-2020. Month-ahead prices on TTF spiked to an all-time high of EUR 340/MWh (USD 99/MBtu) at the end of August. In the US, Henry Hub natural gas prices were $8.81/MMBtu in August 2022, $2.15/MMBtu in May 2023 and averaged $5.09/MMBtu during the past year. The Russian supply shock made EU natural gas consumption fall by around 13% in 2022, gas demand in industry falling 25%. The impacts of these shocks on the productivity and competitiveness of key energy intensive industries has become a key concern for policymakers around the globe.
• Volatility and uncertainty are still key concerns. Gas supply and demand gaps still loom, particularly in Europe, raising price concerns. Uncertainty is mainly driven by China’s LNG appetite, with an uncertainty range of about 40bcm, Russia’s behavior, potential unplanned LNG outages and weather conditions in Europe and northeast Asia. Manufacturing economies in Europe will be exposed to international gas markets like never before.

Is the green transition mostly about subsidies, costs and smart grids?

• Industrial policy is the new normal. Energy security and climate concerns prompted the EU and the US to accelerate the energy transition, with big infrastructure packages designed to incentivize new energy sources. Together, the Bipartisan Infrastructure Law, the CHIPS and Science Act, and the IRA, which have partially overlapping priorities, introduce US$2 trillion in new federal spending over the next 10 years. The Infrastructure Package invests $1.2 trillion and the IRA invests $369 for climate and energy measures.
  

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• The EU, on its end, has announced the Green Industrial Plan and the Net Zero Industries Act, facilitating and accelerating the investments in key energy sources and its manufacturing. Packages in the EU and the US respond to what is politically feasible in each side of the Atlantic, but point to a new reality: in an ever changing energy system and geopolitical landscape marked by fragmentation, competition and transitions happening at different speeds, industrial policy and the role of governments in energy systems is the new normal.

Different paths to a greener economy: US and European approaches

• Albeit their structural different, policies across the transatlantic space share the same values and pursue the same goals. Albeit the different instruments and programs put forward in the EU and the US, both share the same, clear-cut goals: accelerate the transition towards a greener economy and securitize supply chains that are particularly controlled by China. A new understanding of economic security and, potentially, a new ‘Washington consensus’ on how the trading system should look like, is emerging around the concept to de-risk supply chains. This is particularly the case for solar and critical mineral supply chains, for example, where the EU and the US understand that having only one supplier for key inputs is dangerous, and are devising instruments that incentivize diversification.
• Transatlantic approaches to the energy transition must incorporate developing countries. In this equation, how to integrate developing countries into the mix as reliable suppliers that can benefit from new development opportunities becomes key – and requires a transatlantic understanding that bypasses purely bilateral concerns to take a global approach to energy issues. Key third countries, from Sub-Saharan Africa to Latin America, can become reliable suppliers of key inputs for the green transition if the EU and the US can devise not only domestic industrial policies but also incentives that reach beyond its shores.

The search for sustainable financial solutions: governments and private investors

• Governments and IFIs / DFIs need to devise instruments to increase financial flows to developing countries and incentivize emissions reductions. Developing countries need greater green investments to ensure energy access, security and sustainability, as well as fight the effects of climate change. IFIs/DFIs are particularly well positioned to redefine the flows of finance towards energy transition investments in developing countries, delivering on both development and climate. In the new normal of the energy trilemma, IFIs/DFIS’ lending strategies have to be upgraded to incorporate investments critical to ensuring timely realization of the necessary infrastructure, as well as investments geared to ensure that new supplies are developed with the highest standards of compliance with Net Zero Patheways (e.g. on methane emissions).
  

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• Financial solutions can be technology neutral, incentivize emissions reductions and promote clean energy solutions across the chain, from increasing of energy efficiency throughout production and consumption chains, emission reductions of legacy energies, developments of low carbon energy vectors, advanced biofuels, breakthrough technologies.  Private climate disclosures and ESG results-based approaches to financing can incentivize and allocate capital towards emissions reductions activities, unlocking the potential of the private sector to deliver for energy security, sustainability and access around the world. For this to happen, sectoral and taxonomic approaches have to be restructured, in favor of a thorough assessment of the contribution of projects, companies, and ultimately sectors to balancing the trilemma and achieving sustainable energy.