Europe can — and must — win the energy war


“Europe shall be solid in disaster and would be the sum of the options adopted for these crises.” These phrases from the memoirs of Jean Monnet, one of many architects of European integration, echo right this moment, as Russia closes its principal fuel pipeline. That is absolutely now a disaster. Whether or not Monnet’s optimistic perspective prevails, we have no idea. However Vladimir Putin has assaulted the ideas on which postwar Europe was constructed. He merely must be resisted.

Power is a crucial entrance in his struggle. It will likely be pricey to win this battle. But Europe can and should free itself from Russia’s chokehold. This isn’t to underestimate the problem. Capital Economics argues that at right this moment’s costs the worsening of the phrases of commerce would quantity to as a lot as 5.3 per cent of Italy’s gross home product over a yr and three.3 per cent of Germany’s. These losses are greater than both of the 2 oil shocks of the Nineteen Seventies. Furthermore, this ignores the disruption to industrial exercise and the impression of hovering power costs on poorer households.

It’s inevitable, too, that sharply rising power costs will result in excessive inflation. The expertise of the Nineteen Seventies signifies that the most effective response is to maintain inflation firmly beneath management, because the Bundesbank then did, moderately than permit determined makes an attempt to stop the inevitable reductions in actual incomes to show into a seamless wage-price spiral. But this mix of enormous losses in actual incomes with lower than absolutely accommodative financial coverage signifies that a recession is inevitable.

Tough although the long run appears, there’s additionally hope. As Chris Giles has written: “There’s nearly no solution to escape a Europe-wide recession, nevertheless it want be neither deep nor extended.” The probability of a recession has in all probability risen additional since then. However work by IMF employees reveals that substantial adjustment is possible, even within the brief run. In the long term, Europe can dispense with Russian fuel. Putin will lose if Europe can solely maintain on.

Line chart of Oil price ($ per barrel) showing The real price of oil price is not that high by historical standards

A latest paper from the IMF factors to the potential position of the worldwide liquefied pure fuel market in cushioning the shock to Europe. European integration inside world LNG markets is imperfect, however substantial.

The paper concludes {that a} Russian shut-off would result in a decline in EU gross nationwide expenditure of solely about 0.4 per cent a yr after the shock, as soon as one takes the worldwide LNG market under consideration. With out the latter, the decline could be between 1.4 and a pair of.5 per cent. However the former, whereas much better for Europe, would additionally imply larger costs elsewhere, particularly in Asia. The estimated fall of 0.4 per cent additionally ignores demand-side results and assumes full integration of world markets. For these and different causes, the precise impression will certainly be far larger.

One other IMF paper means that, with uncertainty added, Germany’s GDP could possibly be 1.5 per cent beneath baseline in 2022, 2.7 per cent in 2023 and 0.4 per cent in 2024. IMF work on particular person EU international locations additionally concludes that Germany wouldn’t be the worst hit member state. Italy remains to be extra susceptible. However the worst hit are going to be Hungary, the Slovak Republic and Czechia.

The large lesson of the oil shocks of the Nineteen Seventies was that by the mid-Eighties there was a world glut. Market forces will certainly ship the identical consequence in time. The short-term impression can even be manageable. The wanted actions are to cushion the shock on the susceptible and encourage wanted changes, which could embrace emergency reopening of gasfields.

Ursula von der Leyen, European Fee president, has asserted that the intention of coverage ought to now be to scale back peak electrical energy demand, cap the value on pipeline fuel, assist susceptible shoppers and companies with windfall income from the power sector, and help electrical energy producers going through liquidity challenges brought on by market volatility. All that is smart, as far as it goes.

An important facet of this disaster is that, like Covid, however in contrast to the monetary disaster, virtually all European international locations are adversely affected, with Norway the large exception. On this case, above all, Germany is among the many most susceptible. Which means that the shock, and so additionally the response, are in frequent: it’s a shared predicament. However it’s also true that particular person members not solely face challenges that differ in severity, but in addition possess considerably completely different fiscal capability. If the eurozone is to get by means of this problem efficiently, the query of sharing fiscal sources will once more come up. It should finally be unsustainable to anticipate the European Central Financial institution to be the primary fiscal backstop in such a disaster. But if weaker international locations had been to be deserted, the political penalties could be dire.

Line chart of Gas prices ($ per million btu) showing EU and Asian gas markets are already highly integrated

At the least two additional massive points come up. The narrower one is the position of the UK beneath its new prime minister, Liz Truss. She has an instantaneous alternative: to fix the nation’s fences with its European allies in response to the shared risk of Putin, or to interrupt the treaty her predecessor made to “get Brexit finished”. Europeans will rightly neither neglect nor forgive if she chooses the latter on this hour of want.

Line chart of 10-year bond spreads over Germany (% points) showing Eurozone bonds spreads are still very small and must remain so

The second and much greater concern is local weather change. As Fatih Birol of the Worldwide Power Company writes, this isn’t a “clear power disaster”, however the reverse. We want way more clear energy, each due to local weather dangers and to scale back reliance on unreliable suppliers of fossil fuels. We learnt this lesson within the Nineteen Seventies. We’re studying it once more. The case for an power revolution has develop into stronger, not weaker.

How Europe responds to this disaster will form its fast and longer-term future. It should resist Putin’s blackmail. It should alter, co-operate and endure. That’s the coronary heart of the matter.

Observe Martin Wolf with myFT and on Twitter

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