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Raspotnik Andreas

Question: It is reported that in Europe, more than half of the oil and gas comes from Russia. Energy costs accounted for more than half of the eurozone's record inflation rate in January. The uncertainty of Russia's future supply may exacerbate the supply tension. In your opinion, what specific actions will European countries take to alleviate the inflation and energy crisis caused by sanctions against Russia?

Brief overview of energy dependency

The European Union is (and has always been) highly dependent on the import of energy products, in particular oil and gas. Over the last three decades, EU dependency on energy imports – primarily due to a downturn in the primary production of coal, crude oil, natural gas and nuclear energy – has increased from 40% in the 1980s to 58.2% of the EU’s gross available energy in 2018; in other words, net imports accounted for more than half of gross inland energy consumption.[1] Over the period from 2014 to 2019 domestic gas production, for example, in the EU fell significantly, from 153 billion cubic metres (bcm) to 109 bcm, whereas total consumption rose from 419 bcm to 482 bcm. This underlines the increasing import needs of the EU.[2]

The highest need (gross inland consumption + international maritime bunkers) was for oil and petroleum products, 547.3 Mtoe, of which 94.6% (512.5 Mtoe) were imported. The major imports in 2018 came from Russia (151.6 Mtoe), Iraq (44 Mtoe), Saudi Arabia (37.8 Mtoe) and Norway (36.7 Mtoe), with some imports also from the United States (12.2 Mtoe) and Canada (2.9 Mtoe).[3] In 2019, the total net imports of gas amounted to 398 bcm, which is about 358 Mtoe. Russia accounted for almost 46% of natural gas imports, followed by Norway with 29% and Algeria with 7%, all including both pipeline and liquified natural gas (LNG) imports.[4] A similar analysis for the same period shows that 26.4% of crude oil imports came from Russia, 9.2% from the United States and 8% from Norway.[5]

Which specific actions will the EU take?

Energy diversification

On March 8, the European Commission proposed an outline of a plan to make Europe independent from Russian fossil fuels well before 2030, starting with gas, in light of Russia's invasion of Ukraine. This plan – REPowerEU – highlights a series of measures to respond to rising energy prices in Europe and to replenish gas stocks for next winter. REPowerEU will seek to diversify gas supplies, speed up the roll-out of renewable gases and replace gas in heating and power generation. The aim is to reduce EU demand for Russian gas by two thirds before the end of 2022.[6] Essentially, resilience of the EU-wide energy system shall be reached via two pillars: Diversifying gas supplies and boosting energy efficiency. On the one hand, higher Liquefied Natural Gas (LNG) and pipeline imports from non-Russian suppliers, and larger volumes of biomethane and renewable hydrogen production and imports should help the diversification process. On the other hand, reducing even faster the use of fossil fuels in our homes, buildings, industry, and power system should boost energy efficiency.

This will go hand in hand with the Fit-For-55 Package, which is already aimed at reducing the Union’s our annual fossil gas consumption by 30%, equivalent to 100 bcm, by 2030. With REPowerEU the EU could gradually remove at least 155 bcm of fossil gas use, which is equivalent to the volume imported from Russia in 2021. Further objectives for 2022 will included a legislative proposal to requiring underground gas storage across the EU to be filled up to at least 90% of its capacity by 1 October each year.

Generally, it has been argued that replacing Russian gas is indeed feasible, yet bound to be rather costly in the short run, involving a broad range of measures in addition to the ones mentioned in REPowerEU. Increasing the supply from other sources might also delay the closure of coal and nuclear plants as currently discussed in Germany. Additionally, one would also need to aim to cut domestic demand for gas and other fuels.[7]

Inflation

The war in Ukraine will likely add to upward pressure on inflation, with the biggest impact via higher gas and oil prices. Naturally, any disruption to the supply of gas from Russia could cause prices to surge again. Additionally, also the economic growth for 2022 is currently expected to be weaker than initially anticipated, which partly relates to the strong economic ties between the European Union and the Russian Federation, with some Member States more affected than others. According to the Wall Street Journal, this presents the European Central Bank (ECB) with a dilemma. While it could tackle inflation by winding down its bond-buying program and thus opening the way for a rise in its key interest rate later this year (or early 2023), such move would likely exacerbate the slowdown in growth and sharpen a decline in inflation.[8] In a recent discussion by the economic think tank Bruegel, its former director Jean Pisani-Ferry highlighted that as long the prices only rise due to higher energy prices, the ECB should wait to increase interest rates. However, if the prices for other goods are to be rising as well, the ECB would need to act accordingly. Ferry further emphasizes, that the immediate risks to the European economy do not only arise from supply shocks but essentially also from the (potential) negative impact of geopolitical threats on household confidence and investors’ sentiment.[9] In situation like these, Member States have already started measures to contain the rise in prices and to support vulnerable households. The problem ahead though will be if governments should primarily rely on direct transfers or rather intervene through across-the-board tax costs?[10] For February 2022, the Euro area annual inflation is expected to be 5,8%, up from 5,1% in January, with again stark difference between the various Member States.[11] The EU will further need to contemplate over how to best tackle the problem of intra-EU logistics and the mere fact that some Member States (mainly those being more reliant on Russian gas, e.g. Austria, Slovakia, the Baltics but also Germany and Italy) will be more affected by higher inflation than others.



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