Wednesday, June 19, 2024
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Europe’s energy system is facing an unprecedented crisis as supplies of Russian gas have been drastically reduced, leading to soaring wholesale prices of electricity and gas. The situation threatens to worsen, potentially causing gas shortages, higher prices, and a major recession. European governments have implemented various policy responses, but conflicting objectives and cross-border spillovers have hindered clean solutions. A coordinated effort is needed to reduce energy demand, increase supply, and keep energy markets open while protecting vulnerable consumers.

The root cause of the surge in European gas prices is the reduction in Russian supply, with liquefied natural gas (LNG) emerging as the primary replacement option. The increase in wholesale electricity prices is driven by higher gas prices and shortfalls in nuclear and hydroelectric generation. The most expensive energy source is now gas, resulting in volatility and demand destruction.

While providing financial support to companies and households to weather the crisis is an option, it could be prohibitively expensive and delay adjustment to a new price equilibrium. A more effective approach would be to reduce the level and volatility of energy prices in wholesale markets. One proposal is the implementation of price caps, either on gas imports from Russia or on wholesale prices within the European Union. However, both options come with challenges, including the risk of retaliatory actions from Russia and potential supply-demand imbalances.

An alternative solution involves increasing energy supply and encouraging energy savings. This can be achieved through support payments independent of energy consumption, subsidies for reducing energy usage, and a coordinated effort among EU member states to undertake comparable measures. Such coordination would address both consumer protection and the economic efficiency of the energy market.

To address supply concerns, the European Union could leverage its purchasing power to negotiate with gas suppliers as a single buyer. This approach would secure gas at a reasonable price while providing suppliers with long-term contracts for better investment planning. Additionally, maximizing domestic energy supply in the short term by increasing gas output and extending the operation of nuclear power plants can help alleviate the crisis.

The European Union has already taken initial steps toward coordinated gas and electricity demand reduction, but supply-side initiatives and deeper integration are necessary. The crisis presents a formidable challenge that requires a collective effort and a grand bargain at the EU level. By striking a balance between supply and demand and accelerating the transition to cleaner and more affordable energy, Europe can overcome the current crisis and shape its future energy system.

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