The last fortnight has been a nightmare for Europe. It has raised a whole range of challenges that no government had expected to face.
The European Union was not prepared for this crisis, as it seemed unimaginable until it happened. While caring for the millions of refugees is the most urgent task for governments, for most individuals removed from the conflict zone, the dramatic impact on the cost of living, especially energy, is the most immediate difficulty.
There is no escaping the fact that we in Europe are all poorer as a result of the fallout from the war in Ukraine.
By contrast, due to the very high energy prices which have resulted, suppliers of oil and gas are the beneficiaries of the disruption. The war is effecting a major transfer of resources from Europe to countries such as Saudi Arabia.
While the gas continues to flow, Russia too will benefit from the high gas price. There is little that can be done about this loss of EU income in the short term.
Economic impact
As yet, it is too early to assess the economic impact of the war. Across the EU, governments need to take action to protect the most vulnerable of their own citizens from the price surge, as well as devoting major resources to caring for the millions of refugees.
At the same time, government revenues will be hit by the inevitable economic slowdown: balancing the books is going to be difficult, even in the medium term.
The high prices are signalling to us all in a painful way that we need to wean ourselves off our dependence on fossil fuels. However, even with an increased sense of urgency this will take us decades.
In travelling towards climate neutrality by 2050, we will still need natural gas to fill in the inevitable gap when the wind does not blow or the sun does not shine. We also need to factor in how we deal with its carbon footprint.
While alternative technologies may be developed, which may avoid this continuing need for gas, they are still a long way off. Thus the security of gas supply will continue to be of great importance to the EU for decades to come.
At the moment Russia supplies up to 40 per cent of the gas that Europe uses, with much of the rest coming from declining gas fields elsewhere in Europe. While there is a growing worldwide market for liquefied gas, the supply is limited, with few producers.
The volume cannot be ramped up quickly to substitute for Russian sources, as major investment is needed in the facilities to liquefy gas for transport, and then reconstitute it to be piped to consumers and businesses. To finance such investment, we need to move away from the current market model dominated by short-term contracts.
Short-term contracts
Thirty years ago most gas was sold on the basis of long-term contracts that provided certainty for producers, facilitating major investment in new gas fields and pipelines. However, today much of the gas used in Europe is sold on short-term contracts.
This reflects the fact that, in a competitive market, a company that agrees to buy gas at a fixed price for 20 years could well go bust if the market price falls below the price they are paying.
That makes it risky for a supplier to make a long-term contract with a buyer, who may not survive to honour the deal. But in the absence of long-term contracts, suppliers are slow to invest in expensive liquefied natural gas technology, because there’s a lot of uncertainty about whether the investment will pay off.
This market structure is rather different from the oil market, where huge companies, such as Shell and BP, take risks to develop new oilfields, and reap big rewards reflecting the riskiness of the projects.
If the investment needed to secure our long-term gas supply is to take place, governments may have to take a more active role in guaranteeing that such investment will pay off.
An EU-wide approach would make sense, and avoid problems with state aid rules if there were national-level guarantees.
The problem of financing the development of gas is similar to the challenges faced in driving investment in renewables.
Investors in such highly capital-intensive businesses need a degree of certainty that undertaking the investment will pay off.
European consumers and businesses are the ultimate beneficiaries of investments that give us security of energy supply and tackle climate change. Through our governments, we need to share the risk, if these investments are to happen.
