TheMarketForIdeas

The European Union has many inherent advantages and a number of good policy decisions made over the years, to promote convergence and take advantage of its size for economies of scale. However, there are a few sore spots as regards major policy trends that produced significant damage to the fabric of the European Union and divided it. One such problem is that of energy, and the impact of the recently begun war in Ukraine and the response of the EU to the war throw these issues in stark relief. Having achieved a surprising unity of perceptions throughout the West as regards the illegality of Russia’s actions in Ukraine and the need to both deter, discourage and punish those actions, a comprehensive set of sanctions was agreed upon and implemented.

Some were symbolic, as in the confiscation of the Western property of Russian oligarchs, and it is another discussion entirely as to whether this was merited or whether the possible consequences of arbitrary seizure of property will come back to haunt the West. Others were substantial and effective, and involved cutting Russian access to certain markets, especially for technology and producer’s goods, which are necessary for the proper functioning of every industry in the country.

One set of sanctions, however, has been often invoked and demanded, especially by Ukraine and by some of the Eastern Flank NATO members, but has not and likely will not be implemented – cutting Russia off from the energy markets which ensure the largest proportion of its income. The Americans banned Russian oil imports, but the US was recently the largest energy producer in the world, so it has the wherewithal to replace that oil. However, the European Union proposed more modest measures, such as a gradual decrease in oil imports from Russia throughout 2022 and with nothing of substance being said on natural gas. Even those pronouncements caused movements in the market. Even though it is selling less energy in quantity than before, Russia has almost doubled its income from energy, given the high prices that the uncertainties of the confrontation in Ukraine have caused. Europe’s dependence on Russian energy, whose political focus is in Germany itself, the beating heart of EU industry, is a great geopolitical liability which makes the EU unable to realistically wean itself off Russian energy without devastating economic effects, veering into the apocalyptic. And this situation is not just one of immutable circumstance, predestined or beyond our control like the weather or some natural disaster, but the result of conscious and misguided policy, with Germany itself often in the lead. 

Addicted to energy 

There is no advanced civilization, especially an industrialized one, without abundant sources of sustainable, affordable and accessible energy. The European Union is a shining example of this, with energy consumption strongly correlated with economic and industrial strength and sophistication.

On the eve of the Russian invasion of Ukraine, the natural gas situation in Europe looked like in Figure 1.

Figure 1. Source: MUFG Report, “Russia-Ukraine: A brief Assessment and Update on the Crisis”, March 2022 

The elephant in the room is Germany, the largest energy consumer in Europe and the largest per capita and absolute emitter of carbon, through its role as the industrial heart of the continent.

Following the commencement of the “special military operation” in Ukraine, a number of countries reduced or eliminated their imports of energy from Russia, the Baltics among them, who had been preparing for such an eventuality for a long time through the floating terminal in Klaipeda, Lithuania, and other measures. Poland and Bulgaria were cut off by Russia in late April 2022 over their refusal to pay for gas in rubles, which was the Kremlin’s request towards “unfriendly” countries and was meant to support the ruble. The most that Germany and the other nations did was to commit to a gradual elimination of oil imports and to float the idea of lessening gas imports, presumably at the rate of alternative sources coming into play. As of the writing of this article, the EU had decided on banning imports of oil from Russia by the end of 2022, with an exception for Hungary and Slovakia (and possibly Bulgaria), applicable until the end of 2023. With various confirmations from producer nations that they either cannot expand natural gas production or deliveries fast enough to wean the EU off Russia, all that was left was the strident calls from an economically illiterate but emotionally engaged civil society to cut Russia off for good, at presumably ruinous cost to Europe. The EU is already feeling the pinch, with high energy prices, despite not having supply problems yet, and with this growth easily transmitted to people’s bills for heating, transport and food. 

A crisis foretold 

Three issues brought Europe to this point. The first and the most important was the rise of Green parties in Europe, committed to the decarbonization of the economy, which still revolves strongly around coal in countries such as Germany, Poland, the Czech Republic and Romania. The problem with renewable sources is that they are intermittent, with an average up-time for wind turbines of just 20%, as opposed to nuclear’s 99.9%. This means that any renewables must be offset by existing rapid-fire power plants, either in coal or natural gas, by water-storage hydropower plants or by batteries. Otherwise, a grid on which civilized countries rely to always have power for homes and factories, regardless of the time of day or of the year, is going to suffer rolling blackouts. Since nuclear is a baseload power and cannot be turned off and on at will, water-stored power in hydropower basins cannot be scaled to cover the entire economy for geographic cost and environmental reasons and batteries run into huge cost issues and availability of metals, including rarer materials such as Palladium, of which Russia is the largest provider in the world (see figure 2), that only leaves coal or natural gas. Since coal is supposed to be phased out, the destiny of a decarbonizing Europe is to consume more and more natural gas, whose logical source for now, since it is dependent on the pre-availability of extensive pipeline, LNG storage and LNG transport infrastructure, can only be Russia. This is why the EU, in a moment of sanity, included natural gas in its green energy taxonomy as a transition fossil fuel that emits less carbon and other pollutants and can aid societies in increasing their renewables percentage.

Figure 2. Source: MUFG Report, “Russia-Ukraine: A brief Assessment and Update on the Crisis”, March 2022 

Secondly, the Green parties have committed to a strain of environmentalist thinking that also excludes nuclear. Starting with the Energiewende policy enacted by Germany following the Fukushima disaster to reduce its own nuclear disaster threat from the constant earthquakes and tsunamis besetting Germany (sic), the country started rapidly phasing out nuclear energy, while struggling to bring wind power in the North Sea and other sources online. This actually led to increased emissions and energy prices, as coal plants had to be brought online initially to handle economic demand, as they are also doing now to cope with the Ukraine crisis. The irony is that Germany became strongly reliant on energy imports to balance its grids, which often came from 70%-nuclear France or coal-reliant Poland and Czechia. The Germans even today have 25% coal in their energy mix, despite strong efforts to transition away from it, and the largest open pit coal mine in Europe is in Germany. In the beginning of 2022, Germany closed three of its last nuclear reactors, and will close the other three by the end of this year. This has momentous consequences – Siemens drew down and closed its nuclear division, a capability that it cannot easily rebuild, and it is doubtful whether the final three reactors can be operated beyond 2022, given ongoing shutdown procedures and the slow dissolution of the supply chains for parts. Even France flirted with the idea pf reducing its nuclear power, as its oldest operating power plants reach the end of their initial operational span of 50 years. Now, as elsewhere in the world, states are extending lifespans by 30 years in a bid for greater energy self-sufficiency. In another moment of sanity, the EU managed to include nuclear power in its green taxonomy, but that does not represent a change in the underlying anti-nuclear reality. While renewable sources benefit from significant direct and indirect subsidies (the largest being that it is the taxpayer who pays for back-up power waiting to start and for the parallel infrastructure), nuclear power is rife with anti-subsidies and other deterrents such as high bureaucracy, beyond what is needed to ensure safety. The small-scale nuclear renaissance of the Trump Administration in the US is fizzling out, as California proceeds with its plans to close its last nuclear reactor and no authority has yet given permission for a “small modular reactor” (SMR) to be built. SMRs were the solution the US was touting to the EU’s nuclear timeline problem, including in Romania and especially since the two largest EU-built nuclear reactors waiting to come online, Olkiluoto and Flamanville, are at least 10 years overdue and greatly overbudget.

Lastly, just as it did not take into account that demography is destiny, the EU neglected that infrastructure is destiny. Pivoting towards non-Russian energy producers will prove to be difficult, as key infrastructure is oriented towards Russia. The reason for this is not some conspiracy, but rather the ability of the Russian Government to mobilize funding to create strategic infrastructure, whereas many alternative EU projects are led and implemented by private consortia looking for the bottom line, and so are either ill-fated (like the Nabucco line) or too small to make a difference (like AGRI). The private investor wants to address a market, not build a fallow pipeline in case the EU reorients its consumption in 10 years, so Russia’s commitment to building infrastructure like Nord Stream, Blue Stream, South Stream (blocked and since replaced by TurkStream, which started deliveries in 2020, replacing the pipeline through Ukraine and Romania) spelled death for investor-led projects. In this way, most energy roads in Europe go to Moscow. Russia has also acted to constrain other initiatives – for instance, assuming that an unstable Kazakhstan with Russian peacekeepers would want to contribute to EU energy independence, the amended treaties on the Caspian Sea give littoral powers (including Russia) a veto over projects that present environmental danger, such as maybe a pipeline through the Caspian. If we would want to send energy through the South, the only routes are through Iran, which has its own battles to fight in Vienna as a sanctioned state. 

Conclusion 

To sum up, Europe has to pick two out of three – decarbonization, lower dependence on Russia and affordable energy. It cannot have all three with the current and foreseeable situation in terms of infrastructure. Weaning Europe off Russian energy will require coal and nuclear power, while increasing the renewables in the mix and decarbonizing the economy will increase demand for natural gas that cannot, in the short and medium term, come from other places except Russia. The amount of investment required to power advanced economies through renewables is extraordinary, requiring multiples of installed capability equivalent to all existing demand because of intermittency issues, but the problem is academic, since reserves of the required minerals are much lower than what will be actually needed for storage infrastructure, acting as a hard physical limit with current technology. The US can become a credible alternative supplier of natural gas, but it will require significant investment in LNG tanker fleets, and will also result in higher prices for American consumers, who are notably more car-dependent than Europeans and quick to punish politicians over high energy prices.

The only way out of this conundrum is nuclear power, which has been steadily discouraged and maligned politically ever since the Soviet Union found it expedient to run influence operations to this effect in the US and Western Europe during the Cold War. We are living in the aftermath of a political revolution against nuclear, and it will take a lot of changes before we can declare ourselves confident that nuclear power will be viable as a systemic gamechanger for the future energy mix. Meanwhile, over half of the world’s reactors under construction are in East Asia, especially in China.

Europe’s energy woes are entirely self-inflicted, and they started with ideology, which transferred into politics and ultimately impacted the economics of continued dependence on Russian energy. Too much zeal in breaking with Russia risks a voter rebellion that throws out EU governments and brings in leaders that not only will play it safer, but may undo other elements of the sanctions’ regime, seeing how Russia will have been confirmed as an indispensable country for Europe’s economic outcomes (and their careers). While the dependence of many countries on Russian energy places them in this situation, it is Germany that stands out through its heft in European affairs. The German “Wandel durch handel” or “change through trade” of Chancellor Merkel and her predecessors has proven to be an illusion in the case of Russia but provided an excuse for Germany to focus on economic issues to the exclusion of all others, including apparently energy security, resilience and its ability to pursue European foreign policy goals. The US did the same with China for a long time, and its late awakening made reactions even more painful and unpopular with elites and ordinary people.

As for Romania and other still developing nations in Europe and elsewhere, I will leave this as a final message – there has never (yet) been an instance of a country achieving developed status without access to cheap and reliable energy. I doubt we will be the first to prove the observation wrong.