Will Russia-Ukraine war disrupt Europe’s energy transition?

Many European countries have sought to reduce carbon emissions and limit the effects of climate change.

To achieve this they have moved away from coal, the most carbon-intensive fuel, and increased their reliance on natural gas in recent years. For example, the number of EU member states producing anthracite, the purest form of coal with the highest carbon content, fell from 12 in 1990 to just two in 2020, being Poland and the Czech Republic.

However, this shift has made the EU’s energy mix much more dependant on international trade dynamics and geopolitical relationships. Coal can be produced domestically, but natural gas is mainly imported.

The EU imports 90% of its gas consumption, with Russia, its largest gas supplier, providing around 45% of those imports in 2021. Countries in the EU have different degrees of reliance on Russia for their natural gas supply. Austria and Poland imported more than 80% of gas from Russia in 2021, Germany more than 50%, while for France and Spain the share was less than 8%.

Phasing out Russian fossil fuels

Following the Russian invasion of Ukraine, the EU has committed to phasing out its dependency on Russian fossil fuels. A sustained policy effort across multiple sectors will be needed.

The EU is seeking to diversify its gas supplies, while speeding up the introduction of renewables. Reducing energy consumption and improving energy efficiency will also be important, given the tight supply and current energy infrastructure constraints. While the plan can fast-track the clean energy transition and fight the climate crisis, this is no easy task. The task is made harder still given the bloc is already battling elevated inflation caused by bottlenecks as economies have re-opened.

The war is aggravating inflationary pressures, disrupting production and trade of several commodities particularly energy, fertilizers, and grains, where Russia and Ukraine are key exporters. Food and energy prices have climbed sharply with the invasion of Ukraine and have remained elevated since then, pushing the global economy towards a more stagflationary world as recently discussed in our latest Economic and Strategy Viewpoint.

Can Europe achieve its climate neutrality target, secure energy affordability, ensure security of energy supply, all this while decoupling from Russian energy and fighting high inflation?

Higher fossil fuel prices are key to reducing high-carbon energy consumption and incentivising the net-zero transition. That is the role played by carbon pricing.

On one hand the war and the subsequent energy sanctions against Russia could speed up that direction of travel. On the other hand, however, higher gas prices could threat energy affordability, favouring a coal comeback.

Governments are making efforts to ensure stable supplies of energy for European households and businesses. While these measures are necessary to mitigate the impact of climbing gas prices, they could jeopardise EU’s lower emission path in the short term.

The first key evidence is that emissions from the EU’s power sector have climbed sharply since the start of the invasion, signalling that there has been a partial switch back to coal as a source of electricity (Chart 1).

In March, emissions from the EU power sector were already up more than 20% year-on-year. Emissions are likely to keep rising throughout 2022 as Russia is now cutting capacity on the Nord Stream 1 pipeline, one of the main conduits for Russian gas to Europe.

Amid concerns over further gas supply cuts before winter, Germany and Austria have recently announced they are planning to reopen mothballed coal plants for electricity generation. A sudden reduction in Russian energy exports could be highly disruptive for European countries. The OECD has estimated that a decline of 20% in imported energy inputs has the potential to reduce European gross output by over one percentage point, with large differences across countries.

Lithuania and Greece would be hit the hardest, with a reduction in GDP of more than 2%, while France, Denmark and Ireland would be the least exposed, with a growth hit of less than 0.7%.       

Europe accelerating medium-term transition plans

The second key evidence is that governments are providing measures to shield vulnerable households from rising energy prices via subsidies, scrapping surcharges or capping electricity prices.

Among the European countries Germany has been the most generous, supporting household and firms with €43 billion since September 2021, followed by Italy (€37 billion) and France (€35 billion). Subsidising energy consumption is important to help consumers with the cost of living crisis in the short run. But it can have some drawbacks, indirectly incentivising the use of fossil fuel energy and making the required switch from dirty to cleaner technologies even more expensive in the long run.

While this could work against Europe’s climate neutrality plans, there are signs that the continent is taking steps towards an acceleration of renewable energy production for the medium-term.

The EU is planning to double its solar photovoltaic capacity by 2025 and to double the rate of deployment of heat pumps. In particular, the European Commission (EC) is proposing a solar rooftop requirement for commercial and public buildings from 2027, and for new residential buildings from 2029.

In a bid to reduce emissions from the transport sector, the EU has also voted on a ban on the sale of new petrol and diesel cars from 2035 to accelerate the switch to electric vehicles.

Energy inflation set to be key challenge

Research from the International Energy Agency (IEA) highlights that clean energy technologies, including wind turbines, solar panels and electric vehicles, are much more mineral-intensive than fossil fuel energy.

Charts 2 and 3 show that that an offshore wind plant requires around 13 times more mineral resources than a gas plant and an electric vehicle requires six times more mineral resources than a conventional car. This means that there will be an increase in mineral and metal demand during the transition.

Belgium’s Katholieke Universiteit Leuven has estimated additional energy transition demand for certain metals in Europe. Demand for copper will increase by 35% compared to what the continent already uses today, while consumption of silicon, nickel and cobalt will respectively rise by 45%, 110% and 350%. Demand for lithium is expected to be 35 times higher finds the research.

The study estimates that this surge in demand is only expected to weaken after 2040, when more metals will become available through recycling from scrapped vehicles and other equipment such as wind turbines.

This is thanks to the fact that metals have permanent physical properties so can be re-used (in stark opposition to fossil fuels) so that by 2050 secondary markets will be the major supply source for the metals needed.

Until then, Europe is likely to witness severe disruptions and bottlenecks given the tightness of global supply and its import reliance for many of these key materials. The IMF compared projected demand and supply for metals over the next 30 years assuming the IEA’s scenario for net zero emissions is achieved.

It found a supply shortage of more than 50% for graphite, cobalt, nickel and lithium. This supply-demand imbalance will put upward pressure on prices for these key metals, and therefore on energy inflation, keeping energy affordability concerns elevated.

The high European import reliance for these key materials will also continue to weigh on the dependency of its energy supply on international trade dynamics. This means that the continent will continue to remain vulnerable to sources of geopolitical risk over the next few decades.

This could be exacerbated by the fact that supply chains for the raw materials needed in the transition are more geographically concentrated than that of oil or natural gas.

Chart 5 shows the share of top three producing countries in extraction of key minerals and fossil fuels, highlighting that the global production of lithium, cobalt and rare earth elements is controlled by a few countries.

In particular, the Democratic Republic of the Congo is responsible for around 70% of global cobalt supply - a key metal for electric-car batteries. Meanwhile China accounts for 60% of global production of rare earth elements production.

China also dominates the production of graphite, another critical battery component. Finally, the tensions between Europe and Russia could further jeopardise the transition as Russia is an important producer of nickel and cobalt.

In particular, Russia is a large supplier of raw materials to the EU, accounting for 17% of European imports of aluminium and nickel, 7% of copper and 5% of cobalt and nickel.

At the same time, net zero for Europe looks still achievable as measures to accelerate the deployment of renewable energy and clean technologies are being taken.

There are a few key challenges ahead, as supply shortages of key raw materials could weaken the EU’s ability to achieve its green targets.

However, once the continent has built all the infrastructure needed to produce solar and wind energy, it will finally become energy-independent, enjoying infinite and unconstrained sources of power.