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Europe energy fallout will cascade down the years

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LONDON, Sept 12 (Reuters Breakingviews) – Europe’s politicians, consumers and businesses are understandably focused on how to get through a rough winter. But nobody should kid themselves that the continent’s gas crisis will be over by the spring.

The energy squeeze is a multi-year problem which will make Europe poorer and less competitive while saddling the region with higher public debt. Dealing with this at the same time as tackling high inflation will cause ructions which will cascade down the years.

Energy crises have the habit of triggering traumas which play out over many years, as Helen Thompson points out in her book “Disorder: Hard Times in the 21st Century”. Take the Suez Canal crisis of 1956, when Britain, France and Israel aborted their invasion of Egypt following American opposition. This helped convince many European countries to turn to the Soviet Union for supplies of hydrocarbons, the consequences of which we are witnessing today.

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Or take the Yom Kippur war in 1973. That led to massive hikes in crude oil prices, fuelling runaway inflation which was only put to an end by harsh monetarist medicine and terrible recessions on both sides of the Atlantic in the early 1980s. Vladimir Putin’s invasion of Ukraine is likely to cause a similar long-lasting trauma. Europe is particularly exposed.

1.3 TRILLION EURO HIT

One way of quantifying the hit is to look at how much higher energy bills will be, based on forward gas prices. Utilities analysts at Goldman Sachs calculate customers will have to pay 1.3 trillion euros more next year than last year – even if prices are capped at a level that stops power generators making excess profits.

Of course, other parts of the world have been hurt. Japan relies on liquefied natural gas (LNG) and developing countries are being priced out of the gas market while facing soaring coal prices. But the United States and China are doing better. America is a big winner because it is filling the hole left by Russia, supplying Europe with shale gas at eye-popping prices.

China doesn’t produce much oil and gas at home. But it is better placed than Europe, says Alastair Syme, Citigroup’s global head of energy research. The People’s Republic has cut down some gas imports and filled the gap with domestically mined coal. What’s more, it has been buying Russian oil at a discount to the global market price. In future it should be able to get big discounts on Russian gas too, as the Kremlin won’t have any other big buyers to turn to.

COLD TURKEY

Europe was always going to pay a high price for going cold turkey on Russian gas, having ignored the warning signals when Putin invaded Georgia in 2008 and annexed Crimea in 2014. The desperate scramble to find alternative gas supplies has pushed prices to stratospheric levels.

It is not just short-term prices that are soaring. The price of gas this winter is around 215 euros per megawatt hour (MWh), seven times higher than a year ago. But gas for delivery next winter still costs close to 200 euros per MWh. What is more, to persuade gas suppliers from, say, North Africa to ramp up production, Europe will need to lock itself into long-term contracts at high prices while building expensive pipelines and other infrastructure.

Reuters Graphics
Reuters Graphics

European leaders will, of course, accelerate their rollout of green energy, which is now an even more compelling investment proposition. But with America and China also ramping up renewables, building wind farms and fields of solar panels won’t be as cheap as before.

All this will erode Europe’s competitiveness. The euro zone, which previously had a big trade surplus with the rest of the world, has swung into a deficit. Lower exchange rates can make up for some of this: the euro and the pound are down 10% and 13%, respectively, against the U.S. dollar so far this year. But devaluation makes Europe poorer and won’t on its own save energy-intensive industries such as steel, chemicals and paper, which have already cut production.

HIGHER FOR LONGER

In a textbook world, market forces would help lower demand for gas to bring it into line with supply, while heavy industry would relocate to parts of the world with cheaper energy. Governments would focus on helping the poorest people get through the harsh winter and retraining workers in industries that had become uncompetitive.

But governments are being much more interventionist because they fear voters will refuse to pay their bills or turn to extremist politicians. The United Kingdom last week announced a package to freeze prices for consumers for two years that credit analysts at DBRS Morningstar expect to cost 150 billion pounds, or about 6% of national income. The European Union is also working on a massive support package.

Part of the EU plan will be to break the link between gas and electricity prices. This is sensible. But there are two problems with across-the-board subsidies that some governments are providing. First, they don’t do enough to restrain demand. As a result, prices are higher than they needed to be and will stay higher for longer. Second, the cost of mega-bailouts will add to government debt, which had already mounted as a result of the pandemic-related bailouts. Since it looks like wholesale gas prices will stay high, it may not be politically possible to wind down these support packages.

NO MORE CENTRAL BANK CREDIT CARD

It’s the role of governments to borrow to help society through a crisis. But extra debt comes at a cost. Either taxes will have to go up, or spending will have to fall, or the debt will have to be inflated away, at the expense of savers.

Europe is already facing high inflation while interest rates are rising. The days when governments could rely on central banks to buy their debt – effectively providing them with zero-interest no-limit credit cards – are over. Indeed, as governments loosen fiscal policy in response to the energy crisis, the European Central Bank and the Bank of England may tighten monetary policy further.

Meanwhile, economic hardship could poison politics. Incumbent governments may adopt more foolish short-term policies, extremist politicians may find it easier to win power and the solidarity between EU countries may start to fray. Hard times, indeed, are ahead – and not just this winter.

Reuters Graphics
Reuters Graphics

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Editing by Peter Thal Larsen and Oliver Taslic

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