EU economy still grappling with long tail of 2022 energy shock

Although gas and electricity prices have receded below their 2022 peak, they are not forecast to return to pre-pandemic levels in the foreseeable future, the European Commission said on Monday (15 January), warning of the long-term economic consequences of high energy prices on the EU’s competitiveness.

European businesses “continue to face different energy costs with consequences for their growth,” the EU executive warned in a note to the Eurozone’s 20 finance ministers who were in Brussels for a regular meeting.

In particular, the EU’s high gas import-dependency “has widened the relative disadvantage of European producers with respect to the USA”, the world’s largest gas-exporting country, where companies benefit from access to cheaper energy, the Commission said.

“This will weigh on the euro area current account balance and have wider economic consequences,” the EU executive warned.

The surge in gas prices has sent electricity prices through the roof in 2022, prompting a reform of the EU’s electricity market to decrease the Union’s exposure to volatile gas prices.

Asymmetric shock

But while the 2022 energy shock impacted the entire euro area, “some member states were affected more than others,” the Commission paper added, saying this is posing challenges in terms of inflation and competitiveness.

Up to 81% of companies in some countries said energy costs constitute a major obstacle to their long-term investment decisions while the proportion was as low as 24% in other EU countries, according to an October survey by the European Investment Bank.

The asymmetric nature of the shock can be explained by the diverging dependence of EU countries on Russian gas imports, whose prices skyrocketed in 2022 following economic sanctions imposed on Moscow for its military aggression in Ukraine.

However, it is also the result of beggar-thy-neighbour policies implemented by countries like Germany, and to a lesser extent France.

EU countries have earmarked €540 billion to shield industries and households from rising energy costs since the start of the crisis, with Germany alone injecting €158 billion into its economy, according to Bruegel, a think-tank.

“The differentiated impact of the hike in energy cost is partly the result of the differences in energy support packages that countries introduced in response to the crisis, with the national budgetary support ranging from about 2.6% to 0.10% of GDP in the Euro area,” the Commission said in its note.

This has left energy companies in poorer EU countries more exposed to external energy shocks, particularly in Eastern Europe where cash-strapped governments have been less supportive of utility companies, S&P Global Ratings indicated in a note published on 8 January.

“We think affordability challenges are more acute in Eastern Europe as the average GDP per capita is significantly lower than in Western Europe,” S&P said.

In response, governments in those countries might be tempted to reintroduce windfall taxes that were implemented at the height of the crisis in 2022, S&P said.

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Energy prices “to remain high until 2025″ and plummet afterwards

Other short-term risks include the Russia-Ukraine war and conflict in the Middle East, which “are now affecting shipping routes in the region”, said Paolo Gentiloni, the EU’s Economy Commissioner.

“Should this persist or worsen, the possible implications for prices and supply chain disruption could once again fuel inflationary pressures,” he said at a press conference following the Eurogroup meeting.

Continued geopolitical tensions in the EU’s neighbourhood “reminds us that we’ll continue to see energy prices that are high for some time,” acknowledged Paschal Donohoe, the Irish finance minister who chaired the Brussels ministerial meeting.

“We recognise the need to reduce our exposure to global price fluctuations in the energy sector. And that this can only be done through coordination and through better integration,” he told journalists after the meeting.

The main ways to achieve this is to continue diversifying energy sources, accelerate the roll-out of renewable energies, decarbonise the economy, and boost interconnections in European electricity markets, he added.

Consultants at the McKinsey Global Institute went further, saying Europe should aim to halve electricity and gas prices in order to restore its competitiveness relative to China and the United States.

“Europe needs sufficient affordable energy if it wants to maintain energy-intensive tradable industries such as agriculture, chemicals, steel, or shipping to match other regions,” MGI wrote in a briefing published on Tuesday.

Meanwhile, power prices in Europe are expected “to remain high until 2025”, S&P said in its note.

However, as of 2026, the agency expects electricity prices to plummet on the back of a surge in renewable energy capacity. “S&P Global Commodity Insights estimates a 30%-60% decline in baseload prices across Germany, France, Italy, Spain and the UK (E5) over the five years to the end of 2030,” S&P wrote in an opinion piece published in August.

Electricity pricing is Europe’s hidden industrial policy

The subsidy race triggered by the energy crisis in 2022 showed how electricity policy is central to industrial policy. Addressing this at EU level will become even more important in the coming years as Europe moves to electrify transport and other sectors, argue Ben McWilliams, Giovanni Sgaravatti, Simone Tagliapietra, and Georg Zachmann.

[Edited by Nathalie Weatherald]

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