## Beating the European Energy Crisis ## Source details **Canonical URL:** [Beating the European Energy Crisis](https://www.imf.org/en/publications/fandd/issues/2022/12/beating-the-european-energy-crisis-zettelmeyer) ## Other formats - [Markdown version](/en/publications/fandd/issues/2022/12/beating-the-european-energy-crisis-zettelmeyer/index.md) - [Structured JSON version](/en/publications/fandd/issues/2022/12/beating-the-european-energy-crisis-zettelmeyer/index.json) - [Bundle manifest](/en/publications/fandd/issues/2022/12/beating-the-european-energy-crisis-zettelmeyer/bundle-manifest.json) ## Bibliographic details - Authors: JEROMIN ZETTELMEYER, SIMONE TAGLIAPIETRA, GEORG ZACHMANN, Conall HEUSSAFF - Published: December 1, 2022 --- ### Europe’s energy crisis: context and urgency - Supplies of Russian gas—critical for heating, industrial processes, and power—have been cut by more than 80 percent this year. - Wholesale prices of electricity and gas have surged as much as 15-fold since early 2021, with severe effects for households and businesses. - Europe may be about to experience its first winter without Russian gas, risking even higher prices, gas shortages, and a major recession. - If governments were to fully cover the projected increases in energy costs, that would easily add up to €1 trillion, or about 6 percent of EU annual GDP. ### Causes and wholesale price dynamics - Primary cause: reduction of Russian supply. - Liquefied natural gas (LNG) is the primary replacement option; the cost of LNG has more than doubled since Russia’s February invasion of Ukraine. - Wholesale electricity prices reflect: surge in natural gas prices; shortfalls in nuclear and hydroelectric generation; substitution by more expensive coal and gas plants. - In most European power markets, gas currently sets the marginal (most expensive) price, causing lower-cost producers to realize extremely high profits unless hedged. - Market tightening has reached the point where small changes in supply have large effects on prices, producing high volatility and "demand destruction" where some customers stop consuming. ### Government policy responses observed - Two broad classes of policies: - Mitigation of higher costs for consumers and businesses: retail price caps, regulated tariffs, support programs for energy-intensive companies, liquidity or capital backing for energy companies, and nationalization options. - Stabilization and reduction of wholesale prices and securing supply: policies to encourage energy savings, increase supply, and cap energy costs (particularly wholesale gas prices). - Trade-offs and risks highlighted: - Subsidies or price caps can worsen the underlying problem by increasing demand. - Cross-border spillovers: subsidizing consumption in one country raises EU-wide wholesale prices and can hurt consumers in other countries. ### Assessment of wholesale price caps - Three cap approaches discussed: - Regulating all gas import prices: judged counterproductive; would make it impossible to attract sufficient gas to the EU and could raise prices. - Cap only on Russian gas: potentially sensible but risky—Russia could retaliate by stopping remaining supplies. - Iberian exception (Spain and Portugal model): caps price of gas used for generating electricity, effectively limiting electricity cost; has contained wholesale electricity costs in Spain and Portugal but incentivized burning more gas for power. - A cap on all transactions at Europe’s gas hubs and on over-the-counter trading: - Could be paired with a contract-for-difference mechanism paying importers the difference between international price and the European price, funded by the EU budget. - Would lower wholesale gas and electricity prices but risks enforcement difficulties: trading could move off-caps to over-the-counter higher prices; sellers might withhold supply; demand would increase if prices are substantially limited; rationing could be required. - Conclusion on caps: emergency interventions like gas price caps risk worsening the situation, especially if implemented as a patchwork of uncoordinated national policies. ### The "grand bargain" proposal: coordinated demand reduction, supply increase, and market openness - Core elements: - Combine support payments that do not depend on energy consumption with subsidies for reducing usage while retaining price signals for demand reduction. - Subsidies could be proportional to recent energy consumption. - Use design principles like Germany’s "electricity price brake": subsidize the retail price of electricity up to a calculated frugal household level; additional usage faces sharply higher costs. - Resolve free-rider problems politically and legally through regulation and financial incentives such as access to an EU fund. - Supply-side initiatives: - Leverage EU purchasing power as a single buyer to negotiate long-term contracts with gas suppliers; goal to replace the 150 billion cubic meters Russia used to export annually to Europe. - Maximize domestic supply in the short term (examples in text): The Netherlands raising gas output; Germany continuing to operate nuclear power plants scheduled to close. - Consider reciprocity mechanisms and joint EU funds to compensate countries or citizens bearing additional risks (example: compensating citizens of The Netherlands for increased earthquake risk from greater gas production). ### Recent EU actions and gaps - July commitment: member governments committed to reducing gas demand by 15 percent during the winter. - September regulation: endorsed four sets of policy actions: - electricity demand reduction, - a revenue cap for low-cost power producers benefiting from high electricity prices (except those burning coal), - a "solidarity contribution" from fossil-fuel companies (including coal producers), - support for small and medium enterprises. - Mechanism: low-cost power producers are to return profits above the revenue cap to their national governments to finance consumer support. - Critique: these measures emphasize coordinated gas and electricity demand reduction but largely ignore the supply side. ### Key findings and policy recommendations (enumerated) - Findings: - Russian supply cuts are the primary driver of the crisis. - LNG costs have more than doubled since February 2022. - Market volatility is extreme; small supply changes produce large price swings. - Fully insulating consumers via government support could cost €1 trillion (about 6 percent of EU annual GDP). - Replacing 150 billion cubic meters of Russian gas imports is a core supply challenge. - Policy recommendations: - Avoid uncoordinated national wholesale price caps that can increase demand and create cross-border spillovers. - Pursue a coordinated EU "grand bargain" combining: - collective demand reduction targets and mechanisms, - coordinated efforts to increase short-term and long-term supply, - retention of internal energy market openness, - protection for vulnerable consumers via consumption-independent support and consumption-reducing subsidies. - Use EU-level financial tools (e.g., funds, contract-for-difference mechanisms) to stabilize imports and compensate national policy trade-offs. - Negotiate long-term pooled contracts with suppliers to provide predictable revenue streams and secure gas affordability. - Consider short-term domestic production increases and temporary operation of existing low-carbon plants where politically feasible, supported by reciprocity or compensation mechanisms. *IMF F&D Magazine — "Beating the European Energy Crisis" (December 2022) by Jeromin Zettelmeyer, Simone Tagliapietra, Georg Zachmann, Conall Heussaff* --- ## Content in this bundle - **Zettelmeyer** - [Zettelmeyer (Markdown version)](/-/media/files/publications/fandd/article/2022/december/zettelmeyer.pdf.md){rel="alternate" type="text/markdown"} - [Zettelmeyer (PDF)](/-/media/files/publications/fandd/article/2022/december/zettelmeyer.pdf){rel="external" type="application/pdf"} --- _Source: https://www.imf.org/en/publications/fandd/issues/2022/12/beating-the-european-energy-crisis-zettelmeyer_