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A Magazine of Ideas

Europe's Energy Problem

Friday, June 20, 2014

Developments in the Middle East and Ukraine show Europe needs to improve its energy policy or face serious economic consequences.

Fast-moving events in Ukraine and the Middle East highlight the need for Europe to improve its energy policy. In particular, they underscore Europe’s excessive dependence on Russian energy supply, which poses a major risk to its economic growth prospects. That dependence also constitutes a serious impediment to Europe’s foreign policy, limiting its ability to maneuver, as has been all too clear during the recent U.S. attempt to impose meaningful economic sanctions on Russia for its activities in Crimea and eastern Ukraine.

These risks are all the greater for those countries in southeast Europe that have low natural gas inventories and that are excessively dependent on Russian natural gas supply to meet their energy needs.

Additionally, Europe is at a great disadvantage competing with the United States due to energy costs. U.S. natural gas prices are around one-third those in Europe.

Over the past several months, in the context of the deepening Ukrainian political and economic crisis, Russia has not hesitated to use its virtual monopoly position as Ukraine’s natural gas supplier to destabilize the Ukrainian government. Indeed, it has hiked Ukrainian gas prices by around 80 percent and it has insisted that Ukraine must pay Gazprom large payment arrears for Russian energy supplies to continue. The series of recent terrorist attacks on important gas pipelines passing through Ukraine further raises questions about the security of Russian natural gas supplies through Ukraine.

U.S. natural gas prices are around one-third those in Europe.

Worse yet, the Russians have suspended natural gas shipments to Ukraine, which poses a real risk to continued Russian natural gas supplies to Europe for the third time in the past few years. Russia supplies approximately 30 percent of Europe’s natural gas needs, approximately half of which passes through Ukraine. Fortunately this disruption is occurring during the summer months, at a time of low energy demand and of adequate oil and gas inventories in most of Europe. However, if sustained, it could have serious long-run consequences for the European economy.

In addition to these developments in Ukraine, there have been disturbing events in the Middle East that ought to encourage Europe to take a fresh look at its energy policy. Over the last few weeks, the impending fragmentation in Iraq has thrown into question the longer run feasibility of Iraq’s present level of oil production of around 3 million barrels a day. It has also dimmed the prospect of Iraq playing a key role in increasing future global oil production capacity. Combined with ongoing disruptions to Libyan and Syrian oil production, events in Iraq have already pushed international oil prices to their highest levels in the past year.

Russia supplies approximately 30 percent of Europe’s natural gas needs, approximately half of which passes through Ukraine.

Against this background, Europe needs to seek ways to increase its energy independence along a number of different fronts. Immediate action should be taken to bring back into production moth-balled coal production facilities as well as to diversify energy supply sources by building new liquefied natural gas terminals. Those terminals would allow Europe to diversify its sources of natural gas supply, including that from countries like Qatar and the United States. Action might also be taken to promote domestic shale oil and gas production, to improve Europe’s energy storage capabilities, and to expand its interconnector pipeline network, which would allow natural gas to be transported from European countries that have adequate natural gas supply to those that do not.

Europe must move more expeditiously and decisively in these areas of policy than it has been wont to do so in the past, or its longer-run economic growth prospects could be seriously undermined.

Desmond Lachman is a resident fellow at the American Enterprise Institute.

FURTHER READING: Lachman also writes "Europe in Denial," "Are the U.S. Dollar's Days Really Numbered?," "Yellen's Wishful Thinking," and "Europe’s Outlook in 2014."

Image by Meg Bosse & Dianna Ingram / Bergman Group