Europe should brace for energy shock

The war in Ukraine and the onset of the pandemic in 2020 are similar in that they are an external shock with a wide-ranging impact on the European Union, Jacob Kirkegaard tells Kathimerini.

The Danish analyst and senior fellow at the German Marshall Fund of the United States and the Peterson Institute for International Economics, foresees a new common fund for dealing with the expected energy crisis, though it will not be as large as the pandemic recovery instrument.

He also believes that the Stability and Growth Pact (SGP) will remain suspended in 2023, while also predicting that regardless of what decisions the EU takes, Russian gas flows to Europe will drop fast, and soon.

Is this another 2020 moment? Should we expect a Recovery Fund 2.0? Are the frugals on board?

The invasion of Ukraine is similar to 2020 in the sense that the EU is dealing with an external shock that affects all EU members, even if those bordering Ukraine are of course more immediately affected. The risks of the crisis getting worse – i.e. a Russian attack on EU/NATO – if left unaddressed is similar too to the pandemic, as is the possibility of solving some of the EU’s long-term challenges, including dependency on fossil fuel imports from Russia/decarbonization, in response to the crisis. In addition, one of the main proponents of NextGenEU, French President [Emmanuel] Macron, is the head of the EU in the first half of 2022 and the host of the upcoming Versailles Summit. It would be unlike Macron to not utilize such an opportunity to promote his long-term agenda of making the EU more “strategically autonomous” and capable of acting independently also in a crisis. As such, there are good political reasons for the EU to reach back into its Covid-19 drawer and repeat the NGEU format with another common fund towards conditional, targeted, relevant grant-based investments across the EU. This is especially so, as many of the traditional fiscal hawks in eastern Europe and Scandinavia, in addition to Germany, have been calling for more EU action to be taken and themselves face significant fiscal costs from refugee hosting. At the same time, it seems unlikely that the economic crisis in the EU triggered by the invasion is at the level of the pandemic, meaning that we should not expect a new common fund to be at the same size level as the NGEU.

Is this the most efficient way for the EU to support member-states right now against surging energy costs?

It is likely to be difficult for the EU to directly provide member-states budgetary support for protecting low income households against energy cost increases, as the manner in which this is done most efficiently will vary greatly among member-states. Instead, as with the NGEU, common EU funds are likely to be targeted towards investments in commonly agreed areas, focused on energy independence from Russia, including new LNG [liquified natural gas] infrastructure, renewables and energy efficiency enhancing initiatives.

How will the new crisis affect discussions over SGP reform?

In the short term, the invasion will end the negotiations, as economic uncertainty will make it increasingly unlikely that the Commission will reintroduce the SGP in 2023, and even if it does so, it will be with a set of implementing guidelines that do not make any real difference for the actual fiscal policy of member-states. The issues at the heart of the Ukraine war’s impact on the EU economy – energy independence, fossil fuel dependency, etc – are core in the ongoing discussions about SGP reform, but this debate now takes a lower priority than establishing a firm and immediate EU response to our energy dependence on Russia. As such, there is unlikely to be any substantive negotiations on the SGP until this response is agreed, including in my opinion likely a version of NGEU 2. This will mean a minimum one year postponement of substantive SGP reform discussions.

Is it realistic to shoot for a 67% reduction in Russian gas imports this year? And should the EU pull the trigger on an oil embargo?

A 67% reduction is very, very ambitious, and would likely require a complete shift in the phaseout of coal and nuclear power stations across Europe (and consistently sunny and windy weather!). This seems unlikely to happen, but being as ambitious as possible is necessary, both to hurt the Russian war effort as much as possible and to unleash massive common EU investments in new renewable production capacity. Even reaching a successful 67% reduction in gas imports would not be as effective in instilling economic pain on the Russian economy as an immediate outright ban on such imports. But this has been ruled out by several EU leaders including PM [Mark] Rutte [of The Netherlands] and Chancellor [Olaf] Scholz [of Germany] as unsustainable given the economic costs it would impose on the EU.

The political pressure, however, is rising for an oil embargo, given the unilateral US Congressional action on that for US imports and the increasing private sector boycott of Russian oil sales. This was most recently witnessed by the decision of Shell to, after criticism of purchases last week, stop buying any Russian oil on the spot market. As such, no matter if EU politicians do not take this morally correct but economically tough decision, the flow of Russian oil to Europe will be reduced rapidly in the coming weeks.