Europe faces a long-lasting energy and geopolitical crisis

Europe faces a long-lasting energy and geopolitical crisis

When Europe’s friends around the world are asked what they think of the old continent’s prospects, they often respond with two sentiments. One is admiration. In the struggle to help Ukraine and counter Russian aggression, Europe has shown unity, determination and an exemplary willingness to bear the enormous costs. However, the second is the alarm. A brutal economic contraction will test Europe’s resilience in 2023 and beyond. There are growing fears that the restructuring of the global energy system, US economic populism and geopolitical rifts threaten the long-term competitiveness of the European Union and non-member countries, including Britain. Not only is the prosperity of the continent in jeopardy, but also the health of the transatlantic alliance.

Don’t be fooled by the spate of good news coming out of Europe in recent weeks. Energy prices are down from summer and a spell of good weather means gas installations are near max. However, the energy crisis continues to pose dangers. Gas prices are six times higher than their long-term average. On November 22, Russia threatened to reduce the flow of the last operating gas pipeline to Europe, while missile strikes caused emergency power cuts throughout Ukraine. European gas storage facilities will have to be refilled in 2023, and this time without any piped Russian gas.

Costs beyond Ukraine

Vladimir Putin’s energy weapon will have costs beyond Ukraine. According to our models, in a typical winter, a 10% increase in real energy prices is associated with a 0.6% increase in deaths. Therefore, this year’s energy crisis could cause in Europe more than 100,000 additional deaths of older people. If so, Putin’s energy weapon would claim more lives outside Ukraine than his artillery, missiles and drones directly claim in that country. It is another reason why Ukraine’s resistance to Russia is also Europe’s struggle.

On the other hand, the war is creating financial vulnerabilities. Energy inflation spreads to the rest of the European economy and creates a serious dilemma for the European Central Bank (ECB). The ECB has to raise interest rates to control prices. However, if it goes too far, it risks destabilizing the weaker members of the eurozone; among them, the indebted Italy.

Vyshhorod (kyiv) (Ukraine), 11/23/2022.- Firefighters work at the site of an apartment block destroyed by shelling in Vyshhorod, near Kyiv (kyiv), Ukraine, 23 November 2022, amid Russia's invasion.  At least four people were killed and 27 others injured as a result of Russian shelling hitting the Vyshhorod district, Kyiv Oblast Police Chief Andrii Nebytov said on telegram.  According to a statement by Ukraine's national power supply Ukrenergo on 23 November, power outages were reported across all of the regions of the country following a series of Russian missile strikes targeting the country's critical infrastructure.  Russian troops on 24 February entered Ukrainian territory, starting a conflict that has provoked destruction and a humanitarian crisis.  (Fire, Russia, Ukraine) EFE/EPA/OLEG PETRASYUK

The war in Ukraine is creating financial vulnerabilities. Image of destruction in kyiv


As the energy crisis rages, the war has exposed the vulnerability of the European business model. Too many European (mostly German) industrial companies have been dependent on abundant Russian energy inputs. Many companies have also become more dependent on China, another autocracy, as an end market. The prospect of a break in relations with Russia, structurally higher costs and a disengagement from the West and China has caused many boardrooms to jitter.

Those fears have been amplified by economic nationalism in the United States, which threatens to drive business across the Atlantic in a whirlwind of subsidies and protectionism. President Joe Biden’s Reduced Inflation Act includes $400 billion in aid to energy, industry and transportation, and also includes provisions about manufacturing in the United States. In many respects, the plan resembles the industrial policies followed by China for decades. As the other two pillars of the world economy become more interventionist and protectionist, Europe, with its peculiar insistence on upholding World Trade Organization rules on free trade, seems too naive.

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Endesa reactivates its As Pontes thermal power plant, as of November 2, 2022, in As Pontes, A Coruña, Galicia (Spain), due to the energy crisis

Businesses are already reacting to the subsidies. Northvolt, a valued Swedish battery company, has said it wants to expand its production in the United States. The Spanish energy company Iberdrola is investing in the United States twice as much as in the European Union. Many employers warn that the combination of expensive energy and US subsidies puts Europe at risk of massive deindustrialisation. German chemical giant BASF recently made public plans to “permanently” scale back its European operations. It also doesn’t help that Europe is aging faster than the United States.

The loss of investment impoverishes Europe and feeds a sense of declining economic vigour. If we refer to the trajectory of GDP before the covid, Europe has fared worse than any other economic bloc. Of the 100 most valuable companies in the world, only 14 are European. Politicians will be tempted to abandon the rule book and respond with their own subsidies in an escalation of corporate giveaways. The German economy minister has accused the United States of “hoarding investments.” French President Emmanuel Macron has called for “a European awakening”.

Dispute over subsidies

Thus, the dispute over subsidies also fuels tensions between the United States and Europe. US financial and military support for Ukraine far exceeds that of Europe; And as it turns to Asia to meet the challenge from China, the United States is upset that the European Union is not paying for its own security. The majority of NATO members have missed the goal of devoting 2% of GDP to defense. The European Union showed astonishing ingenuity in the face of Russian aggression. While the war has brought the United States and Europe closer after the rifts of the Trump years, the danger is that prolonged conflict and economic tensions will slowly drive them apart again. Nothing would please Putin and Chinese President Xi Jinping more.

To avoid a dangerous break, the United States must not lose sight of the big picture. Biden’s protectionism threatens to drain Europe of vitality, even as the United States props up the Ukrainian military and fleets of gas carriers cross the Atlantic to supply Europe with energy. The main objective of “bidenomics” is to prevent China from dominating key sectors: the United States has no strategic interest in seizing European investment. It must make it possible for European companies to benefit from its energy subsidies and more deeply integrate transatlantic energy markets.

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Tomorrow is the first day of winter, a season in which low temperatures make it necessary to turn on the heating for more hours at home to combat the cold.  This year, surely there are families that throw more blankets because today, once again, the price of electricity will reach levels never seen before in Spain.

Europe, for its part, needs to protect the economy against energy crunch. Schemes that correctly seek to subsidize consumers and businesses to meet basic energy needs should limit demand by charging higher prices on the margin, as in Germany. To reduce energy prices in the long term, Europe must accelerate the renewable energy revolution, while continuing to keep energy markets open to competition. You must also adapt to a new security reality. That means spending more on defense so that it can pick up the load when the United States turns its sights to Asia.

In addition to admiration and alarm, the other sentiment that governs transatlantic relations is frustration. The United States chafes at Europe’s economic torpor and its inability to defend itself; Europe is outraged by the economic populism of the United States. However, just as Europe must not be divided by war, it is also vital that the most powerful democratic alliance in history adapt and resist.

© 2022 The Economist Newspaper Limited. All rights reserved.

Translation: Juan Gabriel López Guix

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