The EU does not need an empty symbol of solidarity

The recent “political agreement” of the EU energy ministers on natural gas was presented as an example of European unity and solidarity. It may be a show of political unity, but it was substantially rare.

The essence of the agreement is a “voluntary reduction in demand for natural gas by 15% for this winter.” Furthermore, it is left entirely to the Member States to decide how to achieve this. It is nothing more than politics for the gallery. The European Commission wanted to gain the power to make the reduction mandatory and declare an EU-wide gas emergency, but the member states did not accept it.

An empty proposal without real solutions

The core is thus a political signal of a 15% reduction (relative to the average of the previous five years, which is close to the 2021 level). This percentage seems reasonable, although the Commission did not provide a convincing analysis as to why this figure is sufficient when Russia provided more than 30% of the EU’s gas supplies in 2021. previous document of CEPS Policy InsightsI have shown that a 15% reduction in gas consumption in Europe should be sufficient, given that the shortfall caused by the loss of Russian supplies could be offset by LNG imports.

Substantial amounts of LNG are being made available to Europe as Asian demand contracts as prices there approach the European level. But the importance of the global dimension of the LNG market is not even mentioned in any of the numerous documents that the Commission published to support its proposal.

Unfortunately, the agreement does not mention how the goal of reducing gas consumption is to be achieved. The Commission’s fact sheet “A European gas demand reduction plan” only lists measures such as “national public awareness campaigns” or mandatory temperature reductions in public buildings.

None of these measures would achieve a significant reduction in gas consumption. The Commission and the Council clearly avoid the key issue, namely the need for higher prices, both for consumers and for industry. The objection to higher prices is, of course, that they are politically toxic. But the uncomfortable reality is that, unless it costs more, few will “voluntarily” reduce their gas consumption.

In the industry, higher prices have already led to considerable gas savings. The actual prices paid by the industry are often a closely guarded trade secret. But, as documented in the study on the price of energy CEPSmany energy-intensive companies have secured long-term contracts with low subsidized rates.

However, even these industries are subject to market forces, as they have the option to reduce production and sell the gas (or electricity) they save at market prices. This is already happening at big scale in some Member States and has contributed to a significant drop in gas consumption in Germany: in May this year, it was approx. one third lower than in 2021.

This underscores the important role of organized exchanges that allow market participants to contract now for electricity and gas deliveries for the coming winter. These futures markets incentivize saving gas now. Therefore, they are not a “playing field” for financial investors, as some populist politicians who demand a reform of the electricity market to curb the power of speculators maintain. These markets can fulfill their role of revealing shortages in advance, but only if Member States do not exercise emergency powers to cancel existing contracts and divert deliveries in the face of short-term crises.

The harsh reality of heating homes this winter

The key political issue that remains is the price of energy for households. On average, households use half as much gas, but this increases considerably during the colder seasons. Therefore, household gas savings during the coming winter will be decisive.

Available data shows that households react to higher prices, but the price increase has to be large to provoke a really significant reaction. Probably a price increase is needed ten times greater than the desired reduction in consumption, so an increase of more than 150% in the price of gas is needed to achieve the desired reduction of 15%.

Prices have already risen in many countries, but not by much yet, and politicians are hesitant to allow distribution companies to pass on higher imported gas prices, which could be hard for poorer households to bear.

However, there are smart solutions that keep the price signal right without overburdening the budgets of poor households. For example, governments could subsidize a certain basic amount of energy (gas and electricity) for households at a fixed price, but with high market-based prices above that level.

The quantity provided at a low price could be linked to the number of people living in the household. The poorest households living in small apartments would benefit much more than the richest ones living in spacious houses. Those who live in large homes would also have much more room to reduce consumption, for example by limiting heating to fewer rooms.

Another approach would be to offer households a “energy saving premium” in the form of payment for each kWh saved (relative to the level of the previous year). This would be another incentive to reduce gas consumption. These measures might be difficult to implement in countries with a myriad of local distribution companies, but this is the key task for governments across the EU right now.

The importance of letting price signals work also applies across countries. Gas must be allowed to flow where consumers are willing to pay the highest price. In some countries it may be easier to reduce gas consumption than in others. Therefore, it is not necessary to have the same reduction target for everyone: this Commission proposal is just an empty symbol of solidarity.

Europe does not need grand proclamations of energy solidarity. It just needs to let the internal market work; and policy makers need to ensure that consumers face the true cost of energy.

Article originally published in the Web of CEPS.