Overview
In 2021, Europe prospered in a favourable macroeconomic environment, with the public equities market up around 18% at its max. Private equity transaction activity had reached new highs as the world began to recover from the economic and health-related fears instilled by the pandemic. However, markets had little time for relief before escalations of the Russian-Ukraine war sparked a historical energy crisis. The EU scrambled to meet energy demand. Withstanding global pressure on their impacts on the climate crisis, parts of the EU fell back on non-renewable sources and signed long-term Liquid Natural Gas (LNG) contracts, an oil alternative, to cover the shortage. Emerging out of the peak of the crisis, Europe faces mounting pressures to stay in alignment with the global energy transition. Decisions and policies during the crisis created pivotal shifts in the EU's investment landscape and a slew of new considerations. With the public sector forced to prioritise short-term energy issues, the private sector has a profitable opportunity to lead the European transition to renewable energy.
A Brief History of European Energy
Before attempting to project the future of European energy, it helps to gain clarity of the past, particularly of how Europe fostered a dependence on Russia for its energy supply. Back in the 1950’s, the continent dominantly used coal for energy generation. During the late 20th century, natural gas became an increasingly promising solution for its lower cost and cleaner nature than coal. The EU wanted in on this new-age energy, but quickly depleted their resources, such as those found in the U.K and Netherlands’ north sea gas fields. Consequently, Europe turned to Russia, who had cheap and easily accessible natural gas supplies. Energy trade helped foster the two nation’s relationship. Since Russia provided a steady source of affordable energy supplies, Europe sought to diversify pipelines from Russia as opposed to diversify suppliers.
The Energy Crisis
These historical choices paved the way for the 2022 energy crisis, when the continent received an ultimatum resulting from the confluence of climate, short-term energy shortage, and macro headwinds. As Russia escalated the conflict with Ukraine, NATO-allies implemented sanctions to coerce Russia into peace. In retaliation, Russia severed trade with countries par-taking in the sanctions, which included those in the EU. Due to Europe’s unique energy dependence on Russia, the continent fell into an energy crisis. Parts of Europe were in states of emergency as many feared a winter without heat. At the time, an immediate solution to relieve the energy shortage was to enter into long-term LNG import contracts with participating regions. As power demand is expected to double by 2050, these contracts would go a long way in providing the continent with much needed energy security. The European Commission had several concerns about locking into long-term contracts, such as a hindrance of free flow of gas in Europe and set-backs to emissions targets. However, homes without heating were much more pressing and immediate of an issue than economic and climate concerns that can be mitigated with other policies. In July 2022, the EU updated their sustainable finance taxonomy to include gas and nuclear energy, with stringent conditions.
This decision came with contention for the fact that gas infrastructure development is not sustainable by definition, and that nuclear energy has set precedence for brewing catastrophic disasters if poorly managed. However, it did give Europe a much needed flexibility to leverage non-renewables for mitigating the shortage. Europe’s LNG import levels increased by 60% from 2021 to 2022. 2023 followed a similar trajectory, with numerous energy companies signing LNG contracts with QatarEnergy that may deliver LNG up to 2053. Renewable energy production also ramped up significantly since the onset of the crisis. Solar and wind power surpassed gas to generate a fifth of Europe’s electricity in 2022. These efforts, coupled with a fortunate warm winter, led Europe through the peak of the crisis. Though initially a scramble to meet demands, the crisis had one key silver lining: an accelerated shift towards renewable energy and putting sustainable energy security at the top of the EU's agenda.
Towards Sustainable Energy Security
The Russian-Ukrainian War compelled the EU to replace Russian imported energy resource demands with internal solutions. New investment opportunities within the private energy sector would reduce the EU’s exposure to global energy market volatility and encourage self-reliance. Infrastructure development may be a key part to achieving decarbonized energy and reducing the price gap between renewable and non-renewable sources. Contrary to non-renewable energy, renewables have higher upfront expenditures but lower operating costs per unit of generated energy. Although the optimal choice, renewable plants also face challenges from delays, regulatory issues, and macro-headwind pressure. Many foreign investors participate in these development projects through greenfield investments. In greenfield investing, foreign businesses set up subsidiaries in the target country to construct a project starting from undeveloped land. Both foreign and domestically funded investment projects will push the EU towards a more sustainable energy generation.
Energy providers are typically undifferentiated due to the commoditized nature of utilities. Energy prices tend to be alike from companies with the same generation method, shifting value creation strategies toward reducing costs instead of adjusting prices. Specifically, there is a lack of green energy infrastructure support for consumers. According to research conducted by Goldman Sachs, providing one unit of energy output through a green source will require 2 to 3 times the amount of capital expenditure on the infrastructure than through grey energy. Fortunately, research and development has significantly reduced renewable energy costs in the past decade. For instance, the global weighted average levelized cost of electricity (LCOE) for onshore wind projects was around 30% lower than the natural gas, the least expensive fossil-fuel solutions in 2023, a stark contrast to 2010 when it was 95% higher than its fossil fuel counterparts. These advancements promote the economic viability of renewable energies in today's market. There are numerous directions for renewable investment, and it may help to explore some of the options at hand.
Utility-Scale Batteries
A solution that will likely play a massive role in the energy transition and promote energy security is Utility-Scale Batteries. Utility-Scale Batteries are a form of storage technology that allows power systems to store generated power. This technology gives energy generators the flexibility to stockpile electricity when it is abundant and release as needed. Batteries mitigate the instability of energy outputs levels inherent to the intermittent nature of renewable energy. For example, batteries help deliver stable solar power by building up reserves during times of the day or year with more abundant sunlight, and releasing them when there is little sunlight.
Though the EU had little direction for battery investments for much of the decade, 2023 appeared to be a turning point with notable increases in grid-scale battery investing. The UK leads the charge in expanding utility-scale battery infrastructure and is expected to quintuple energy storage capacity by 2030. These investments will help address missing infrastructure and promote cost-saving innovation, though more efforts are needed. In particular, legislation must adapt to maintain a favourable environment for cultivating green investments. The EU Agency for the Cooperation of Energy Regulators (ACER) notes that the vagueness of lesligation leads to excessive costs and an uncertain investment environment. Germany exemplified this when prior to legislation changes in 2023, companies servicing batteries paid twice to connect to the power grid as they were considered both a producer and consumer of energy. Well-formed regulation is a key part of effective battery investments.
Hydrogen
Another promising area of renewable investment is Hydrogen. Hydrogen power is split into green (renewable) and blue (non-renewable) hydrogen, categorised by the energy production means and emissions of the process. Green hydrogen is produced via electrolysis of water using electricity generated from other renewable sources, whereas blue hydrogen requires fossil fuels in its generation. Hydrogen produces power by reacting with oxygen in electrochemical cells that resemble batteries. This energy source is advantageous in its potential to aid a seamless transition away from natural gas, as existing gas infrastructure can be adapted to hydrogen. Several areas, such as production, distribution, storage, and more require further investment to bridge infrastructure gaps. Transportation of hydrogen is especially difficult as converting hydrogen to liquid form or ammonia is costly and requires complex technologies. Despite these hurdles, the European Union (EU) anticipates that hydrogen could comprise up to 20% of its renewable energy mix by 2050. In particular, industries such as steel production that rely on natural gas can move closer to net zero emissions with hydrogen power. In the short term, blue hydrogen will likely remain in use as improving technology lowers the cost of green hydrogen. Eventually, the hope is that all blue hydrogen is phased out, promoting a cleaner, more sustainable energy landscape that aligns with global climate goals.
Renewable Investment Outlook
According to Bloomberg, global investment in the energy transition stands at record levels. $1.8 trillion in global investment flowed into the energy transition in 2023, which was a 17% increase from the previous year. The continuous development of all kinds of renewable infrastructure will support green energy security in the long-term. However, there are many challenges and considerations in the short to medium horizon.
For one, FDI in essential utilities such as energy creates risk and thus involves scrutiny by the EU, which seeks to balance economic benefits with national security concerns. This is particularly pertinent in greenfield investments, where foreign investors might hold substantial operational control over critical infrastructure. Such control could, in efforts to meet the EU's 2050 energy transition goals, lead to the renegotiation of infrastructure security policies to accelerate development that may risk national security. Therefore, while FDI can accelerate the energy transition targets, the EU must be alert and prudent on enacting FDI related regulations.
Moreover, while Europe was a frontier in the renewables build-out, this was under an eased economic environment, unlike what the world is presently facing. On top of rising rates, currency parity, and more, there is also the uncertainty of how the European Central Bank (ECB) will proceed with its efforts to tame inflation. Even after the peak of the energy crisis, the macroeconomic environment remained restrictive for a while, posing continued challenges for any investment endeavours. Though Europe currently maintains high interest rates, many anticipate the ECB to cut rates in the latter half of 2024.
The energy crisis also brought upon a new wave of complications to the energy investment landscape in near decades via LNG contracts. LNG suppliers such as the US require additional storage infrastructure to keep up with demand. Building out LNG infrastructure is time-consuming and costly; developers often do not see returns until several years into operations. Contractors were hesitant to start projects due to the heavy uncertainty around how LNGs will fit into the long-term energy transition puzzle. However, the industry is now seeing record influx of investment as it anticipates significant demand from two key players, Europe and China. Europe relies on LNG for achieving energy security, and China needs LNGs to transition away from coal. With more and more long term contracts locked in, LNG investments are at record levels with a 70% export capacity expected for the US by 2030. LNG appears to be locked in the global energy mix past 2050, which is past the deadline for the net zero target set in the Paris Agreement. The expansion of LNG infrastructure could crowd-out renewable investments and poses another risk for investors.
Conclusion
Europe has quite a ways to go to achieve energy security as dependence on Russia lingers. Since 2022, LNG import quantities from Russia have increased in lieu of piped gas supplies, while Russian gas also remains a sizable portion of Europe’s energy reserves. Europe is in talk to impose sanctions on Russia LNG that are expected to take effect later in 2024. Moreover, a newfound reliance on global LNG contracts subjects Europe to risks in the LNG market.
On the macro scale, there is a general trend of deglobalization and trade fragmentation that complicates investment endeavours. Pertaining to the EU, there were 750 liberalizing trade policies announced in 2023 against almost 2,900 harmful policies up to November of the year.
Through the aftermath of the crisis, renewable energy sources have become significantly more affordable. This improvement represents good progress in the energy transition, however turbulent the transition has been. The private sector's flexibility to undertake investment projects can be a crucial driver for Europe to achieve energy security and reduce reliance on unpredictable LNG markets, while also capitalizing on economic opportunities. As Europe moves forward, private and public markets will need to collaboratively navigate these challenges to ensure a stable and sustainable energy future.
