The Economics Behind Europe’s Energy Rebound

• The European energy market faced a crisis due to the collapse of the energy partnership with Russia and the invasion of Ukraine.
• The unseasonably warm winter in Europe helped reduce natural gas consumption, but rising costs played a bigger role in lowering energy consumption.
• Despite the challenges, Europe managed to lower its winter gas usage by 16%, exceeding the European Union’s most optimistic targets and avoiding the worst of the crisis.

In the fall of last year, things were looking beyond grim for the European energy market. Coming on the heels of extreme energy market volatility caused by the enduring Covid-19 pandemic, Europe’s single-biggest energy trade partnership collapsed. When Russia – which was providing about 40% of the European Union’s natural gas at the time – illegally invaded Ukraine, energy markets quickly descended into chaos. 

In the immediate wake of the invasion last February, Europe strongly and vocally condemned Russia’s actions, and Russia strongly resented that condemnation. On both sides, energy was the only real trading chip. As Europe tried to engineer a pathway toward sanctions on Russian energy without risking the complete devastation of their own economy and the safety of its citizens, Russia flexed its muscle by turning off the natural gas taps at a whim. 

All signs were pointing toward mutually assured destruction. Natural gas prices were inflated tenfold ahead of what was certain to be a brutal winter with punishing energy prices and heating shortages plunging Europeans into energy poverty and dangerously cold temperatures. In a typical European winter, demand for gas increases more than two-fold. The Economist finds that for every single degree that the temperature drops, the average European consumes an additional 1.2kWH of energy per day – a 4.6% increase. Amid a deluge of press about the energy crisis heading into the cold winter months, Foreign Policy stressed that the media couldn’t even begin to cover the extent of the looming disaster, publishing an article entitled, “You Have No Idea How Bad Europe’s Energy Crisis Is.”

And then, the winter passed with barely a whisper. Europe had somehow, unbelievably, been spared. 

Europe managed to lower its winter gas usage by a whopping 16%, exceeding the European Union’s most optimistic targets and ultimately allowing the bloc to avoid the worst of the crisis. It has been widely reported – including by yours truly – that it was an unusually warm winter that saved Europe from a devastating energy crisis, and thereby simultaneously foreshortened the Russian war in Ukraine. But according to a new analysis from the Economist, that explanation is grossly oversimplified. While the unseasonably warm weather was integral to Europe’s energy rebound, that explanation alone is far from the whole story. In reality, the picture is both complex and extremely simple, coming down to some of the most basic concepts in economics.

A statistical model built by the Economist found that “temperatures alone explain only around a third of the true reduction in gas demand this winter.” Even after taking the mild weather into account, “Europeans still reduced their gas use by around 12%.” Instead, the bulk of the reduction in consumption can be explained by rising costs, which reduced demand. Simple as that. Most European gas bills were facing bills about 60% higher compared to the previous year, so they cut back on consumption. The Netherlands, the UK, and Germany saw the sharpest absolute drops in energy consumption: “gas usage per person was 24% lower in the Netherlands, 18% lower in Britain and 7% lower in Germany, compared with predicted levels.”

While the problem largely seems to have solved itself, the Economist warns that a long-term solution will still be necessary to avoid future energy crises. A bigger emphasis will have to be placed on energy efficiency – which played only a very small role in this winter’s European energy resilience – and other forms of clean and alternative energies to fall back on. “Putin’s grip on Europe may look weaker than expected,” the Economist warns, “But the continent needs long-term solutions to ease its tight energy supply.” The war isn’t over, after all, and neither is the imperative to lessen Europe’s dependence on the Kremlin and on fossil fuels in general.

By Haley Zaremba for Oilprice.com

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