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European energy policy is far better than it is given credit for

European power prices have soared on a combination of Russian gas flows being curtailed, and an extremely hot and dry summer. This has led to many criticising European energy policy, particularly the closure of nuclear power plants. I think this view is broadly wrong, and European energy policy has been very sensible. The first thing to remember is that Europe has been far more aggressive in the installation of renewable power than North America.

Germany in particular had been adding renewable power aggressively. But the problem that Germany has been realising in recent years is that renewable power can cause chronic “OVERSUPPLY”, particularly on windy weekends. It has common for market commentators to show how much German baseload power prices have risen in the last year. However, if they just move the start date back a few years, another curious feature appears. German baseload power prices negatively on occasion.

If the future will likely see more renewable energy being produced (a decent assumption), then you want your energy supply to be more flexible, not less flexible. That is you do not want your baseload to made up of an energy source that cannot be adjusted to price signals. Nuclear energy is just that type of energy, and has a long history of not only bankrupting its owners, but also requiring heavy government subsidies. This is exactly the sort of energy that Europe (and the US) has been phasing out.

So far so sensible. The issue that is most important now is the reliance that parts of Europe had on Russian gas. Total Europe imports of Russian gas has been in decline since 2008, while Europe imports of LNG has been a rising trend. This again points to sensible policy. And it should be remembered that Russia had been a reliable supplier to Europe throughout the Cold War.

Increased European use of LNG is a very logical policy, as leading LNG exporters such as the US and Australia are political and military allies of Europe.

The spike in energy prices this year should provide the financial incentives for Germany to grow its renewable energy capacity. The negative pricing of base power a few years ago, lead Germany to slow wind and solar investment. I see that policy being reversed and German renewable power generation rising again.

Putting it all together, the long-term effect of Russian cutting gas flows to Europe will be the acceleration of existing trends, with Europe building out more renewable energy, and importing more LNG. European energy policy just needs to keep calm and carry on.

Capital Flows and Asset Markets
Russell Clark