Recent gas and power price spikes are exposing an increasingly vulnerable European energy system. Ongoing coal and nuclear closures and a tightening carbon market are leading Europe to become increasingly reliant on natural gas, of which about 60% comes from imports—raising concerns about overall system fragility. If Europe had experienced similar gas market tightness a few years ago, gas demand would have been curtailed by the utility sector (accounting for 34% of EU gas demand) as higher gas prices would have incentivized higher-carbon-intensive alternative fuels for power generation. This hasn’t occurred in current circumstances, partly because of a tightening European carbon market. Today, when natural gas prices outperform coal (by rising more or falling less), that incentivizes coal generation—given the higher carbon content in coal, demand for carbon allowances rises, causing carbon prices to go up until fuel switching no longer occurs, and generation of power through natural gas again becomes preferable. This means that, in a tight gas market, prices could theoretically rise until demand is curtailed elsewhere in the economy—e.g., in energy-intensive industries like fertilizer, glassmaking or steel production, with potential ripple effects across the economy. On that basis, it is becoming ever-more difficult for Europe to reconcile its increasing reliance on gas imports with tightening environmental restrictions.
Of course, no one wants to go back to the old carbon-intensive energy system. Europe’s solution to a lack of self-sustainability is to accelerate the deployment of renewables, which are largely recognized as deflationary to energy bills while reducing reliance on gas and limiting carbon emissions. We expect renewables deployment to accelerate by a factor of three or four over the next decade versus the last. Still, despite an ambitious renewables agenda, significant investments in other sources of baseload capacity are needed. The first step could be for Europe to recognize nuclear as a viable zero-carbon alternative in the EU taxonomy framework. Another could be to recognize natural gas as a transition fuel to incentivize sufficient investments and limit exposure to geopolitical issues and global supply-demand dynamics, while bridging the gap between legacy energy systems and tomorrow’s zero-carbon solutions.
In our view, these big-picture trends offer sustainable long-term investment opportunities in companies helping build a robust zero-carbon energy system—and represent multidecade opportunity to capitalize on an accelerated energy transition pathway. The big winners from today’s energy market volatility are nuclear operators, renewables developers and companies investing in energy system resilience.