Emerging from the War in Ukraine into a Secure Energy Transition

Introduction

The European Union (EU) is slowly recovering from the most severe energy crisis to date, despite signs pointing to vulnerabilities over the last 15 years. The liberalization of the EU gas and electricity markets since the 1990s effectively placed private companies in charge of energy security.^[1] In the absence of a centralized strategic vision, European companies steadily built a domestic energy system that relies on Russian natural gas and is unable to bounce back in case of disruptions. Once a geopolitical shock like the invasion of Crimea in 2014 materialized, the EU was reminded of its issues. Yet natural gas soon resumed flowing and initiatives to mitigate supply security issues were put on hold.

For a long time, supply security for critical raw materials (CRM) used in green energy technologies followed a similar path. The private sector developed and scaled wind parks, solar panels, and electric cars without much governmental involvement. The first notable EU initiative focused on CRM supply security was the EU Commission’s CRM list from 2011.^[2] It aimed to prevent undesirable dependencies on foreign actors but included no binding provisions. Until 2023, CRM supply security was inadequately addressed.

The war in Ukraine was a wake-up call for European policymakers. The electricity and natural gas crises of 2022 unraveled the scale of socioeconomic disruption that can be caused by energy insecurity. In response, the EU introduced an unprecedented number of initiatives in the field of security of supply, both in terms of conventional fuels^[3] and the “net zero industry.”^[4]

In this essay, I analyze the impact of the war in Ukraine on the EU’s approach to energy security, taking CRM as a case study. First, I make a comparative analysis of natural gas and CRM supply security approaches in the EU until 2023, showing that the dependency on Russian energy is not the only dependency the EU should be wary of. Based on this analysis, I draw lessons learned from the energy crisis in 2022 that the EU can apply to strengthen supply security in the energy transition. Finally, I argue that strategic competition in the energy transition goes beyond supply security: it also involves the race toward strategic autonomy and leadership in technological innovation. I also discuss industrial strategy as a weak component to the EU’s current approach to CRM security and strategic competition.

Energy Dependence on Russia: An Economic Affair

The dominant assumption that market liberalization maximizes efficiency has ruled the European energy system since the 1990s. The First Energy Package is a set of European directives adopted in 1996 for electricity and in 1998 for natural gas, with the purpose of privatizing state monopolies and opening the energy market up for competition.^[5] This market liberalization was completed by the Second and Third Energy Packages in 2003 and 2009, respectively. By then, the internal energy market had been established. European consumers could choose their preferred suppliers, who would compete for the best service provision and price.

With the creation of the internal energy market, the mandate to secure energy supplies was handed over from governments to companies. European companies competed in the internal market to provide the most reliable and affordable supply of natural gas and electricity. They signed long-term import contracts with players who could provide cheap supplies. Security of supply was not accounted for: no regulations were in place requiring geopolitical consideration to be built into the process or limiting the proportion of imports that can be sourced from one supplier.

Russia, one of the largest natural gas producers in the world, could supply natural gas to the EU for an affordable price through pre-existing infrastructure from Soviet times. Russian pipeline gas could be supplied at a cheaper price than, for instance, liquefied natural gas (LNG) could. Non-Russian suppliers were outcompeted. Slowly but surely, the EU import dependence on Russia increased while imports from other countries remained limited.

Time and again, economic decisions trumped geopolitical concerns in the EU’s energy system, slowly leading to the crisis of 2022. The debate surrounding the Nord Stream 2 pipeline is a clear example.^[6] The EU was torn between the economically-profitable decision to bring larger amounts of cheap natural gas primarily to Germany and Western Europe and a geopolitically-problematic choice to allow Russian state-owned Gazprom to become more dominant in Europe’s energy system.^[7] Central and Eastern European countries warned against this choice, but the economic argument again triumphed over the debate. After the invasion of Crimea in 2014, the EU established its “Energy Union” with the goal of stimulating solidarity between member states and building intra-European connections to mitigate the impact of possible interruptions in energy flows.^[8] Nonetheless, the decision to build Nord Stream 2 was upheld. In 2018, domestic production of natural gas, specifically from the Netherlands, decreased due to induced seismicity related to the extraction of gas in the Groningen area,^[9] which has led to the field’s expected closure in 2023.^[10] Despite the already high dependency on Russia at that time, Russia would become one of the main suppliers to fill the gap, together with the U.S. and Qatar.^[11]

The pandemic destabilized the European energy system and laid the groundwork for the energy crisis resulting from the war in Ukraine.^[12] In 2021, lifting lockdowns and re-opening societies after the COVID-19 pandemic led to rapid economic recovery. Global energy markets could not respond as quickly as anticipated given that prices and demand had plummeted the previous year. The gap between supply and demand led to sharp increases in the price of oil and natural gas.^[13]

While it was still recovering from the pandemic shock, the European energy system was hit when Russia invaded Ukraine on February 24, 2022.^[14] Energy security was the primary concern in the first months after the invasion given that the EU’s import dependency on Russian natural gas hit 53 percent in 2021.^[15] Russian natural gas flowed to the EU under a business-as-usual scenario in the first months after the invasion, but the threat of a possible interruption loomed over European consumers. The Kremlin weaponized energy supply by interrupting gas flowing to Germany in summer 2022 in response to EU sanctions packages.^[16] Within ten months of the invasion, the EU’s gas imports from Russia represented only 12.9 percent of the total in November 2022.^[i] The energy crisis rapidly shifted from supply security to affordability. The switch away from Russian oil was economically painful for European households, small businesses, and large industries.^[ii]

The EU aims to prevent future energy crises by strengthening the resilience of its energy system and, eventually, transitioning to green energy. Supplier diversification and legal obligations for holding strategic reserves are key measures for resilience to future disruptions. In the longer term, the energy transition brings a key opportunity to establish a secure, sustainable, and affordable energy system.^[17]

Critical Minerals and Green Tech: Repeating Past Mistakes

The energy transition decreases EU dependency on Russian imports but simultaneously increases reliance on other suppliers. Achieving the European Green Deal^[18] in 2050 is conditional on manufacturing green technologies—wind turbines, solar photovoltaics, electrolyzers, and electric cars—and sourcing sufficient minerals to build these technologies. The EU is highly dependent on imports of raw materials and components for the energy transition, primarily from China.^[19]

China is the dominant player in mineral and green tech markets and supplies a significant share of EU demand.^[20] Its position was achieved through state-led action whereby state-owned companies have for decades followed a strategic vision.^[21] The process, it should be noted, was facilitated by the ability to source cheap energy from coal, lack of transparency regarding human rights and environmental standards, massive investments abroad, and heavy subsidies for domestic industries.^[22]

Until 2023, the EU approached security of supply for minerals and green tech just as it did natural gas: it relied on the market to fulfill demand and saw minimal governmental involvement. Just as in any manufacturing industry, European businesses sourced the necessary materials for manufacturing green technologies. Given China’s intensive activity in the field of mining and refining minerals, and later manufacturing components for green technologies, Chinese companies were able to provide sufficiently-affordable supplies to European businesses.

The EU consolidated its dependency on China for raw materials and components for green technologies despite broad awareness of supply security issues. The realization that CRM are being sourced from one main supplier—China—and that this could become problematic first came in 2010. A dispute between China and Japan led to an interruption of Chinese rare earth element exports in 2010.^[23] In response, the EU conducted a Unionwide study about import dependency and the global availability of these minerals. A set of raw materials associated with high import dependency and supply risk likelihood was designated critical by the EU since 2011. This Critical Raw Materials list is now updated every three years and grew from 14 materials in 2011 to 34 in 2023.^[24]

Diversification of suppliers for CRM is costly and involves long lead times which, in the absence of a government strategy, was not pursued by private enterprises. Starting a new mine involves a preparation time of 10 to 15 years, given the need for environmental assessments, permitting, and exploration time.^[25] Private equity firms in particular tend to seek short-term returns from an investment, thus shying away from such commitments without loan guarantees from the government. Establishing a refining facility takes less time, but it often involves energy-intensive polluting processes. As such, offshoring the production of CRM was the preferred strategy for private companies until 2023.

As of 2023, the EU has designed a governmentally-led approach to supply security for CRM. The Critical Raw Materials Act (CRMA)^[26] and Net Zero Industry Act (NZIA)^[27] are meant to mitigate supply security issues and prevent a possible energy crisis like the one in 2022 from rematerializing. THE

Energy Transition in the Midst of Strategic Competition

Lessons learned from the war in Ukraine show that European energy security can no longer be primarily governed by economic principles. A geopolitical lens to establishing new energy supply chains is essential. Diversification of suppliers in any strategic sector must become the benchmark for European decision-making, despite the global move toward protectionism and strategic competition.

At the same time, strategic competition is increasingly defined by the race toward new technologies, beyond merely securing necessary supplies. Being a leader in technological innovation lays at the core of the current great power competition. The announced export controls for semiconductors from the Dutch firm ASML to China,^[28] as well as the broader push for state support of private companies in capitalist economies across the EU and the U.S., show that a strong industrial base is a key advantage in this new geopolitical game. The CRMA and NZIA are designed to strengthen supply security in light of the renewed strategic competition. In addition to these, the EU should design an industrial policy that integrates the net zero industry, with the decarbonization of existing manufacturing capabilities, to maximize strategic advantage.

Over the last decade, strategic competition between the U.S. and China became increasingly palpable and the EU’s role in this dynamic increasingly questioned. The U.S.-China rivalry permeated geopolitics and became the dominant trend in international relations. Rather than picking one side of the rivalry, Europe has chosen to carve a path of its own by pursuing strategic autonomy.^[29]

During the COVID-19 pandemic, the potential impact of a move toward protectionism in strategic sectors became clear. Governments all over the world realized the need to build resilient supply chains that can function without interruption and rapidly recover in times of crisis.^[30] The eruption of the war in Ukraine came soon after this realization, forcing the EU to engage in reactive policies to mitigate impacts, with no time to engage in preventive action.

The move toward protectionism and reshoring in strategic sectors is especially problematic for the EU given its decades-long industrial stagnation. Between the 1990s and 2010, Europe’s manufacturing power has decreased, followed by stagnation since 2010.^[31] As such, European industry did not shrink significantly in absolute terms. However, it has struggled to match the competitive advantage of Chinese and other East Asian industries. Oil refining, chemical industry, and manufacturing have been outpaced by developments in East Asia.^[32]

The reasons are twofold. On the one hand, European companies have been dealing with an uneven international playing field, competing with state-owned companies, low environmental standards, and cheap (in the case of China, coal-based) energy. On the other hand, the EU itself did not take decisive action to stop this process until the late 2010s, when it first started pushing for strategic autonomy. A weak industrial strategy, long bureaucratic and permitting processes, an uncertain business environment, and the structural push toward the energy transition made it increasingly difficult for energy intensive and manufacturing companies to operate in Europe, let alone to expand.

In the meantime, strategic competitors invested in expanding their capabilities, especially when looking at green tech and digital sectors. China has been investing in expanding its strategic advantage in manufacturing industries for years. Strategic plans like “Made in China 2025” have consolidated the path toward industrial development.^[33] Although the U.S. has suffered from a similar deindustrialization process to the EU, it nonetheless has a relatively better reputation in terms of industrial development, given its large domestic energy sector. The Inflation Reduction Act (IRA) of 2022 was seen as insurance that the U.S. government supports domestic companies not just to decarbonize but also to scale up innovation.^[34]

The EU’s push for strategic autonomy since 2017^[35] and the CRMA and NZIA of 2023 show the EU’s response to these developments. They show that the EU is actively pursuing the development of industrial capacities for strategic sectors. And while the progressive deindustrialization in conventional industries does not preclude the development of a green tech industry in Europe, it could make it more difficult to achieve this objective compared to the U.S.

The EU industrial approach is focused on a fragmentation between climate and energy policy. The goal of decarbonization is almost opposed to supporting current industry, which is seen as an obstacle to net zero. This is hurting European competitiveness. Moreover, the fragmentation between climate goals and existing industry is setting up Europe for a chaotic and painful transition from fossil fuels to renewables. Excluding current human capital and industrial power from the EU’s revamped plans seems like an inefficient approach when trying to maximize strategic advantage.

Conclusion

The war in Ukraine highlighted structural deficiencies in the EU’s approach to security of energy supply. For a long time, the market was left in charge of supplying sufficient affordable natural gas as well as critical minerals. Yet energy security is a matter of national security. Its pursuit requires a strategic long-term vision established by the government, within which private entities can operate.

The EU’s approach to energy security shifted in 2023, following the war in Ukraine and the subsequent energy shock. The Union is now trying to secure supplies in a context of strategic competition characterized by state support for strategic industries, reshoring, and protectionism.

As the race toward new technologies, including green tech and digital, is at the core of strategic competition, the EU needs a strong and integrated industrial strategy. Apart from subsidies aimed at new industries, a robust European green industrial strategy must foster the decarbonization of existing industries and acknowledge the role of existing expertise in the transformation toward a green competitive economy. For instance, the EU must set clear targets to encourage the demand for low-carbon energy products in existing industries. This can foster technological innovation, accelerate the formation of a supply base as mandated in NZIA, and position the EU as a first mover. It will be much more difficult to achieve climate goals and maintain a competitive economic system if Europe’s current industrial sector, skills, and experience are replaced rather than reformed.

[i] The supply was replaced with primarily LNG imports from the U.S., Qatar, Nigeria, and Norway. See European Council, “Where Does the EU’s Gas Come from?”

[ii] The result of Europe’s energy crisis was an inflation of commodity prices all over the world. As a cascading effect, countries all over the world faced severe energy and food insecurity. See: International Bank for Reconstruction and Development and the World Bank, Commodity Markets Outlook: The Impact of the War in Ukraine on Commodity Markets (Washington, D.C: World Bank Group, April 2022).

[1] Matteo Ciucci, “Internal Energy Market,” European Parliament, August 31, 2022, https://www. europarl.europa.eu/factsheets/en/sheet/45/internal-energy-market.

[2] “Critical Raw Materials,” European Commission, https://single-market-economy.ec.europa.eu/sectors/ raw-materials/areas-specific-interest/critical-raw-materials_en.

[3] “REPowerEU: Affordable, Secure and Sustainable Energy for Europe,” European Commission, May 18, 2022, https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal/ repowereu-affordable-secure-and-sustainable-energy-europe_en.

[4] “Net Zero Industry Act,” European Commission, March 16, 2023, https://single-market-economy. ec.europa.eu/publications/net-zero-industry-act_en; and “European Critical Raw Materials Act,” European Commission, March 16, 2023, https://single-market-economy.ec.europa.eu/publications/ european-critical-raw-materials-act_en.

[5] Ciucci, “Internal Energy Market.”

[6] Martin Russell, "The Nord Stream 2 Pipeline: Economic, Environmental and Geopolitical Issues," 2021, https://www.europarl.europa.eu/thinktank/en/document/EPRS_BRI(2021)690705.

[7] Russell; and “Polish PM Calls Nord Stream 2 ‘Weapon’ of Hybrid Warfare,” RadioFreeEurope/ RadioLiberty (RFE/RL) blog, May 28, 2018, https://www.rferl.org/a/polish-pm-calls-nord-stream2-weapon-of-hybrid-warfare/29255392.html.

[8] Kacper Szulecki et al., “Shaping the ‘Energy Union’: Between National Positions and Governance Innovation in EU Energy and Climate Policy,” Climate Policy 16, no. 5 (July 3, 2016): 548–67, https://doi.org/10.1080/14693062.2015.1135100.

[9] Jilles Van den Beukel and Lucia Van Geuns, “Groningen Gas: the Loss of a Social License to Operate,” The Hague Centre for Strategic Studies, February 2019, https://hcss.nl/report/groningen-gas-the-loss-of-a-social-license-to-operate/.

[10] Mrinmay Dey and Bart Meijer, “Netherlands Sticks to Plan to Close Groningen Gas Field by October - FT,” Reuters, January 22, 2023, https://www.reuters.com/markets/commodities/netherlands-sticks-plan-close-groningen-gas-field-by-october-ft-2023-01-22/.

[11] Irina Patrahau and Lucia van Geuns, “Gas Supply Security in the Netherlands: Geopolitical and Environmental Dilemmas,” in HCSS Geo-Economics (The Hague: The Hague Centre for Strategic Studies, March 2021), https://hcss.nl/wp-content/uploads/2021/03/Gas-Supply-Security-final-web.pdf.

[12] “Global Energy Crisis,” IEA, https://www.iea.org/topics/global-energy-crisis.

[13] James Herron et al., “Oil Prices: How the World Went From -$40 to Nearly $100 For Crude Oil,” Bloomberg, February 16, 2022, https://www.bloomberg.com/news/articles/2022-02-16/oil-prices-near-100- as-global-economy-struggles-to-balance-post-covid-crash#xj4y7vzkg.

[14] Irina Patrahau, Lucia Van Geuns, and Jilles Van den Beukel, “From the War in Ukraine to the Energy Transition: Searching for a New Balance in the Oil Market,” The Hague Centre for Strategic Studies, 2022, https://hcss.nl/report/searching-for-new-balance-in-the-oil-market/.

[15] “Where Does the EU’s Gas Come from?” European Council, February 7, 2023, https://www.consilium.europa.eu/en/infographics/eu-gas-supply/.

[16] Chris Giles, “Russia’s Energy Weapon Fails to Fire as Required,” Financial Times, January 16, 2023, World Economic Forum, https://www.ft.com/content/ea48a356-9e8d-4dfe-b3f1-10ee5b7fd9a4.

[17] European Commission, “REPowerEU.”

[18] “A European Green Deal,” European Commission, https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal_en.

[19] “European Critical Raw Materials Act.”

[20] “European Critical Raw Materials Act.”

[21] Irina Patrahau et al., “Securing Critical Materials for Critical Sectors: Policy Options for the Netherlands and the European Union,” in HCSS Geo-Economics (The Hague: The Hague Center for Strategic Studies, 2020).

[22] Yuzhou Shen, Ruthann Moomy, and Roderick G. Eggert, “China’s Public Policies toward Rare Earths, 1975–2018,” Mineral Economics 33, no. 1–2 (July 2020): 127–51, https://doi.org/10.1007/s13563-019- 00214-2; Frank Pothen and Kilian Fink, “A Political Economy of China’s Export Restrictions on Rare Earth Elements,” SSRN Electronic Journal, 2015, https://doi.org/10.2139/ssrn.2619123; and Patrahau et al., “Securing Critical Materials for Critical Sectors: Policy Options for the Netherlands and the European Union.”

[23] Keith Bradsher, “Amid Tension, China Blocks Vital Exports to Japan,” The New York Times, September 23, 2010, https://www.nytimes.com/2010/09/23/business/global/23rare.html; and S. Bobba et al., “Critical Raw Materials for Strategic Technologies and Sectors in the EU: A Foresight Study,” JRC and European Commission, 2020).

[24] “Critical Raw Materials.”

[25] Ekaterina Bouckley, “Could Constrained Metals Supply Delayenergy Transition?” SP Global, March 27, 2023, https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/metals/032723- could-constrained-metals-supply-delay-energy-transition.

[26] “European Critical Raw Materials Act.”

[27] “Net Zero Industry Act.”

[28] Pieter Haeck, “The Netherlands to Block Export of Advanced Chips Printers to China,” Politico, March 8, 2023, https://www.politico.eu/article/netherlands-impose-restrictions-chips-export-to-chinaasml/.

[29] Mario Damen, “EU Strategic Autonomy 2013-2023: From Concept to Capacity,” European Parliamentary Research Service, July 2022, https://www.europarl.europa.eu/RegData/etudes/ BRIE/2022/733589/EPRS_BRI(2022)733589_EN.pdf.

[30] Damen, “EU Strategic Autonomy 2013-2023.”

[31] David Born, Peter Vogt, and Steffen Geering, “De-Industrialization in Europe?” Roland Berger, 2022, https://www.rolandberger.com/publications/publication_pdf/roland_berger_de_industrialization_ in_europe.pdf.

[32] Born, Vogt, and Geering; and Irina Patrahau et al., “European Tank Storage in Global Supply Chains: Outlook to 2030,” The Hague Centre for Strategic Studies, 2022, https://hcss.nl/report/european-tankstorage-in-global-supply-chains-outlook-to-2030/.

[33] “Made in China 2025,” The State Council, The People’s Republic of China, https://english.www.gov.cn/2016special/madeinchina2025/.

[34] “Inflation Reduction Act Guidebook | Clean Energy,” The White House, https://www.whitehouse. gov/cleanenergy/inflation-reduction-act-guidebook/.

[35] Damen, “EU Strategic Autonomy 2013-2023.”