Rising energy prices are pulling climate action in two directions

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The war between the US and Iran, and the associated blockade of the Strait of Hormuz, has sent oil and gas prices soaring. The longer the conflict drags on, the greater the fear that these price increases will become more structural. The uncertainty surrounding the progress of the conflict remains exceptionally high. One moment an agreement seems within reach, and a few hours later the temperature between the negotiators drops below freezing again. It is therefore very difficult to predict how long the conflict will drag on. Meanwhile, concern about the impact of higher energy prices is growing ever further.

Calls for flexibility

The rise in fossil fuel prices is causing headaches for many parties, including large consumers of fossil fuels. These include the transport sector, mining, the steel industry, the semiconductor industry and the chemical industry. Even limited changes in energy and raw material prices have a significant impact on their overall costs and their competitiveness.

In the EU, many of these companies already face significant additional costs as a result of EU climate policy, and more specifically the EU Emissions Trading System (EU ETS). This system regulates the trading of emission allowances for industrial installations. For several years now, they are required to surrender one emission allowance for every tonne of CO2 emitted. The number of available emission allowances is gradually decreasing, which means that the amount of greenhouse gases that can be emitted annually is also decreasing. The EU ETS is thus intended to contribute to the EU’s goal of becoming climate-neutral by 2050.

Prompted by higher energy prices, a handful of EU countries (the Czech Republic, Bulgaria, Poland, Romania, Greece and Slovakia) have called on the EU to increase the number of free emission allowances allocated to industry. Not coincidentally, all of these countries are deeply reliant on heavy industrial activity for their economic growth. The EU appears open to increasing the number of free emission allowances, but on condition that the companies receiving them report on the steps they are taking to decarbonise.

There are also calls from consumers to mitigate the impact of higher energy prices. Unlike the previous energy crisis, which erupted following Russia’s invasion of Ukraine, the response of most EU governments to consumers’ grievances has so far been more targeted and limited in time. This is partly because the economic impact of the rise in energy prices is (for the time being) more limited, and partly because the budgetary hangover from previous energy measures is still fresh.

Calls for a faster transition

Whilst some are calling for a watering down of climate policy, there is also a significant group that wants to translate higher energy prices into more climate action. Among other things, they point to the strategic importance of energy independence. They see the war in the Middle East as a second reminder for the EU in just a few years’ time that fossil fuels are a thing of the past and that renewable energy is the future.

This group wants to see policymakers utilize higher oil and gas prices to strengthen the momentum for renewable energy and to encourage investments in more energy-efficient technologies. The case for renewables was already strong before the war in the Middle-East, as renewable technologies have become many times cheaper in recent years and fast improving battery performance is reducing reliability and flexibility concerns. Still, many people feel that the energy transition is going to slow. They are afraid that excessive energy support measures in reaction to the current energy crisis would dampen price signals and that the opportunity for a faster transition away from fossil fuels would be missed.                                                                                                                                                                                                                                                                                                             

The middle ground

The fact that higher energy prices are encouraging the transition to renewable energy and energy efficiency is on balance a good thing. Still, targeted interventions should not be fully dismissed. They could be advisable for security reasons, because the EU does not want to be overly dependent on fossil fuel providers, for strategic reasons, in case goods produced in the EU sometimes have a much lower carbon footprint than those produced in non-EU countries, or for economic reasons, because the consequences of an overly abrupt phase-out of heavy industrial activity would lead to an unprecedented economic downturn in certain EU countries. Finally, the impact of higher energy prices on vulnerable groups must also be closely monitored and mitigated if necessary.