Insights & Analysis

February 2, 2022

Energy security and transition: Three lessons from the EU for Alberta and Canadian climate policy

The European Union (EU) has long been seen as a world leader in climate action. It has established ambitious targets to reduce greenhouse gas emissions (GHGs) and, unlike some others, has already made considerable progress towards meeting those targets.

However, two parallel developments are causing turmoil in continental energy markets and igniting controversy about how best to approach climate action, energy transition, security, and affordability.

In this analysis, we explore those developments and discuss the potential lessons they offer to Alberta and Canada as we plot a course towards a low-emissions future.  

The EU’s twofold challenge

The Energy Crisis

The EU has been in the throes of an energy crisis since last fall. Electricity and natural gas prices have soared since September. Households are facing enormous increases in energy and home heating costs. And energy-intensive businesses are cutting output and closing facilities. Although current prices have fallen back from their highs, they are still far above historic norms, and the problem is expected to persist. According to The Economist, the average European household faces electricity and gas bills of about US$2,100 in 2022, up from about US$1,360 in 2020.

How this all happened is, as with most crises, the result of the confluence of several events and policy actions. The Canadian Global Affairs Institute provides an excellent, detailed account of these factors but an abbreviated version goes something like this:

To start somewhere, about 10% of Europe’s electricity comes from wind turbines (twice that in countries like the UK and Germany) and, for whatever reason, the wind didn’t blow much last year. In the third quarter of 2021, Europe’s largest wind producers harnessed just 14% of installed capacity compared to an historic average of about 20-26%.

At the same time, Europe’s capacity to generate electricity through coal and nuclear power have dwindled over the years, largely because of policy interventions, including the planned phase-out of coal by 2030.

All this placed pressure on natural gas-fired production to fill the gap. But European gas prices have soared recently, because of a combination of dwindling local reserves, lower domestic (and global) production, competing demand from Asia for liquefied natural gas (LNG), and dependence on Russian gas imports which have not risen to meet European demand.

While this only scratches the surface of the full, detailed explanation, the short version is that Europe has aggressively eliminated fossil fuel baseload electricity capacity, undercut its own natural gas production and grown dependent on imports to manage the intermittency of its renewable electricity supply.

While prices have retreated since last fall, the crisis isn’t expected to go away any time soon. For one thing, four of France’s nuclear power plants have recently been shut down because safety checks revealed structural problems. In total, about 20% of France’s nuclear power capacity is offline (including six other reactors out of service for other reasons). Repairing the problems could take months, removing a significant share of baseload power from the European grid. More importantly, the looming threat of conflict between Russia and Ukraine threatens to drive gas prices higher once again. The US wants to impose sanctions against Russia, but that places a heavy risk on European countries (Russia accounts for about one-third of Europe’s natural gas supply) in the middle of the winter when domestic supplies are already dangerously low.

Changing guidance on sustainable financing taxonomy

While all this was unfolding, the European Commission—the bureaucratic arm of the EU—quietly released a draft revised sustainable finance taxonomy on New Year’s Eve. The taxonomy, in effect, defines the kinds of investments considered to be sustainable as the EU moves towards meeting its climate targets. Its goal is to provide clarity to investors and direct investments to those sustainable projects and activities.

The draft taxonomy stated for the first time that “there is a role for natural gas and nuclear as a means to facilitate the transition towards a predominantly renewable-based future.” In other words, natural gas and nuclear could be considered sustainable investments.

In the case of natural gas, the draft taxonomy states that gas can be used as a “transitional fuel” and that new investments in natural gas-fired electricity generation could be considered sustainable provided that:  

  • Power plants produce emissions below 270g of CO2 equivalent per kilowatt-hour;
  • They replace a more polluting fossil fuel plant;
  • They receive their construction permits before the end of 2030; and
  • They are able to transition to burning lower-carbon gasses (like hydrogen) by 2035;

In the case of nuclear power, new plants would be labelled as “green” only under the condition that they have a plan, funds, and a site to safely dispose of radioactive waste.

These developments ignited controversy in the policy and investment communities and have divided EU members. Some see the proposed taxonomy as a necessary transitional step to meeting the EU’s climate targets and to shield against the affordability, intermittency and reliability issues the region is currently experiencing; in other words, the perfect should not be the enemy of the good. Others, however, worry that allowing more natural gas development will forestall the energy transition by extending a lifeline to GHG-emitting sources of electricity, locking in the infrastructure, and delaying the move to a renewables-based grid.  

On the ground, high energy prices have ignited protests and raised concerns about the impact on Europe’s poor. It is estimated that more than 35 million Europeans can’t afford to heat their homes. In the face of energy poverty, high electricity and home heating prices risk eroding popular support for taking action on climate.

In response, EU governments are implementing stopgap measures aimed at controlling the symptoms of the problem—emergency income supports, tax reductions and, in the case of France, mandating that its largest electricity provider cap growth in its prices.

Three Lessons for Alberta and Canada

Energy security matters

At first glance, there is little to compare Alberta and Canada with the EU when it comes to energy security: Canada is a large net exporter of natural gas, crude oil, and electricity. We have abundant supplies of all three; and, mercifully, we are not beholden to a potentially hostile foreign power for that energy.

That said, the EU was once in a much stronger position than it is today and its wounds when it comes to energy supply are, to a degree, self-inflicted. Natural gas consumption in the bloc has declined by about 11% since 2004, but production has fallen by 58%. As a result, its net imports of natural gas have risen from about 28% of its domestic consumption in 2004 to a full two-thirds. Combined with policies to phase out nuclear power in countries like Germany, the region has systematically undercut its own energy security and is now overly reliant on Russia for heat and power.

While Canada should never have the problem of relying on Russia for its energy, the EU experience should remind us of the importance of maintaining our own energy security in future, including baseload electricity and fuels. Over-reliance on foreign energy imports erodes our sovereignty and autonomy as a country.

The intermittency of renewables is a challenge

Renewable energy is a critical component of a low-carbon future for Alberta and all of Canada. We need more investment in these resources, especially here in Alberta where we have natural advantages with wind, sunshine, and our deregulated electricity market.

However, the EU experience is a reminder that the intermittency of renewables is a challenge for which we do not yet have a solution. Until such time as the storage problem is solved economically and at scale, we will need baseload and peakload power for when the wind doesn’t blow, the sun doesn’t shine, and energy demand spikes. And two of those three things tend to happen when it’s really, really cold.

Some argue that adding even more renewable capacity will help smooth out this intermittency problem, but the opposite is more likely to happen. There’s a reason Alberta’s wind farms are concentrated in the Pincher Creek area: it’s windy there. Adding new capacity is more likely to magnify the peaks and troughs of renewable energy production than it is to smooth them out. This will lead to greater price volatility in electricity markets and place added pressure on baseload power generation which, by 2023 in Alberta, will be almost exclusively natural gas.

High prices undermine decarbonization efforts

An unspoken truth about much policy formation is that people will support all kinds of initiatives they think someone else will pay for. Decarbonization is no exception. There’s a reason consumers get a rebate on the carbon tax. And there’s also a reason Canadians will line up around the block to save 10 cents on a litre of gas. A 2021 Ipsos poll found that 73% of Canadians would spend no more than $100 a year to tackle climate change, and 52% would not be willing to spend a penny.

To the extent that high or volatile energy prices are associated with a low-carbon transition, they threaten the success of that transition. People support net zero, but they don’t support their energy bills doubling. In the EU, countries are stepping in with a patchwork of grants and tax cuts to help households with soaring energy prices. France is forcing the largest nuclear power company in the world to cap price increases in order to protect consumers. But these are only stopgap measures.

Some suggest that since natural gas prices are driving this problem in the EU, the solution must be to accelerate the shift away from expensive gas to cheaper renewables. Indeed, it’s well-documented that utility-scale renewable energy prices are lower than they are for coal, gas or nuclear. But if this is true, and renewable energy production in the EU is rising while gas, coal and nuclear generation is falling, why have overall electricity prices increased so much?

There is no single answer to that question. One factor is that the intermittency problem adds costs because of the need to frequently ramp up and down baseload power generation. Another is that suppliers are hedging their exposure to price volatility, driving overall prices higher. Another still is that prices tend to be set by whichever plant was needed to deliver the last megawatt of demand—and that’s usually a fossil fuel producer. And finally, there’s the problem of transmission. The high variability of renewables and their low average capacity utilization mean that extra transmission capacity is needed to handle the fluctuations. That added buildout will also increase costs, even though generating the electricity itself may be significantly cheaper.

Regardless of the reason, the European experience tells us that Canadian policy needs to be thoughtful and ensure that electricity prices do not increase significantly during an energy transition. If they do, it could undermine public support for critically necessary emissions reduction.

Conclusion

The federal government has committed Canada to reducing its emissions by 40-45% below 2005 levels by 2030 and achieving net zero by 2050. Accomplishing these goals is no easy task. It will require action far swifter and capital outlays an order of magnitude higher than anything we have seen to date.

The lesson from the EU is that while climate goals are important, we need to implement thoughtful policies that avoid—or at least minimize—unintended consequences. Energy security, affordability and reliability cannot be forgotten on the road to net zero.



Mike Holden, VP of Policy & Chief Economist

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