Divestment from Russia

"The only thing you have to lose is your chains"

The impact of the Ukrainian war on EU energy markets has been extraordinary. There have been many excellent proposals to help EU countries radically reduce their dependence on Russian fossil fuels by next winter. But these plans lack the evidence to help countries reconcile short-term energy security priorities with long-term climate change laws.

This post presents a new analysis making the case for an immediate switch from fossil-to-clean energy. This analysis finds that while EU countries divest from Russian fossil fuels over the next 12 months, including the expectation of increased domestic production, there are strong economic incentives to accelerate the switch from fossil-to-clean energy sources at the same time.

Energy market chaos

Energy markets have become increasingly chaotic since Russia’s unprovoked attack on Ukraine. Russia is considered a pariah state as governments and corporations find its actions unacceptable. Sanctions are crippling the Russian economy; the rouble has collapsed, bond default risk has spiked and the Moscow stock exchange has closed. As these sanctions extend to energy, uncertainty is creating extreme price volatility. EU gas and coal prices have increased to record highs of $166/MWh and $448/ton, respectively. Even EU carbon has taken a hit, declining over 30% in two trading sessions, as funds managing Russian credit may have been forced to liquidate.

An over-reliance on Russia

Being the world’s largest exporter of gas, the second largest exporter of oil and the third largest exporter of coal, Russia plays an oversized role in global energy markets. Thus, sanctions on Russian fossil fuel exports are likely to cause considerable disruptions to global energy flows. These sanctions are expected to hit the EU the hardest.

Russia currently has a vice-like grip over the Bloc’s energy demand, supplying 40% of the EU’s gas and 45% of coal imports in 2021. The Member State with the greatest exposure to Russia is Germany, which imported 65% of its gas and 46% of its coal from Russia in 2020. This reality perhaps explains why Germany initially blocked tough sanctions in fear of retaliation.

IEA’s 10-point plan

A number of organisations have produced research outlining how the EU can immediately reduce its dependence on Russian coal and gas. The IEA, for example, recently published a comprehensive 10-point plan to reduce the EU’s reliance on Russian gas. According to the IEA, these efforts could reduce the EU’s consumption of Russian gas by one third in one year. This plan recommends:

1. No new gas supply contracts with Russia.
2. Replace Russian supplies with gas from alternative sources.
3. Introduce minimum gas storage obligations to enhance market resilience.
4. Accelerate the deployment of new wind and solar projects.
5. Maximise generation from existing dispatchable low-emissions sources: bioenergy and nuclear.
6. Enact short-term measures to shelter vulnerable electricity consumers from high prices.
7. Speed up the replacement of gas boilers with heat pumps.
8. Accelerate energy efficiency improvements in buildings and industry.
9. Encourage a temporary thermostat adjustment by consumers.
10. Step up efforts to diversify and decarbonise sources of power system flexibility.

These steps seem consistent with the IEA’s net-zero emissions (NZE) scenario. According to the IEA’s NZE scenario, the carbon intensity of electricity grids in advanced economies, such as the EU, should be net-zero by 2035. This constraint implies that unabated (i.e. CCS unequipped) coal and fossil gas generation should be phased out. As detailed below, this is currently inconsistent with the impact assessment scenarios of the EU Green Deal, which see unabated gas in the electricity mix post-2035.

Carbonomics: fossil-to-clean switching metrics

Several proposals to reduce the EU’s dependence on Russian fossil fuels lack the evidence to help EU countries reconcile short-term energy security priorities with long-term climate change laws. Our analysis suggests that the EU has a strong economic incentive to pursue a twin strategy of weaning itself off Russian coal and gas as soon as possible while ramping up the deployment of zero carbon alternatives.

Coal-to-clean electricity switch price

Fuel switch costs in electricity have historically been analysed through coal and fossil gas generation prices. Fossil gas has a lower carbon intensity than coal, so if the carbon price gets high enough it becomes more economic to burn gas than coal. This level is termed the fuel switch price. We have taken fuel switch analysis a step further, by calculating the fuel switch cost required to leapfrog fossil gas and transition directly to dispatchable renewables. The coal-to-clean fuel switch cost captures the difference in cost associated with operating existing coal and new onshore wind or solar PV plus battery storage.

Due to the declining cost of renewable energy and battery storage coupled with the increasing price volatility of gas, we found it is now cheaper to switch from coal-to-clean than coal-to-gas. Based on new TransitionZero analysis, the average carbon price required to switch from existing coal to existing gas in 2022 is currently €191/tCO2, while the average carbon price to switch from existing coal to new solar or wind plus battery storage over the same period is €15/tCO2. The EU’s prevailing carbon price is around €70/tCO2, meaning there is a strong economic incentive to switch from coal-to-clean, rather than coal-to-gas.

Grey-to-green hydrogen switch price

The use of green hydrogen is considered an important abatement option to replace gas and coal in several heavy industry sub-sectors. Grey hydrogen, via a steam methane reformer and fossil gas, has long been considered the cheapest form of hydrogen. Based on analysis from the IEA, the capital cost of grey hydrogen is $0.34/kg and operating costs are $0.17/kg plus the cost of fossil gas. Green hydrogen, via alkaline, proton exchange membrane or solid oxide electrolysis from renewable energy, on the other hand, is relatively expensive. The total cost of green hydrogen in the EU is estimated to be €4.5-6.0/kg. Due to the production process for grey hydrogen being carbon-intensive, the higher costs of green hydrogen can be offset by a carbon price.

Assuming high gas prices in the EU for the foreseeable future, our new analysis finds green hydrogen is the cheapest form of hydrogen. Based on a green hydrogen cost of €4.5/kg, the average carbon price in 2022 to incentivise a switch from grey-to-green hydrogen is €37/tCO2, which is below the prevailing EU carbon price. The EU Commission is targeting a production cost for green hydrogen by 2030 of €2/kg, meaning even if fossil gas prices decline these declines could be partially offset by cost deflation in green hydrogen.

German leadership needed

Germany is the EU’s superpower and therefore needs to lead the phase-out of Russian coal and gas. The closure of its nuclear plants has resulted in increased reliance on Russian gas, which has proven a poor strategy to manage the energy trilemma to balance security, affordability, and sustainability. The good news is that Germany is showing a willingness to change tack. A leaked draft shows Germany is considering an accelerated target for reaching 100% renewable electricity by 2035 and a delay to the closure of its nuclear plants.

It is unclear whether the 100% by 2035 is based on supply or demand, with the former being more technically challenging than the latter. 100% renewable supply means replacing all legacy gas capacity by 2035, as well as nuclear, coal and lignite. Whereas, meeting 100% of demand with renewables implies legacy gas capacity remains online. Nonetheless, this leadership should encourage other dependent Member States, such as Italy, to make similar reforms.

To reach the new target, between now and 2035 Germany will need to increase its solar PV capacity around fourfold, double its onshore wind capacity and more than triple its offshore wind capacity. This would be an extraordinary transformation. All eyes will now be on Germany, as if they pull this off, it could offer a valuable blueprint to other countries.

Unchained

The Russian invasion of Ukraine is a dangerous humanitarian crisis. This invasion goes against fundamental values of human wellbeing, safety and dignity. TransitionZero staff hope there will be a peaceful end to this conflict as soon as possible. Looking ahead, fuel price shocks, from shutting Russia out of the global economy, will reverberate in energy and financial markets for some time. As the recent IPCC report has shown, the world is already suffering from climate impacts and every fraction of a degree matters to limit the most destructive effects. Our analysis shows the EU has nothing to lose and everything to gain from dovetailing short-term energy security imperatives with long-term climate priorities.