A whole new global energy system is emerging

IN 2022 AN energy shock caused chaos in Europe and much of the world, fuelling inflation and making a recession more likely. In 2023 the world will still be grappling with unstable oil and gas markets, but will also redouble its efforts to create an energy system that is cheaper, cleaner and more secure. The fossil-fuel era in the 20th century featured many Faustian bargains, from Franklin D. Roosevelt’s alliance with the House of Saud in 1945 to Europe’s deals with post-Soviet Russia. In 2023 most countries will strike two new pacts with the devil. In the short term they will embrace investment in polluting fossil fuels in return for security. In the long term they will adopt state-led industrial policy in an attempt to accelerate a renewables build-out.

The crunch caused by Russia’s invasion of Ukraine has been painful. By September 2022 a third of the rich-world inflation rate of 9% was attributable to energy. President Vladimir Putin’s strangling of gas supplies to Europe forced firms and consumers to cut consumption by a 10% year on year and sparked fears of deindustrialisation. Europe’s scramble to import liquified natural gas (LNG) by sea sent its global price soaring, leading to brutal cutbacks in poorer countries such as Pakistan. Crude-oil prices stayed high and OPEC showed that it remains a menace by cutting production, ignoring the pleas of President Joe Biden to pump more. Coal demand returned to its all-time-peak.

By November spot gas prices in Europe had eased owing to cutbacks by industry and warm weather. Nonetheless in 2023 global energy markets will remain febrile. By depleting its gas-storage tanks, Europe will make it through to the spring. But by then it will be clear that years of energy austerity beckon: Russia supplied 36% of Europe’s gas and even the accelerated pace of LNG imports in late 2022 offset only a third of that. If China’s economy revives in 2023 its demand for oil and gas will surge, squeezing global markets further. Momentum will build to create a better energy system.

What will this look like? After the 1973 oil shock consumption and emissions dipped and high prices triggered an investment boom in new sources of supply such as Alaska, and in alternatives such as nuclear. This time there is a shock but so far no investment surge. In 2023 capital spending by the world’s top 500 energy firms is forecast to be only 9% above pre-pandemic levels. Firms are put-off by geopolitics and the uncertainties of the green transition.

Momentum will build to create a better energy system

The liberal ideal of a global energy market—governed by a common carbon tax and hyper-efficient cross-border supply chains for solar panels and batteries—is dead. An alternative organising principle, with two energy spheres of influence, one democratic and one autocratic, is a stretch. America is ambivalent about becoming Europe’s main energy supplier, and may prefer to limit exports, keeping prices low at home for consumers and business. China indulges Russia and Iran despite Western sanctions, but is wary of depending on them.

The green transition creates a further source of uncertainty that inhibits investment. New gas projects may have their lives cut short by tighter emissions rules, unless they can be adapted for new technologies such as green hydrogen. Investment in renewables remains too low and price caps and windfall taxes on generators, introduced by many countries in 2022, are hardly incentives to ramp up spending.

Big problems, big government

Faced with this, governments will step into energy markets even more in 2023 to secure diverse supplies and boost investment. In gas, that points to more deals in which the state underwrites the risk of long-term contracts and of assets becoming “stranded”. European countries will intensify their pursuit of alliances with gas suppliers such as Algeria and Qatar. In renewables it means an embrace of state-directed (and subsidised) build-outs. This may help fast-track projects, but will also mean the boom is wrapped in industrial policy, with the aim of boosting jobs and manufacturing at home. This is already the strategy in China and India, and America’s Inflation Reduction Act involves $400bn of subsidies and “Make it in America” provisions. Europe will follow suit to keep industry on its shores.

Like all Faustian pacts the new energy deals will involve dangers that become clearer over time. The state backing of fossil-fuel deals will create a new generation of polluting assets that will have to be shut down prematurely in 5-10 years to meet emissions targets, at great expense. And the embrace of more nationalistic, protectionist philosophy will mean the $50trn global clean energy build-out over the next decade is less efficient. But those costs will only be weighed long after 2023—and the immediate energy crisis—is over.■

Patrick Foulis: Business affairs editor, The Economist

This article appeared in the Leaders section of the print edition of The World Ahead 2023 under the headline “Faustian bargains ”