Europe may not find energy efficiency sexy — but it’s crucial

The writer is a senior research fellow at the Centre for European Reform

Given how much time EU leaders devote to discussing gas price caps, you would be forgiven for thinking that they are the solution to Europe’s energy woes. Another favourite: fretting about industrial competitiveness — not only because high energy costs put Europe at a disadvantage, but also because the US is offering big subsidies to green technology sectors through the Inflation Reduction Act.

Europe’s leaders are right to try to protect consumers and keep business costs down, and they should lean into energy efficiency to deliver on both fronts. It is the least sexy of green investments, with less visibility than wind farms or new battery factories, but it is the only way to durably curb Europe’s reliance on fossil fuels.

The spike in energy prices is likely to linger for the next few years. Since attacking Ukraine in February, Russia has cut most pipeline gas supplies to Europe. Europe has responded by increasing imports of liquefied natural gas. But once Chinese economic activity picks up again, competition to attract LNG sources will be stronger, and refilling gas storage before next winter will be more difficult. Furthermore, additional investments to increase LNG supply will take time to reach the market. For these reasons, future gas prices in Europe will remain high all the way through to winter 2025-26. And Europe should under no circumstances go back to “business as usual” energy trade with Russia.

In search of a theoretically simple, politically appealing solution to high energy prices, some EU leaders have been trying to convince the European Commission to design a market “correction mechanism” to keep gas prices below a certain level. They are ignoring the fact that high gas prices indicate a real shortage of gas supplies. Effective as a price cap may sound, it would not increase gas flows to Europe — on the contrary, it might make sourcing and allocating gas more complex.

To become more energy secure, Europe needs to curb gas demand and find alternatives to Russian gas. Most of the attention since February has focused on supply, with governments striking deals with LNG-producing countries. But the crisis has also prompted cuts to the red tape that had been holding back the deployment of renewables. On the demand side, households have largely adjusted by turning down thermostats, and industry by replacing gas with coal and other energy sources and temporarily shutting down factories. But these behavioural and production changes are neither permanent nor costless, and price caps may discourage them.

Governments should be scaling up support for energy efficiency investments, ranging from retrofitting buildings to industrial decarbonisation. Any investment that can bring down energy demand while keeping output up is a no-brainer. But most of the emergency fiscal measures in the past year have focused on subsidies, through regulated prices and income support to households, as opposed to investment incentives.

Most income support measures, such as transfers and tax cuts, have been untargeted, and richer people have had their energy consumption subsidised almost as much as the poor. By insulating consumers from price increases, governments have muted the signal that high prices provide for households to invest in heat pumps and businesses to seek more energy efficient technology.

Short-term, well-designed income support is necessary for lower-income households and SMEs, to avoid them falling into energy poverty and losing competitiveness. But if it is not backed up by investment support for energy efficiency, it risks becoming an open-ended black hole in public budgets.

When it comes to encouraging investment in renewable energy, simplifying permits goes a long way. In this respect, recent EU regulation has gone in the right direction. But on energy efficiency, progress is more sluggish. For example, in the past year France spent €38bn on measures for energy price mitigation, while it plans on devoting only €2.5bn to incentives for building retrofits in 2023.

Europe needs large-scale investment to retrofit the economy and green its energy supply. These investments are the only way the EU economy can remain competitive. Investment at the EU level financed by joint borrowing would be cheapest. The Recovery and Resilience Facility that the EU set up in response to the Covid-19 pandemic goes some way in this direction, but the urgency of shifting away from Russian fossil fuels calls for more. As commission president Ursula von der Leyen said recently, REPowerEU, the EU’s plan to get off Russian gas, “needs greater firepower to accelerate the clean transition”.