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Across Europe there is a distinct sense of déjà vu. Four years ago Russia’s invasion of Ukraine triggered an almighty surge in global oil and gas prices. It compelled leaders in Britain and the EU to implement expensive support packages to cushion the hit to their economies from their dependency on energy imports. With the war in the Middle East entering its second week, the same pressures are once again returning. Global oil prices are up more than 30 per cent and regional natural gas price benchmarks have almost doubled since the beginning of the conflict. European economies cannot afford to keep repeating the cycle.
Gas prices have, so far, not risen as dramatically as they did in 2022, and oil dipped back below $100 a barrel on Monday. Europe has also made strides in diversifying its energy mix and supply base away from Russia. Still, the longer crude shipments through the Strait of Hormuz are disrupted, the greater the economic fallout will be. Even under a relatively shortlived price shock scenario, Oxford Economics estimates that inflation in the UK and euro area will be around 0.5 percentage points higher at the end of the year owing, in part, to a continued reliance on gas imports and limited storage buffers. Investors have also increased bets on interest-rate hikes from the European Central Bank and the Bank of England.
The political pressure to provide economic support is likely to mount. Britain’s Labour government has repeatedly cited the cost of living as its “number one” concern. Prime Minister Sir Keir Starmer said on Monday that government was thinking about what it could do to limit the impact. If crude prices do continue to rise, policymakers ought to heed the lessons of the 2022 energy shock and ensure any support is calibrated. That means designing temporary measures targeted at the most vulnerable individuals and enterprises.
But the greater problem for Europe is that persistent geopolitical instability brings the risk of more frequent energy price shocks. Governments cannot be expected to provide emergency provisions every time there is a crisis. Nor do they have the capacity to do so. Many nations are still unwinding the debts accumulated from earlier cost of living measures. As it is, public finances are limited by rising demands from ageing populations and defence. And once grants or subsidies are introduced they are notoriously difficult to withdraw.
Energy shocks also have a direct financial cost. Each disruption pushes up sovereign borrowing rates as investors price in higher inflation and the possibility of new support measures. UK 10-year gilt yields, for instance, have jumped around 30 basis points since the US and Israel launched attacks on Iran on February 28. This latest shock is another reminder of the need to build adequate fiscal buffers.
The main lesson, however, is that European leaders must strengthen efforts to improve the region’s energy security. This means doubling down on plans to boost power from solar, wind, and nuclear sources, while increasing strategic shock absorbers. Investment in electricity grids, storage and cross-border interconnectors would help better manage the intermittency of renewable power. Faster permitting processes for energy infrastructure would also enable new projects to be built more quickly. In Britain, in particular, questions remain on how to reform its electricity pricing, which currently leaves it highly exposed to volatile wholesale gas prices.
Though these initiatives involve upfront costs and some disruption, they would reduce the need for reactive short-term fixes and protect nations from repeated shocks and ongoing losses in competitiveness. Without a serious expansion of domestic energy supplies, the UK and EU’s economic fortunes will remain dangerously tied to developments elsewhere.
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