Will Europe’s energy crisis be remembered as the event that catalyzed a transformation or bemoaned as a major opportunity missed? The answer, which has enormous implications for Europe’s industrial economy, will start playing out in the coming months.
Industry and government leaders feared the worst when Russia invaded Ukraine in February 2022 and subsequently cut back gas supplies to Europe. The disruption sent gas wholesale prices soaring, with increases of up to 22 times 2019 levels in Germany and more than 15 times greater in some other European countries. Many predicted rationing, rolling blackouts, and economic calamity.
Fast action by government and industry, in addition to some lucky breaks with the weather, forestalled catastrophe. Europe’s economy performed stronger than expected in 2022 (1.9% inflation-adjusted GDP growth in Germany over 2021, for example), but it would be a mistake to believe that industry will continue to simply “pull through.” The challenges to Europe’s energy system are structural, and the shift in gas supply from historically cheap Russian pipeline supplies to more costly liquid natural gas (LNG) imports highlights a major weakness. Gas is not the only issue. Europe remains dependent on single suppliers for up to 50% of key resources such as rare-earth minerals and many prefinished goods. The climate challenge of reducing some 55% of CO2 emissions by 2030 has not gone away.
The crisis remains very much present, but within it lies the opportunity for a structural change that addresses several problems: maintaining a consistent and competitive energy supply, reducing CO2 emissions, and putting Europe’s economy on a competitive footing for decades to come. To be sure, in the near term, industry needs to continue taking the requisite steps to optimize energy use and procurement and double down on general cost cutting. But these actions have their limits and do not address Europe’s structural energy issues. Industry and government also must work toward a more ambitious, comprehensive, and long-term solution: using green markets and technologies to address energy supply and carbon impact while releveling the playing field with other nations, such as the US and China.
Most new technologies carry a near-term cost burden compared with fossil fuels and feedstocks, but the more salient point is that Europe is structurally disadvantaged from a cost perspective on fossil fuels compared with its main global competitors—putting all subsidies aside—while the bloc is largely cost competitive with major regions such as North America and China in many renewables, such as wind, solar, and green hydrogen. Green energy therefore comes at similar costs in Europe as in the US and China, and it taps into a large economic growth opportunity while contributing to solving an existential global challenge.
The current energy situation is an unprecedented challenge, but Europe’s industry has weathered many storms, including the 2008 financial crisis and the COVID-19 pandemic. A green transformation can turn coming disaster into opportunity. This reality makes action a strategic imperative. Here’s our analysis of what needs to happen and how Europe can pull it off.
While the dramatic energy price increases in 2022 (including peaks of more than €300/MWh for wholesale natural gas and more than €800/MWh for electricity based on day-ahead prices) largely caught industry by surprise, many companies reacted quickly and decisively to reduce consumption and, where possible, secure alternative sources (primarily LNG). These steps and a warm winter produced high gas storage levels of 75% across the EU in February 2023, a record for that time of year, and in some countries 40 percentage points over the storage levels of the previous year. LNG volumes are expected to rise as additional terminal capacity and contracted volumes become available.
That said, about half of industrial companies were forced to cut or temporarily suspend production, especially in the building-materials sector, which was also affected by supply chain shortages, rising mortgage rates, and an overall reduction in construction activity. A third of the companies surveyed by BCG in Germany in late 2022 had started to source raw materials and prefinished goods abroad, and 18% had shifted production to countries with better cost structures.
In the wake of the storm, it would be a mistake to assume that energy prices will simply return to precrisis levels. To fill the gap left by reduced gas supplies from Russia, Europe—and especially Germany—will need to rely heavily on LNG, resulting in an increase in imports of 20% to 40% in 2025 over 2021. LNG will likely set European gas prices for the foreseeable future, meaning the landed cost will depend on Henry Hub pricing (the industry standard), plus the transport cost and margin. The scenarios we analyzed show that Germany is suffering significant competitive disadvantage against other regions, not only in the near term but also through 2030. (See Exhibit 1.)
Industry, at least in Germany, appears to be underestimating the impact. While various energy and commodity scenarios point to an uplift of 50% to 100% in natural gas prices in 2030 (to €20 to €40/MWh), roughly one-half to three-quarters of our survey respondents expect increases of only 11% to 50%. (See Exhibit 2 and “The Outlook for Natural Gas in Europe.”) Furthermore, only 36% have started to implement forward-looking measures as a response to the energy crisis.
If the scenarios are right, the resulting energy price disadvantage will fundamentally alter the competitiveness of multiple major European industries. The impact will be felt along the entire value chain, from process industries to end products, either directly or indirectly. (See Exhibit 3.)
Adding further pressure, the US is expanding its current green energy cost advantage with implementation of the law known as the Inflation Reduction Act (IRA), enacted in 2022. With a planned budget of almost $370 billion for clean-energy and green technologies—on top of the more than $110 billion in climate and energy funding included in the 2021 Infrastructure Investment and Jobs Act—the US is aggressively boosting industrial decarbonization and the formation of green markets. The IRA reduces the cost of renewable and green energies by up to 75% (for example, about 57% for onshore wind and 75% for green H2). By 2030, the improved economics will bolster US renewable deployment by four to six times today’s installed photovoltaic (solar) capacity and twice the wind capacity, accelerating the transition away from fossil fuels.
In contrast, the EU historically has emphasized demand-side incentives rather than supply-side subsidies, although recent US (and other) subsidies have triggered a reconsideration. The EU Green Deal Industrial Plan (GDIP), for example, is a package of proposals designed to accelerate decarbonization and compete for global investment. Still, all sectors in Europe face a structural loss in cost competitiveness from the significantly increased production costs (more than 10% in 2030 over 2020). The severity and implications differ depending on a variety of factors (such as energy mix and the flexibility of production and trade intensity). (See Exhibit 4.)
To assess the implications, we examined three of the most energy-intensive sectors of the German economy—chemicals, steel, and building materials—as well as the automotive sector to illustrate the effects along the value chain. Combined, the four sectors accounted for about 10% of German GDP and some 2 million jobs in 2020. We explore the details in “The Price of Inaction for Four Key Industries,” but here are the headlines:
The kind of measures that Europe has already taken can help mitigate the worst effects of the current crisis but cannot overcome the structural disadvantages relative to the US and China. Europe needs to relevel the playing field—and find new sources of competitive advantage.
The obvious opportunities lie in green markets and green technologies, where Europe already has demonstrated capabilities. (See Exhibit 5.) Given the growing number of companies with ambitious supply chain emissions-reduction targets, there is significant emerging demand for green products, including non-fossil-fuel alternatives to chemicals, steel, aluminum, and other materials. According to a recent study by BCG and the World Economic Forum, for example, as of November 2022, 1,957 companies had set certified, science-based emissions-reduction targets, and a further 2,103 had committed to set them—a substantial increase in many sectors. At the same time, scarcity is likely to be an issue for some critical green inputs. There is a notable gap between the commitment of downstream players to decarbonize their upstream value chains and the commitment of upstream players to provide the low-carbon materials needed to meet these targets.
While most European players so far have a cost disadvantage in fossil fuels and feedstocks, the same is not true for renewable ones, at least not compared with the pre-IRA US and China. For companies that want to continue competing in Europe, the green transformation has turned from a growth opportunity into a strategic necessity. Even industries with heavy export footprints, such as energy equipment or assembled goods, have an opportunity to move earlier than others to establish new rules of competition, though green markets will not fully replace traditional ones.
To win in green markets, European companies need to take a leap of faith. A nascent market for green materials exists, but instead of waiting for the market to mature, companies need to develop it themselves. They should accelerate their own net-zero transformations and broaden their efforts from lowering emissions to commercializing sustainability by developing portfolios of green products, for consumers and other businesses. The good news is that our survey indicates most companies are already prioritizing green solutions.
BCG and the World Economic Forum have set out a green go-to-market roadmap for commercializing sustainability. (See Exhibit 6.) It has six steps:
Identify the value proposition of green products. Upstream players will be able to commercialize a low-carbon offering only if it actually brings down their customers’ scope 3 emissions. Where possible, go beyond environmental dimensions (to health and usability, for example), which may increase a product’s value and compel customers to pay more.
When introducing a green product line, companies need to think about creating a green branding strategy. They should double down on emissions transparency by developing the ability to provide a product carbon footprint (PCF) for all major products. For example, BASF is working on the ability to make an auditable PCF available for all its products going forward. Steelmaker ArcelorMittal is an example of a company that has taken a portfolio approach to this challenge. It has developed a vision for a low-carbon target portfolio that balances interim products that decarbonize using physical and mass-balance approaches (such as its XCarb umbrella brand for reduced, low-, and zero-carbon steelmaking) with its long-term investments in developing truly nonfossil steel at the product level.
Europe’s policymakers at both the national and the EU levels should do everything they can to support industry’s transformation efforts. Creating green markets will require stronger transparency requirements. Accelerating demand may entail a willingness by government entities to buy green themselves—and create green markets through product standards and quotas.
The public sector also should support nonfossil transformations financially—and with as little bureaucracy as possible. Europe’s green policy schemes have traditionally been geared toward avoiding overspending. Some have been punitive instead of supportive. Many German policy schemes have been complex and underutilized. For example, only 0.4% of Germany’s relief fund for the 2021 flood disaster has been deployed.
Take another example: Germany’s Carbon Contracts for Difference (CCfD), a well-meaning initiative that supports green technologies but at a cost level that is now uncompetitive. CCfDs aim to support the transformation of energy-intensive industries as part of Germany’s goal of reaching climate neutrality by 2045. The new policy would compensate companies for the additional costs of green production processes compared with today’s more CO2-intensive ones. While the intention is commendable, unfortunately many in industry considered the draft policy, published in December 2022, to be overly complex and destined to create excessive bureaucratic burdens for both companies and the government. (See “The Price of Green Steel.”) The success of the CCfDs is now in question given the potentially low adoption rate by companies and uncertainty over the resulting cost competitiveness of German companies versus global players.
To achieve real step change, broader and simpler approaches focused on clearly defined outcomes are needed. Policymakers should concentrate on energy-intensive sectors critical to the wider economy (such as steel and chemicals) and provide them with easy-to-access (and potentially short-term) financial support. In parallel, policymakers should seek to incentivize demand for green products in downstream industries to help create green markets that are sustainable without subsidies.
Europe also can take lessons from the IRA in the US. The US policy may not be the most efficient means to create a green economy with public money, but it promises to be effective. In contrast, Europe’s policies seem very complex. The GDIP will build on the EU’s more established climate policy framework (including its emissions-trading system [ETS], Fit for 55, and REPowerEU) through regulation, finance, skills, and trade, including looser state aid rules and repurposing about €357 billion of existing funds to match US subsidies. Business leaders looking at green production investments are set to face (mostly) a positive but complicated and evolving environment that requires careful market comparisons across technologies and regions.
Winston Churchill famously admonished, “Never let a good crisis go to waste.” Europe’s situation is dire. But with war raging at its borders and imposing a historic challenge on its industrial competitiveness, European businesses and governments have an opportunity—and an obligation—to push a transformation that can secure prosperity for decades to come. They should not waste it.
Alumna
Partner and Director
Berlin
Partner
Berlin
Alumnus
Many Low-Carbon Products Will Likely Be in Short Supply Over the Next Decade, Warns New Report from World Economic Forum and Boston Consulting Group
A durable competitive advantage in four clean technologies is possible, according to a new report. To get there, US companies must follow two different paths.
