Europe should address the "coal renaissance" by reforming its gas market

Coal is making a remarkable comeback in Europe. Indeed, Europe, which collectively pays so much to stay at the forefront of the clean energy revolution, is consuming ever more of the dirtiest mainstream fuel. But the way to address this problem is not merely to reform the EU Emission Trading Scheme (ETS) to push up the price of coal high enough to make gas competitive. This would be hugely expensive to energy users and hurt the European economy. Instead, policymakers should finally get serious about reforming the gas market to make gas a more competitive fuel.

Maria van der Hoeven
European coal consumption is on the rise, as is clear from the IEA's most Medium-Term Coal Market Report, published in December. Understandably many observers regret this development, but rather than simply bristle at the environmental impacts of coal displacing cleaner gas, Europeans should look at the underlying factors driving this trend and address their implications.

One reason for rising coal is that the shale-gas revolution in America is driving cheap coal abroad, where it can significantly undercut European gas, whose prices are often linked to expensive oil. That link itself is fundamentally dubious, since oil and gas are different kettles of fish when it comes to their applications. Another reason is that prices for traded carbon credits in the EU’s Emission Trading Scheme (ETS) have fallen to new lows over the past year, thanks to the global recession and a dip in both industrial output and power demand. Other factors, like a drought-driven reduction of Spanish hydro-power that ups coal demand there, or a slowing Chinese economy that puts downward pressure on global coal prices, also help.

European policymakers are now in the process of reforming the ETS – a task that we support, and which is vital to maintaining its relevance in terms of driving long-term investment into cleaner energy systems. Lowering the cap on the ETS or withdrawing some credits from the scheme could address the problem of over-supply and push the carbon price higher.

However it would be a mistake to use ETS reform as a primary means to make gas more competitive with coal. That would require drastic measures that go much further than current reform proposals. Pushing the carbon price high enough to encourage significant coal-to-gas switching would cost European consumers billions of euros in the midst of an economic crisis, only to subsidize a fuel which is currently inflated thanks to contractual particularities – and which has been subject to acute supply crises in eastern Europe over the past decade. It would also be a political non-starter.

Gas is a relatively clean-burning fossil fuel, and there is good reason why we at the International Energy Agency have hailed the potential for a Golden Age of Gas globally. The American experience is a case in point, where a booming gas industry creates jobs and can serve as a bridge to a veritable clean energy economy. And it’s true that the gas-fired power sector is suffering as a result of cheap coal. But tilting the market to favour gas washes over the underlying market drivers - and is an expensive proposition to address carbon concerns.

The reason the carbon cap has been ineffectual in raising carbon prices is because Europe is now emitting less carbon than projected when the scheme was set. Granted, that is mostly thanks to a slowdown in economic activity. But coal has breathing room in terms of carbon precisely because European emissions are down. And the recession is not the only reason – renewables in Europe have been growing at an exceptional clip this year as prices fell dramatically, particularly for solar photovoltaics and wind power. So even with rising coal consumption, emissions remain below the levels projected a few years ago.

All this being said, moving away from high-emitting fuel sources must remain a key priority for our societies. What does that mean for the current European situation? The answer must be more efficient, integrated, and functioning markets, both for energy and for carbon credits. For gas, that means reducing drastic price differentials by integrating the market on a European level, promoting more competitive and transparent gas trading, and moving toward a more integrated gas market globally. Looking a few years forward, North American natural gas exports will start to ramp up in the medium term, and some renewables are starting to reach maturity.

Finally, the greatest boost to the carbon price and to clean energy investment will be the recovery of the European economy and the restoration of confidence. Chalk up one more reason for Europe’s leaders to settle the euro-crisis now.

Maria van der Hoeven has been Executive Director of the International Energy Agency (IEA) since September 2011. Before that she was Minister of Economic Affairs in the Netherlands. EER interviewed her in March of last year, see here: See also her op-ed "Subsidy cuts show that renewable energy is coming of age", published by EER on 22 March 2012.