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Arguably one of the most important events of 2024, which received relatively little media coverage, was the release of Mario Draghi’s report, titled The Future of European Competitiveness. This was commissioned by Ursula von der Leyen, the President of the European Commission and presented in September, last year. In the report, Draghi warns that Europe faces declining productivity and growth when compared to the United States (US) and China. He urges drastic action to reverse this trend and argues that Europe must double its post-World War II rebuilding investment levels, requiring an extra €800 billion a year, to stimulate the continent’s economies. The comprehensive report outlined several key areas for reform, which include energy policy, critical raw materials, digitalisation and advanced technologies, semiconductors, energy-intensive industry, defence, and clean technologies, among others.
We think energy policy is something which investors don’t pay enough attention to, and it is not a coincidence that it was the first policy chapter addressed in the Draghi report. This article delves into how it has impacted on Europe’s competitiveness, with Germany being used as a case study given its stature as the largest European economy.
Introduction
Germany is undergoing a significant energy transition, termed Energiewende. This plan aims to achieve climate neutrality by 2045. The approach has many parts, such as the elimination of fossil fuels, increasing renewable energy sources and focusing on energy efficiency. While the plan has helped add more renewable energy sources, it has also faced criticism for its high costs and mixed environmental results.
Electricity prices in Germany are among the highest in Europe, which heavily affects businesses and consumers. This has created difficulties for the country’s manufacturing competitiveness, causing some companies to move production to countries with lower energy costs. German consumers are also increasingly unhappy, given the high energy costs, which has resulted in local pushback against new wind turbine projects. These changes in government policies highlight the struggle to balance environmental goals with economic stability and reliable energy supplies.
In terms of technology and infrastructure, the intermittent nature of wind and solar power has required support from fossil-fuel power plants, which reduces the environmental gains of renewable energy sources. The national electricity grid has also struggled to keep up, having difficulty integrating a higher share of renewable energy production and causing more inefficiencies. Moreover, a quick departure from nuclear energy after the Fukushima event in 2011 unintentionally increased reliance on coal—especially lignite, which is extremely polluting—and natural gas from Russia. These issues have weakened Germany’s efforts to significantly lower carbon dioxide emissions. In addition, geopolitical problems, like the conflict in Ukraine, have made Germany’s energy security even more precarious.
Reasons for the differences in European and US economic competitiveness
There are many well-known reasons for the differences in economic competitiveness between Europe and the US, which can be summarised as follows:
- The United States benefits from a large, diverse market that drives innovation and economies of scale, coupled with relatively flexible regulations and tax policies favouring business growth
- High levels of investment in research and development propel technological advancement
- Robust financial markets and an active venture capital ecosystem facilitate capital access
- Renowned universities and a culture valuing entrepreneurship sustain innovation
- The US dollar’s reserve-currency status and strong geopolitical influence bolster global trade competitiveness
In addition to these factors, the absolute scale of the US’s energy advantage is often underappreciated and is a crucial enabler of cost stability, energy security and manufacturing competitiveness. The US was the top oil producer which includes total oil liquids, including crude, condensates and natural gas liquids (NGLs) globally in 2023, accounting for 22% of world production as per Figure 1.
Figure 1: Top 10 oil-producing countries in 2023 (EIA, 2023)
The shale revolution in the United States significantly boosted natural gas production by enabling the extraction of previously inaccessible reserves through advanced techniques like hydraulic fracturing and horizontal drilling. This transformation turned the US into a leading global producer of natural gas, ensuring energy independence and creating surplus for export as per Figure 2.
Figure 2: Gas production by country/region
The US’s abundance of hydrocarbons (the chief components of oil and natural gas) also provides it with a significant cost advantage when compared to Europe and Asia. US natural gas is currently trading at $3.6/MMBtu (one million British thermal units) versus $14/MMBtu in Europe and Asia as per Figure 3.
Figure 3: Comparative differences between US and Europe, Asia gas prices (Enterprise Product Partners, August 2024)
A shift in Germany’s energy mix
Germany’s energy mix has changed dramatically over the past decade with an increasing focus on renewable energy and wind, and the complete phase-out of nuclear energy in 2023. As evidenced in Figure 4, thermal power (coal, gas, oil) generation capacity has been maintained, in order to ensure crucial redundancy – to guarantee reliable supply during disruptions – with the development of new renewables.
Figure 4: Germany’s changing electricity mix (Fraunhofer Institute, ERCOT)
Concerningly, Germany’s energy production, which is a useful proxy for economic health, fell in 2023 and 2024, as is shown in Figure 5, and is lower than any year since reunification. Even as Germany plans to electrify its economy, it’s making and using less electricity, not more.
Figure 5: Germany’s total energy production between 2002 and 2024 (Energy-charts.info)
Germany’s high cost of energy
One of the significant challenges associated with Germany’s energy transition is the high cost of energy. In the first half of 2024, Germany had the highest electricity prices for household consumers in the EU, at 37% above the EU average. Figure 6 clearly shows how much higher Germany’s average spot electricity prices are when compared to its Western Europe counterparts over the last five-year period as well as the growing divergence between electricity prices which is impacting the country’s industrial competitiveness.
Figure 6: Average wholesale spot electricity prices for EU in 2019 and 2024 (Energy-charts.info)
Several factors are contributing to Germany’s high energy costs:
- Taxes and levies: Germany imposes high taxes and levies on electricity, which significantly increase the final price for consumers
- Renewable energy support: Subsidies for renewable energy, while crucial for driving the transition, have also contributed to higher electricity prices
- Grid expansion and modernisation: The expansion and modernisation of the electricity grid to accommodate the increasing share of renewable energy sources require substantial investments, which are ultimately reflected in electricity prices
- Phasing out nuclear power: The decision to phase out nuclear power has led to increased reliance on fossil fuels, particularly natural gas, which can be subject to price volatility in the global market.
Understanding the european electricty market
In the European electricity market, prices are mostly established via a day-ahead auction system grounded in marginal cost principles. Here, electricity producers present bids indicating how much power they can supply and at what price for the next day, allowing suppliers and consumers to plan. Producers are sorted based on their production costs, with renewable sources like wind and solar usually being the least expensive, given lower operating costs. The system uses a merit order to decide which power plants will generate electricity, starting with the cheapest sources to fulfil demand.
The Draghi report points out a key issue with the merit order system concerning gas prices and their effects on electricity prices in Europe. The report states that even though gas makes up only about 20% of electricity generation on average across the EU, it determines the marginal price for electricity 63% of the time, meaning that electricity prices are often influenced by the cost of the most expensive fuel necessary to satisfy demand at a specific moment. This system creates a strong link between gas and electricity prices, regardless of actual gas consumption, while also adding an element of uncertainty in pricing.
A weather-dependent electricity system
Given the high correlation of gas to electricity prices, due to the merit order system and Europe’s lack of energy self-sufficiency, gas storage levels become a key driver of short-term electricity pricing. From October 2024 to the end of December 2024, gas withdrawals from underground European depots amounted to over 250 terawatt hours (TWh), the second largest ever for the period, and well above the 10-year average of 165 TWh, see Figure 7.
Figure 7: European gas inventory drawdown (Bloomberg, Gas Infrastructure Europe)
The reason being that for two consecutive winters, Europe enjoyed unusually warm, wet, and windy winters — ideal for both curtailing heating demand and generating wind-generated electricity, reducing the call on gas-fired power stations. This luck in the weather protected the region when it was most needed – at the height of the energy crisis. But the 2024-25 winter has turned cold, calm and dry, boosting gas demand.
In December 2024, Germany faced an energy crisis due to a weather phenomenon called Dunkelflaute, which involves cloudy and windless weather, which negatively impacts the production of renewable electricity. As a result, wholesale electricity prices increased significantly this winter, reaching almost €1 000 per megawatt-hour (MWh), the highest level seen in 18 years, as shown in Figure 8 below. Countries like Norway and Sweden were aggrieved because the rise in Germany’s energy demand also pushed up prices in their countries. This crisis has sparked talks about changing energy relations across Europe and raised concern about Germany’s energy transition strategy. This strategy depends on renewable sources but faces challenges during times when generation capacity is low.
Figure 8: Day ahead prices for some European counties on December 12th, 2024 (Epexspot)
The economic impact of Germany’s energy transition
Germany stands out as the laggard for economic performance among the G7 countries over the last five-year period (Figure 9 (a)). A key driver of this underperformance is industrial production which has tumbled, especially in energy-intensive sectors Figure 9 (b).
(a) GDP for G7 countries 2019-2024 (b) German industrial production
Figure 9: GDP estimate for G7 countries and German industrial production
A number of companies operating in energy-intensive sectors have announced plant closures over the last couple of years citing high energy costs, including vehicle manufacturer Volkswagen, chemical manufacturer BASF, and industrial conglomerate ThyssenKrupp. In addition, low growth in China and Europe has hurt Germany’s exports, and, as such, prospects for a quick fix for Germany look limited.
No other industry exemplifies the significant impact on European industrial production more so than auto manufacturing. While Europe, the US, and Japan have all been market share donors to China, Europe stands out, see figure 10. In a 2023 report titled “A road map for Europe’s automotive industry”, McKinsey cites some of the specific reasons, which include the changing landscape from internal combustion engines to electric vehicles but also rising energy costs, inflation, and geopolitical tensions in Europe.
Figure 10: Global share of automotive car production (Bloomberg, International Organization of Motor Vehicle Manufacturers, Europe = Germany, Spain, France, Italy and the United Kingdom)
Another key focus area is the expansion of artificial intelligence (AI) technologies which is significantly increasing the demand for data centres, which in turn is driving up energy consumption. This trend underscores the need for efficient energy management and investment in cost effective and reliable power sources to support the burgeoning digital infrastructure, see figure 11a. Given the massive power consumption of data centres, we can expect the US to continue benefitting from cheap abundant energy. Energy Product Partners estimates that 35 GW of additional power generation will be needed over the next decade in the US (see figure 11b). A significant portion of this power will be supplied by gas. In December 2024, an article in the New York Times cited Exxon Mobil’s plan to enter the power generation business by building large natural gas power plants specifically to supply electricity to data centres, which would crucially be operating independently from the main power grid, underscoring how quickly the landscape is changing.
Figure 11a: Global data centres in units in 2023 Figure 11b: projected growth in power consumption for new build out (Enterprise Product Partners, August 2024)
CONCLUSION
While the Energiewende has catalysed global conversation on energy transition, its implementation in Germany has been fraught with challenges. The policy has not managed to balance economic viability, environmental goals, and energy security as initially hoped. High costs, continued dependency on fossil fuels, and the industrial sector’s struggles paint a complex picture of an ambitious policy that has not fully met its objectives. This scenario serves as a cautionary tale for other nations considering similar transitions, emphasising the need for a well-planned, coherent strategy that considers all facets of energy policy, from economic impacts to technological feasibility and public acceptance.