Prices on Europe’s energy markets have skyrocketed. Private households and companies face enormous burdens. Instead of tinkering around, the governments of the EU member states should now concentrate on two main tasks.

Shortages in Russian gas supplies, French nuclear power and Norwegian hydroelectric power have sent prices on Europe’s energy markets skyrocketing to surreal heights. The European natural gas future rose by a full 30 percent last week.

Last summer, French and German annual contracts for electricity were being traded at around 100 euros per megawatt hour. The price of electricity recently climbed above the 1000 euro mark.

Despite a recent drop in prices, gas prices are still trading at levels equivalent to $400 a barrel of oil. The Shell boss is now warning that the crisis will not be limited to just one winter.

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If households and companies have to sign new energy contracts, this will lead to considerable burdens. The economy is also affected, which is already getting into trouble as a result of interest rate increases by the ECB to combat inflation.

While many economists are forecasting a recession in the coming months, the European single currency is at its lowest level in two decades against the dollar. Tensions and conflicts between the member states are on the horizon.

So far, the European Commission has not shown itself to be ambitious enough. As the latest measure, she is currently proposing a price cap that affects gas consumption for electricity generation and which is to be discussed at a ministerial meeting on September 9th.

It is also conceivable that the Commission will revise the electricity market so that spot prices are no longer determined by the marginal supplier with the highest costs – usually gas-fired power plants.

A price cap sounds good at first. However, since caps will not curb demand for scarce energy, it could be counterproductive.

As a study shows, the introduction of an electricity price cap in Spain has led to a 42 percent increase in gas energy since June. Europe-wide regulations would only further increase gas demand – and with it the risk of rationing in winter.

The current policy allows for significant profits for individual green electricity suppliers that produce at marginal costs close to zero. Should gas prices remain at sustained high levels, such profits could be seen as unjustified returns.

Nevertheless, the same price signal ensures electricity generation in gas-fired power plants on windless days and creates stronger investment incentives for renewable energies.

Instead of tinkering around, governments should now focus on two essential tasks. The first is to curb demand through the market mechanism, while relieving vulnerable populations.

Huge aid is needed, but well-targeted support can limit spending: The IMF estimates that a scheme offering rebates and cash transfers to the poorest 40 percent of the population would be more cost-effective than the current policy mix of fuel tax cuts and retail price freezes .

The second priority must be security of supply – a concern that is not solely in Vladimir Putin’s hands. Other sources of supply for natural gas are possible: This is one of the reasons why French President Emmanuel Macron recently traveled to Algeria.

Within the EU, member states can help to eliminate bottlenecks, for example in the incomplete gas network between countries. A combination of underinvestment and diverging standards is making the current flow of gas from Spain and France to Germany and Eastern Europe more difficult.

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The EU must ensure that if continent-wide rationing occurs, there is agreement on which consumers will be cut off first: otherwise, countries risk stockpiling.

All of this means financial burdens. Greece, Italy and Spain – three of the most indebted members of the euro zone – have already spent 2 to 4 percent of their gross domestic product on tax breaks to deal with the energy crisis.

Luckily for them, the EU has enough firepower to help. The €807 billion Corona reconstruction fund is being paid out sparingly in the form of loans and grants.

So far, however, less than 15 percent of the funds have been used. Energy projects could be financed more quickly and the Commission could offer cheap loans for targeted tax relief. The EU came together to tackle the economic consequences of the corona lockdowns together. And one thing is certain: the energy crisis requires similarly courageous steps.

The article first appeared in The Economist under the title “How to prevent Europe’s energy crunch spiraling into an economic crisis” and was translated by Cornelia Zink.

The article “Now the EU must act as boldly as it did in the Corona crisis” comes from The Economist.