The new European Commission's roadmap from a credit view (Part 2): EU Energy Union

S&P Global Ratings expects the next European Commission to continue to prioritize EU competitiveness and the digital and green transition, as well as defense, security and immigration issues. In this series of Policy Notes, we take a closer look at the issues of :

• the enforcement of EU fiscal rules in a context of rising defense spending,
• Energy market integration,
• Capital market union, banking union and financial services regulation.

On the second point, the subject of this note, we believe that further energy market integration remains key in the EU’s drive to improve its overall competitiveness. So far, the EU has essentially achieved oil and gas price convergence. On the power side, in contrast, we think that divergences will persist beyond this decade. EU-level coordination will be crucial in determining the degree and pace of development of low-carbon hydrogen generation and pipelines. Given the disparity of renewable generation capacity across countries versus the locations of consumption, no one member state can develop the integrated hydrogen chain alone and at scale.

What is the EU energy union and is it attainable?

The energy union is the EU’s strategy to ensure the supply of affordable, secure, and sustainable energy that is as low-carbon and home-produced as possible in an integrated EU market. Because the EU’s energy bill is still 2.5% of GDP higher than in the U.S., further energy market integration remains key in the EU’s drive to improve its overall competitiveness. The EU has improved its gas-import infrastructure and contracts since the start of the Russia-Ukraine war, and so we generally think that the EU has largely achieved the union’s aim in terms of oil and fossil fuel gas.

EU Commission initiatives to foster renewable power generation–from Fitfor55 to RepowerEU and the Green Deal–have helped the EU break records in decarbonizing its power supply mix. In 2023, 44% of power generation was from renewables, and we expect this proportion to rise to 50% in 2024, or about 75% including nuclear. A level of 70% by 2030 would be broadly consistent with the EU’s ambition of renewable energy contributing 42.5% of the primary energy supply. The EU should achieve this target on time, or at the latest in the early 2030s.

There remains much more to do to facilitate power supply, with key projects slated for completion this decade. Most challenging will be enabling low-carbon hydrogen generation and flows; and carbon-capture science and technology (CCST). From an industrial equipment perspective, Net-Zero Industry Act goals remain demanding, notably that of increasing Europe’s own supply of solar panels and batteries.

While the European Commission can initiate, finance, and coordinate certain efforts, actions by member states and even local actions are key, for example, in authorizing new onshore wind and solar capacity. In our view, the EU is particularly relevant when there is a need to:

• Agree market reforms across member states, such as standardizing power prices or optimizing power price zones, for example, deciding whether Germany should split its single power zone. Since 2022, the European power market design reform has made steady progress;
• Improve cross-border flow capacity where energy sources are located far from their consumption locations;
• Broaden financing sources, including from member states’ budgets, to support the adoption of new technologies. Such technologies need subsidizing as they are either less mature–like battery storage, low-carbon hydrogen generation and pipelines, and CCST–and/or less economical–like nuclear newbuilds, or costly cross-country power lines or interconnections; and
• Facilitate a consensus on renewable generation–such as the EU’s target for renewables to contribute 42.5% of the primary energy supply–and market-integration targets, including for interconnections. The EU targets a ratio of available interconnection capacity to total generation capacity of 15% (see chart 3 and “Europe’s Power Push: Can Project Finance Help Fund Interconnections?,” published on Nov. 16, 2023).

What’s more, the EU Commission can facilitate coordination with the following key non-EU European energy partners:

• The U.K., as it switches from importing power to exporting power and hydrogen in the rest of this decade;
• Norway, as a key supplier of gas, power, and potentially hydrogen, and as a storage location for captured carbon dioxide; and
• Switzerland, a key power-transit country.

What credit impact could the EU energy union have?

The concept of an energy union may appear vague and its completion ambitious. However, in assessing the potential rating impact of this union, we focus on price convergence and on how institutional coordination can support energy import, generation, and transmission projects.

The EU has essentially achieved oil and gas price convergence, ensuring equal and competitive access by businesses and households, subject to Europe’s position as an importer and price-taker. On the power side, in contrast, we think that divergences will persist beyond this decade. Notably, the wholesale fuel component of bills could prove cheaper in Norway, Sweden, and Iberia than in Northwest Europe by a significant 10%-30%, bringing prices closer to those typical in the U.S. Wholesale fuel would remain 10%-15% pricier in Italy.

EU-level coordination will be crucial in determining the degree and pace of development of low-carbon hydrogen generation and pipelines. Given the disparity of renewable generation capacity across countries versus the locations of consumption, no one member state can develop the integrated hydrogen chain alone and at scale.

Chart 1