In the wake of Russia’s invasion of Ukraine, the world appears to be at an inflection point. Business leaders have declared the acceleration of deglobalization and sounded the alarm about a new period of stagflation. Academics have decried the return of conquest and hailed the renewal of transatlantic ties. And countries are rethinking almost every aspect of their foreign policies, including trade, defense spending, and military alliances.
These dramatic shifts have overshadowed another profound transformation in the global energy system. For the last two decades, the urgent need to reduce carbon emissions has gradually reshaped the global energy order. Now, as a result of the war in Ukraine, energy security has returned to the fore, joining climate change as a top concern for policymakers. Together, these dual priorities are poised to reshape national energy planning, energy trade flows, and the broader global economy. Countries will increasingly look inward, prioritizing domestic energy production and regional cooperation even as they seek to transition to net-zero carbon emissions. If countries retreat into strategic energy blocs, a multidecade trend toward more energy interconnectedness risks giving way to an age of energy fragmentation.
But in addition to economic nationalism and deglobalization, the coming energy order will be defined by something that few analysts have fully appreciated: government intervention in the energy sector on a scale not seen in recent memory. After four decades during which they generally sought to curb their activity in energy markets, Western governments are now recognizing the need to play a more expansive role in everything from building (and retiring) fossil fuel infrastructure to influencing where private companies buy and sell energy to limiting emissions through carbon pricing, subsidies, mandates, and standards.
This shift is bound to invite comparisons to the 1970s, when excessive government intervention in energy markets exacerbated repeated energy crises. The dawning era of government intervention won’t be a bad thing, however, if managed correctly. Appropriately limited and tailored to address specific market failures, it can forestall the worst effects of climate change, mitigate many energy security risks, and help manage the biggest geopolitical challenges of the coming energy transition. The current energy crisis has refocused the world’s attention on geopolitical energy risks, forcing a reckoning between tomorrow’s climate ambitions and today’s energy needs and offering a preview of the tumultuous era ahead. How governments respond to these challenges, brought into sharp relief by Russia’s invasion of Ukraine, will shape the new energy order for decades to come.
The energy crisis triggered by Russia’s invasion of Ukraine could become the worst in half a century. Many analysts have already drawn comparisons with the 1970s oil crises, but there are important differences. To begin with, the global economy is less energy intense. Economic growth has outpaced growth in energy use, so the world now uses much less energy per unit of GDP. Moreover, many more companies distribute oil globally today than did in the early 1970s, when just a handful of firms controlled most of the world’s oil trade. As a result, energy supply chains are now more durable.
That said, the current energy crisis goes well beyond oil and could thus affect a wider slice of the economy. Energy sources of all kinds stand to be disrupted by the turmoil. Russia is not only the world’s largest exporter of oil and refined petroleum products but also the dominant supplier of natural gas to Europe and a major exporter of coal and the low-enriched uranium used to power nuclear plants, not to mention many other commodities. With coal, gasoline, diesel, natural gas, and other commodity prices all near record highs, further disruption of Russian energy supplies, whether initiated by Russia or Europe, would accelerate inflation, invite recession, demand energy rationing, and force business shutdowns.
The global energy system was under stress even before Russian President Vladimir Putin decided to invade Ukraine. Europe and other parts of the world faced power generation challenges as more and more of their electricity came from intermittent sources such as solar and wind. At the same time, years of poor returns and increased climate pressures had reduced investment in oil and gas, resulting in limited supplies. COVID-19-related supply chain problems compounded the scarcity and added to pricing pressures. In 2021 and early 2022, soaring natural gas prices pushed some European utilities into bankruptcy and forced governments to subsidize energy bills. Things could have been even worse, but warmer-than-expected weather in Europe and Asia eased some of the demand for energy.
Since the outbreak of the war in Ukraine, energy markets have been even more volatile. Credit markets have tightened, leaving little liquidity to support the buying and selling of oil, and both supply and demand have experienced large shocks. Many buyers have steered clear of Russian oil, concerned about Western banking and financial sanctions as well as the potential stigma of doing business with Russia. Already, the International Energy Agency estimates that Russia is producing around one million fewer barrels per day, a number that could climb if the European Union follows through with its plan to ban all Russian crude oil, gasoline, and diesel by the end of the year. Speculation that more sanctions could be on the horizon, coupled with OPEC’s reluctance to backfill lost Russian oil supply, has pushed prices higher still.
Consumers in Europe and elsewhere face an even sharper emergency as a result of record natural gas prices. Such prices would be higher still were it not for two powerful factors that are at least temporarily moving the market in the opposite direction. COVID-19-induced lockdowns in China have seriously dented global energy demand, and the United States and its international partners have released unprecedented amounts of oil from their strategic reserves. For the time being, the volume flowing from strategic stockpiles roughly offsets the loss of supply from Russia.
But the worst is likely yet to come. When Chinese lockdowns ease, oil demand will surge, pushing up prices. The same will be true for natural gas prices, which in turn affect electricity and heating prices. Although Russian gas has largely continued to flow to Europe, Moscow has cut sales to Finland, Poland, and Bulgaria
A complete cutoff of Russian gas supplies to Europe is still unlikely, but hardly unthinkable, and would probably lead to shortages, energy rationing, and the shuttering of energy-intensive industries.
Any additional sanctions would have second- and third-order effects on the global energy system. Already, the turmoil in markets for liquefied natural gas, which has increasingly flowed toward Europe because of higher prices there, has left Asia looking for alternative energy sources. Coal, an abundant and comparatively cheap substitute for natural gas, has won out. China and other countries have boosted coal production amid rising fears of global energy shortages, taking some of the pressure off global gas markets. Without Asia’s increased production of coal, Europe would be less able to cope with the loss of Russian gas. But greater reliance on coal has pushed its price to record highs as well, leaving lower-income countries such as India and Pakistan struggling to meet their energy needs in the midst of deadly heat waves. High prices for natural gas, used to produce fertilizer, are also driving up food prices that were already rising because of disruptions in Russian and Ukrainian agricultural exports.
SAFE AND SECURE
These cascading emergencies demand a reevaluation of the lessons from the 1970s about the right balance between government involvement and market autonomy. Reliance on market forces has yielded enormous benefits over the last 40 years, making energy more affordable and accessible, increasing economic efficiency, and boosting energy security by enabling competitive pricing to shift supplies into markets where they are most needed. Today’s crises, however, highlight certain market failures that can only be addressed with greater government intervention.
Three market failures in particular reveal the need for a bigger role for government in the effort to achieve the dual goals of enhanced energy security and a timely transition to net-zero carbon emissions. First, the private sector lacks sufficient incentives to build the infrastructure and other assets that most countries need to ensure their energy security. Second, market forces alone cannot encourage the building of the infrastructure required for a more orderly energy transition—infrastructure that by definition may be obsolete before private companies have achieved a full return on investment. And third, private firms and individuals lack strong enough incentives to curb emissions whose costs society bears.
Free markets often do a good job of ensuring that consumers have a range of options for sourcing energy. When supplies are disrupted in one location, whether by a natural disaster or political upheaval, free trade in highly integrated and well-functioning commodity markets allows buyers to find alternatives and thereby avoid shortages.
But as the current European energy crisis makes clear, switching to alternative energy sources for political, economic, or diplomatic reasons is only possible when the infrastructure—ports and terminals with excess capacity, for example—is in place to allow for the switch. The private sector lacks incentives to invest in such infrastructure because disruptions are unpredictable and private companies will not bear the full cost to society of the resulting dislocations. Governments therefore need to step in.
Lithuania is a case in point. Nearly a decade ago, the country built a floating liquefied natural gas terminal, aptly named “Independence.” The terminal allowed the Baltic state to reduce its dependence on Russian natural gas and negotiate better prices from Gazprom. But the commercial operation of the terminal alone would not have justified its costs, especially since it has often operated well below capacity. The terminal could be financed only thanks to loan guarantees and other forms of aid from the Lithuanian government, in addition to loans from the European Investment Bank. This decision to invest in energy security infrastructure is paying dividends today, enabling Lithuania to become the first European country to completely cease importing Russian gas after Putin’s invasion of Ukraine.
Germany is also looking to liquefied natural gas to reduce its dependence on Russian gas. Russia has long been Germany’s cheapest source of natural gas, leading Germany to gradually increase its imports from there and by 2021 to source more than half the gas it used from Russia. Now, to bring non-Russian gas into the country, Berlin has earmarked three billion euros to support the development of four floating liquefied natural gas import terminals. Businesses and consumers will have to pay more for their energy going forward, but the government will have created the infrastructure to enable a more diverse natural gas supplier base.
Government-owned stockpiles such as the U.S. Strategic Petroleum Reserve are another tool for energy security that cannot be delivered solely by the market. (In Europe, many governments do not hold reserves but instead require companies to maintain above-normal levels of inventory.) Although such stockpiles can help ease shortages in a crisis, they also require infrastructure that private companies are unlikely to build on their own. U.S. President Joe Biden’s administration has released enormous amounts of oil from the Strategic Petroleum Reserve, for instance, but the government’s ability to release even more to calm global prices is limited by a shortage of available ports and terminals. In the past, such infrastructure constraints were uncommon. Yet the shale boom that made the United States a net energy exporter has dramatically increased demand for port space, which is now mostly claimed by the private sector. For government stocks to increase total global supply rather than simply displace private-sector barrels, additional ports and terminals are needed that may see limited use outside of energy crunches.
Governments may also need to intervene in energy markets beyond those for oil and gas. The critical minerals needed for a successful energy transition, such as lithium, nickel, and cobalt, are likely to be in short supply as electric vehicles become more prevalent and as solar, wind, batteries, and other forms of low- and zero-carbon infrastructure proliferate.
Europe has called the Russian war in Ukraine its 9/11. The terrorist attacks of that day brought about a new security order that dominated the international landscape for 20 years and is still a dominant feature of world affairs. One legacy of the Ukraine war will be a new energy order, originating in Europe but radiating to the farthest reaches of the global economy. It will be defined by the dual imperatives of energy security and climate action. Pursuing them at the same time, without allowing one to compromise the other, will require harnessing the power of markets. But it will also require a much more expansive role for government to leverage, shape, and steer those markets, correcting the failures thrown into sharp relief by today’s crisis. Without government intervention, tailored and restrained but nonetheless increased, the world will suffer a breakdown in energy security or the worst effects of climate change—or both.