Former Italian PM sets out gas policy recommendations to bolster EU competitiveness

Draghi’s recommendations contrast greatly in a number of important ways with the direction that the EU has been taking over the past decade.

WHAT: Renowned economist Mario Draghi has recommended natural gas and other energy policy changes to bolster the EU economic competitiveness.

WHY: The bloc’s competitiveness has been significantly undermined over the past few years by high energy prices, particularly those for natural gas.

WHAT NEXT: Draghi calls for more long-term supply contracts, a shift away from spot pricing and better coordination on developing infrastructure, regulating market behaviour and joint procurement of gas imports.

Italy’s former prime minister and renowned economist Mario Draghi has called on the EU to move away from short-term spot price-based gas purchases and strike longer-term contracts with suppliers in order to improve the bloc’s economic competitiveness. 

The European Commission tasked Draghi, who also served as president of the European Central Bank for eight years, with preparing a report setting out his vision on the future of European competitiveness. The report, published on September 9, analyses the challenges facing various key sectors of the EU economy and puts forward recommendations for addressing them. As Europe currently struggles to recover from its worst energy crisis in decades, it is no surprise that energy policy is the report’s key focus.

Draghi’s recommendations contrast greatly in a number of important ways with the direction that the EU has been taking over the past decade. The former Italian leader calls for a pragmatic approach that ensures that Europe’s gas market has stable and secure supply, supported by improved forecasting.

He also wants to see the EU encourage a “progressive” move away from spot prices. Europe steadily increased the share of spot pricing in its gas supply contracts in the years prior to the energy crisis, chiefly at the expense of oil indexation. While in previous years this helped Europe secure low-cost gas, the energy crisis saw the situation reversed, with Europe’s dependence on spot pricing causing it to pay by far the highest prices for gas in the world. 

Draghi also sees a larger role for government to play in developing strategic import infrastructure, coordinating storage levels, undertaking joint procurement of gas supplies to secure lower prices and limiting speculative market behaviour. 

The competition gap

There is a major gap between the EU and its trade partners in terms of the competitiveness of energy prices, and the bloc also suffers from greater price volatility, which further hampers energy-intensive industries and the economy at large, Draghi said. 

Gas retail and wholesale prices in the EU are currently three to five times higher than those in the US, for example, while historically they were only two to three times higher. And EU prices are also more volatile and unpredictable.

“High degrees of volatility in energy markets, which appear to have become more structural, pose a real threat to the EU’s competitiveness,” Draghi said. “High volatility creates uncertainty, increases [the] price of hedging and can be detrimental to investment decisions in the power sector. This generates even greater uncertainty, including from the point of view of the security of supply, and raises the cost of the energy transition.”

He notes that 60% of European companies said in 2023 that high energy prices were impeding investment, highlighting the cascading effect that they have on the broader economy.

Also taking into account Europe’s high dependence on imported fossil fuels, this creates a major drag on EU resources. The International Energy Agency (IEA) estimates that the bloc’s fossil fuel bill rose from €341bn in 2019 to €416bn in 2023 – the equivalent of 2.7% of GDP.

“These funds could be better used by the EU to invest in infrastructure, innovation, education and other areas, which are essential for developed economies to keep their competitive edge in global markets,” Draghi said.

The EU is the biggest global gas and LNG importer in the world, and given its increasingly limited indigenous resources and the continued need for the fuel, this is not going to change. But Draghi argues that the potential bargaining power that this status brings is not being sufficiently leveraged. During the energy crisis there was also intra-competition for natural gas between different actors that contributed unnecessarily to the spike in prices, he said.

Other key gas importers such as South Korea and Japan face similar challenges but there are key differences. In Korea, state-owned Korea Gas Corp. (KOGAS) has a near monopoly over imports, bringing ashore 90% of the country’s LNG, and this helps it bargain for lower prices. In Japan, meanwhile, state-owned JOGMEC invests in upstream and LNG projects abroad, helping ensure energy access at prices near production costs.

The EU relies more on the spot market to obtain its gas supply than other markets. The share of long-term contracts in import volumes came to 82% in 2022, versus 91% in 2019, and only 60% of LNG was procured under long-term contracts. After losing the majority of its pipeline Russian gas supply in 2022, EU has increased it reliance on LNG, and these volumes are more expensive than pipeline imports, not only because of liquefaction and transportation costs but also competition with other buyers globally.

Notably, even the gas that is bought under long-term contracts is largely indexed to spot markets. European companies have been less active in signing long-term supply deals than their international peers because of uncertainty about future gas needs, causing them to rely more on the spot market.

Draghi notes that while the EU’s gas import needs will fall, this decline will be gradual. The IEA estimates that EU gas demand will drop by 8-25% by 2030 versus the level in 2023, but the amount of supply it has secured contractually still falls short of projected future consumption.

Recommendations

Draghi calls for the EU to come up with a comprehensive strategy to help member states coordinate in securing natural gas during the energy transition, including from where, the volume and under what conditions. Today, individual countries manage their security of supply and any coordination is confined to short-term crisis responses.

“There is no clear, explicit strategy at the EU level regarding where gas should be sourced from during the energy transition and how to deal with the remaining volumes of imported Russian gas,” he explained.

Partnerships should also be forged with reliable and diversified supply partners, with long-term agreements in place to cover the base quantities of gas needed between now and 2050, he said, reducing the use of spot purchases.  

“Future imports would be concentrated first on secured and affordable pipeline gas, which would be cheaper if sourced at ‘production cost plus mark-up’, while maintaining the flexibility and the option of LNG sourcing,” he said.

Long-term deals should be explored that secure preferential fixed prices and guaranteed volumes over several years, and gas infrastructure should be upgraded to ensure imported volumes and be distributed across the EU.

“It is important that these contracts are signed by those companies that are closer to the end-user and deal with actual physical flow (either industries or TSOs) to avoid [an] intermediary mark-up that could increase prices,” he said.

Companies should be encouraged to sign more long-term contracts which use pricing formulas that are less indexed to gas spot prices.

“If mitigating policies are not developed, Europe’s exposure to the spot market could remain in the years to come,” he said. “Global LNG markets may experience periodic cycles of oversupply and scarcity, depending on market uncertainties such as the evolution of gas demand in emerging economies, investment cycles in production countries or geopolitical events, making it advisable to retain diversity, be it in pricing, contract period or sources.”

Gas could be bought at a predetermined cost, perhaps based on the production cost plus a mark-up.

Draghi also highlights the role that domestic production of gas can play to safeguard EU supply security and shield it from geopolitical developments. Local fields could “supply the last molecules of gas in the 2040s and 2050s,” he said.

EU gas production has halved in the last decade and fell by 7.2% in 2022 alone, owing to further cuts in supply at the now-closed giant Groningen field in the Netherlands. And this decline is set to continue.

The EU launched a joint gas aggregating platform in 2023, aimed at connecting more buyers with suppliers and helping the former secure lower prices. The success of this platform is unclear, as volumes and pricing have not been made public. The Financial Times reported on September 29 that only 1bn cubic metres or 2% of the gas offered on the platform was contracted and reported to the European Commission, although more contracts could have been signed but were not reported.

Essentially, this platform, known as AggregateEU, is merely a matchmaking tool but it could go further and undertake joint procurements of gas, Draghi said.

“A single EU buyer entity could purchase pipeline gas and/or LNG for base quantities and run auctions for its volumes at predetermined fixed prices to EU companies, respecting EU internal competition,” he explained. “Aggregating demand profiles would facilitate the management of short-term fluctuations in the market. Pursuing such a model could make the risks of the energy transition more manageable.”

He added that the platform could provide a government-supported hedging mechanism to protect companies signing long and medium-term contracts from extreme market volatility. 

At the height of the energy crisis, Brussels also obliged member states to meet targets for stockpiling gas ahead of winter, and this could be further coordinated so that EU operators do not compete with each other, Draghi said. State counter-guarantees could also be provided to de-risk gas storage in Ukraine’s vast underground caverns.

While the substantial development of LNG import infrastructure in the past two years largely mitigated the risks the market faced owing to the loss of Russian supply, some extra infrastructure may still be needed to diversify supply, he added.

The economist added that there was a lot of scope to improve the quality, interoperability, dissemination and timely availability of energy data and statistics so that the EU can provide greater gas market certainty during the energy transition. This effort would include centralising all public and open energy data sources into a common hub. 

He also stressed the need for further regulation of financial markets for energy under a single EU trading rule book and limiting the potential for speculative behaviour.