- Remarks for EFC in January 2025
Europe faces significant challenges: Persistently low growth, driven by a large productivity gap with the global frontier, has plagued the EU for decades. To this, we now add growing geo-economic fragmentation and a soaring energy price gap to other advanced and emerging market economies. These challenges coincide with an urgent need to accelerate the green transition and to strengthen Europe’s energy security.
Achieving higher growth and resilience demands a dual focus: deepening the single market and pursuing structural reforms at the national level.
Your focus on Europe’s energy market is paramount. Why? Because the energy market is key to lowering energy prices and their volatility, improving energy security, and decarbonizing the economy—goals that are connected and essential to Europe’s long-term prosperity.
But before I explain why greater energy market integration is critical to achieving those goals, let’s look at the facts.
Europe’s broken energy model
The EU’s energy system developed on a foundation of low-cost Russian pipeline gas, which for years kept electricity prices low and relative uniform across member states.
But this model collapsed with Russia’s invasion of Ukraine and Russia’s shutdown of gas flows to most of Europe. This crisis exposed three critical weaknesses in the EU’s energy system:
First, an overreliance on imported fossil fuels, especially Russian pipeline gas.
Second, uneven vulnerabilities across countries, due to differences in energy mix and sources of imported and domestic energy supply.
Third, the fragmentation of the internal energy market and limited degree of electricity market integration and interconnection between EU countries.
I would like to stress that the EU deserves praise for adapting quickly to the cutoff of Russian pipeline gas. Member states worked together to reroute gas supplies, compress demand and improve energy efficiency. However, this adjustment came at a high cost: an increased reliance on expensive LNG imports.
As a result, the median wholesale price of electricity has doubled from the years preceding the pandemic and the Russian gas shut-off, and the price dispersion across EU countries has tripled.
These disparities reflect persistent fragmentation and inefficiencies in the energy system. Without addressing these flaws, Europe will remain vulnerable to costly and disruptive energy price shocks.
The macroeconomic cost of high energy prices
The macroeconomic impact of high and volatile energy costs is profound, touching competitiveness investment, household consumption and thus growth.
Competitiveness: European energy prices are now approximately double those in the United States compared to the period before the Russian gas shut-off. And prices are also higher than in many other big advanced and emerging market This disparity puts energy-intensive industries— such as chemicals, steel and aluminum production—at a serious disadvantage in global markets and hurts industrial production.
Investment: While price volatility is less extreme than in 2022, electricity price volatility in the EU remains three times higher than before the energy crisis, hurting investment.
Consumption: High energy costs reduce household consumption.
This means that Europe is experiencing lower aggregate growth in the short run. And by undermining Europe’s industrial competitiveness and deterring investment, high energy prices erode potential output in the medium term.
Simulations by IMF staff suggest the energy price shocks since 2021 could shave off around one percentage point of euro area potential output by 2027. That is nearly 200 billion euros lost annually.
Benefits of a more integrated energy market
How can Europe address these challenges? The Russian energy shock has deprived the EU of being able to rely on relatively low- cost gas to help smooth the transition to a low carbon energy system. As was recognized with the RePower EU package, Europe will need to accelerate the transformation of the energy system. But doing this cost-effectively requires both making better use of existing cross-border infrastructure and building a more integrated energy market.
How would a more integrated energy market bring down prices, their dispersion, and their volatility?
First, it will take an accelerated adoption of renewables and other low carbon technologies to lower energy costs and meet climate goals. Thus, Europe should leverage the falling costs of renewables generation and storage, especially for solar and batteries.
Second, for this shift to renewables to work well, Europe needs an integrated and robust electricity system. Europe has significant renewable energy potential, but it is unevenly distributed.
Southern Europe excels in solar power, while northern and Atlantic coastal areas excel in wind energy.
An integrated electricity system can better balance supply and demand across countries, reduce reliance on costly backup power plants and storage, and smooth price fluctuations.
Studies suggest cost savings from the shift to renewables and further electricity market integration could amount to around 40 billion euros annually by 2030.
Third, another area where greater coordination and grid integration will be important is the EU’s approach to lowering carbon emissions. IMF staff simulations show that a joint EU-level mechanism that facilitates a more cost-effective allocation of emission-reducing investments and corresponding reallocation of emission cuts across countries and sectors could save an additional 200 billion euros in total by 2030 if it had been fully implemented at the start of 2024. Greater grid integration would be needed to fully realize these cost savings.
Fourth, a cleaner, more integrated electricity system will not only reduce the average price and volatility of electricity, it would also improve energy security by sustainably reducing the dependence on energy imports.
Finally, better integrating both infrastructure and markets across broader areas will reduce price dispersion across EU countries. This creates a more level playing field in the single market and reduces another barrier to Europe’s firms to grow to scale.
Impediments to the creation of a more integrated energy market
Despite its clear benefits, the creation of a fully integrated energy market faces significant obstacles:
First, cross-border externalities involved in building out the European grid are not internalized.
Investments in cross-border energy infrastructure, such as interconnectors, yield benefits beyond the countries directly involved, as all of Europe benefits from a more robust network. However, the costs are borne primarily by those countries. This creates a disincentive for sufficient investment.
Second, there are similar incentive problems at the national level.
Countries with low-cost electricity often resist integration out of fear that domestic prices will rise. Conversely, high-cost countries may be reluctant to open their markets to cheaper electricity imports, which could undercut local producers.
Overcoming these misaligned incentives requires smart policies that ensure mutual benefits. All member countries will benefit from a more energy-secure, competitive EU. This is the time to set aside the vested interests that stand in the way of stronger integration.
And third, the current institutional setup makes it difficult to coordinate and address these issues.
Energy planning and investment decisions remain largely within national jurisdictions, with limited coordination at the EU level (such as the ten-year network investment plans developed by transmission system operators). Addressing this fragmentation requires better coordination at the EU level and it requires institutions capable of aligning policies and investments across member states.
Jointly funded investments should be judged on cost effectiveness grounds and how they contribute to the cost, security and decarbonization goals not just of one country but the entire EU. And some private investments need complementary public guidance and investment to be feasible. For example, a buildout of car charging networks are urgently needed to align industry expectations with policy goals and facilitate the adoption of EVs. Why not do this jointly?
In this context, let me emphasize the critical role of the carbon price in the ETS in setting predictable environment for clean investment. And I hope that the EU will stay on course for ETS II.
The way forward
To unlock the benefits of a unified energy market, the EU needs a coordinated strategy that combines a blueprint for action, strengthened coordination and collaboration at the EU level, and progress also at the national level.
First, an EU-level plan. Europe needs to close information gaps for a better understanding where the potentially most cost-effective and critical investments are.
This can then inform the development of a “blueprint” for the evolution of the EU energy system over the next few decades to efficiently deliver on energy cost, security and decarbonization goals, while taking into account the externalities and incentive problems I just mentioned.
Second, EU-level coordination. The blueprint should serve as a basis for coordinating policies and investments at the EU and national levels.
Europe needs to make a common effort to deliver on the integration of the energy system and clean technologies that will be essential to meeting both its energy and climate goals.
This may require a new EU entity to coordinate the investments essential to fully integrate Europe’s power grid. Much, but not all of this is about infrastructure.
Third, Europe should also consider greater pooling of resources to develop and scale up clean technologies. There is a strong case for more R&D at the EU level to develop next generation technologies, such as for seasonal grid-scale energy storage or to cut emissions in hard to abate sectors like agriculture.
Coordination should extend to industrial policy where our recent work shows that any support for the scale-up of clean tech industries and firms should also rely more on common resources and be done on a meritocratic basis at the EU level to minimize distortions to the single market.
Fourth, streamline permitting processes. Despite some progress, permitting times in many EU countries are still far too long. But Germany’s rapid installation of new LNG import terminals and related infrastructure shows that when there is a political will and sufficient resources, things can move quickly.
Political will like that should be applied to efforts to streamline permitting processes and reduce the time and costs of building new energy infrastructure in Europe.
Fifth, and finally, a single energy market requires better collaboration across all levels—EU, national, regional, and local level. By aligning policies, reducing inefficiencies, and fostering innovation, Europe can achieve a clean, affordable, and secure energy future.
Before I end, a small caveat. The Fund is mainly focused on the macroeconomics and at the EU level. This is not an exhaustive list of what could or should be done, as illustrated by the extensive set of proposals in the Draghi and Letta reports, for instance.
Conclusion
If there is one takeaway from my remarks today, it is this: The EU can simultaneously reduce energy prices, improve its energy security and meet its emission reductions goals. These goals are not only compatible, they are mutually reinforcing. But only by working together will you lower the cost of achieving them.
This will require a renewed commitment from EU member states to integrate the energy system, coordinate planning and investments, and build the institutions and instruments necessary to overcome barriers to completing the single energy market.
And, while I have mainly focused on the energy market today, the broader conclusions on the need for deeper integration are just as relevant for the single market. Deeper integration offers the potential for even greater gains in growth, resilience, and competitiveness.
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