The Iran war is forcing Europe to confront its energy problem

Germany’s share of the North Sea resembles the head of a seagull. At just 41,000 square kilometres it is about 5% the size of Britain’s. Germany plans to squeeze 70GW-worth of wind turbines into this small area by 2045, but it is running into an unusual problem: that many turbines would slow down the wind and reduce the electricity harvest by 37%. It is a tale of Europe’s limited energy potential, and the hazards of trying to find national solutions to a European problem.

The war in Iran and the closure of the Strait of Hormuz are highlighting Europe’s energy shortage. Natural-gas prices in Europe have climbed back above €50 ($58) per MWh; in America, the cost is about $11. Combined with higher petrol prices, that could trigger a new bout of inflation. At a European Council summit starting on March 19th, as The Economist went to press, leaders were due to debate what lessons to apply from the previous price jump in 2022, when Russia, Europe’s main gas supplier at the time, invaded Ukraine.

Ursula von der Leyen, the head of the European Commission, wrote to country leaders ahead of the meeting that Europe had spent an additional €6bn on fossil fuel imports since the start of March, “the price we pay for our dependency”. Some want to go back to old ways. Bart De Wever, Belgium’s prime minister, said on March 15th that the European Union needed to “normalise relations with Russia and regain access to cheap energy”. Other leaders quickly rebuffed him. But they agree that Europe’s energy system is too expensive.

The immediate concern is to contain price increases. Inflation has fallen from its peak of 11% in 2022 to about 2% in most of the EU. A prolonged war could raise it to 4% or more, according to estimates by Oxford Economics, a research firm. That could eat into real pay, which has just recovered from the previous shock.

Some governments have already started to intervene. In Austria petrol stations are now allowed to raise prices only three times a week, and Germany is mulling a similar approach. TotalEnergies, a French oil and gas firm, has frozen the price at its stations in France until the end of the month. Windfall taxes on excess profits, which many countries implemented in 2022, are back on the table in Italy. Several countries are considering tax relief.

The gas shock is particularly worrying for energy-intensive businesses. Metals, chemicals and other basic industrial sectors are still large in Europe, especially in Germany. In its basic chemicals sector, energy costs made up 42% of value added in 2023, up from 28% in 2021, due to higher gas prices. Competition is fierce from China, where a price index for chemicals fell by 36% over the past three years. It could be risky for Europe to give up making basic chemicals, as the loss of rare-earths refining to China has demonstrated.

Policymakers are considering various options to lower prices. The first is changing how the electricity market works. Under the current set-up, the last power plant needed to meet demand sets the price. In Italy, a critic of the system, gas-fired plants set the price in 89% of hours so far in 2026, calculates Ember, a think-tank. In Spain it was 15%. So far in March Italy’s average power price was €142 per MWh, whereas in Spain it was €59.

But the debate is unlikely to lead to major reforms of the market-based system. Nor should it. Energy experts mostly agree that the varying prices send crucial signals when power is dear, rewarding generators who produce at that time and creating strong incentives to invest in more capacity. Changing the basics of the market would create costly uncertainty among investors. Indeed, Spain’s success is an example of the market working: it built more renewables and diversified its sources of electricity, lowering the price.

The main issue in Europe is ballooning system costs, including the cost of improving the grid. These already make up around 20% of household bills. “We are transforming the system from variable fuel costs to largely fixed costs,” says Christoph Maurer of Consentec, a consultancy. To make the renewables-based system work, the EU must invest €1.4trn in its grid infrastructure by 2040, according to its own estimates. Every player, including consumers and industries, is trying to shunt the cost onto someone else, Mr Maurer says.

The shift also requires connecting different parts of Europe’s grid, so that peaks in demand and gaps in generation can be balanced across borders. A recent study shows that this could save about 500GW of costly backup capacity for when renewable sources produce little. But the commission’s proposed grid package from December 2025, which suggested more centralised planning, is facing opposition from countries less dependent on gas that are reluctant to share—France with its nuclear power, Sweden with its hydropower.

The final controversial issue is Europe’s emissions trading system (ETS), which puts a price on carbon. It is under fire from countries desperate to lower energy costs. The carbon price, currently about €66 per tonne, adds about €25 to the price of a gas-powered MWh. Giorgia Meloni, Italy’s prime minister, has called for suspending the system while geopolitical tensions prevail. Even Friedrich Merz, the German chancellor, has mulled changing it to accommodate industry. After eight countries, Spain among them, sent the commission a strongly worded letter defending the ETS, it will probably prevail. But its system of allocating free emission permits to energy-intensive industries, which had been scheduled to be phased out by 2034, could instead be extended.

Europe will have to learn to live with higher energy costs. But there are ways to reduce them without slowing down the North Sea winds. ■