European Commission

Directorate-General for Economic and Financial Affairs

Energy Economic Developments in Europe

EUROPEAN ECONOMY 2014

COUNTRIES

AT Austria

BE Belgium

BG Bulgaria

CY Cyprus

CZ Czech Republic

CIS Commonwealth of Independent States

CN China

DE Germany

DK Denmark

EE Estonia

EL Greece

ES Spain

FI Finland

FR France

HU Hungary

IE Ireland

IT Italy

JP Japan

LT Lithuania

LU Luxembourg

LV Latvia

MT Malta

NL Netherlands

NO Norway

PL Poland

PT Portugal

RO Romania

RU Russia

SE Sweden

SI Slovenia

SK Slovakia

TR Turkey

UA Ukraine

UK United Kingdom

US United States

UNITS

Btu British Thermal Unit

GJ Giga joule

GWh Gigawatt hour

Ktoe Kilo ton of oil equivalent

kva Kilovolt-ampere

kWh Kilowatt hour

MJ Megajoules

Mtoe Million tonnes of oil equivalent

MWh Megawatt-hour

PPS purchasing Power Standard

TCF Trillion Cubic feet

TCO2 Tons of carbon dioxide emissions

TJ Terajoule

TWh Terawatt-hour

OTHERS

ARA Antwerp/Rotterdam/Amsterdam

ARDL Autoregressive distributed lag

BEA Bureau of Economic Analysis

BBL Oil barrel

CER Certified emissions reductions

DSO Distribution system operator

EC Energy Cost

ECM Error correction model

EEX European Energy Exchange

EIA Energy Information Administration

ENTSO European network of transmission system operator

ERGEG European Regulators' Group for Gas and Electricity

ERU Emissions reductions units

ETS Emissions trading scheme

EU European Union

EUA European Union allowances

EUR Euro

FiT Feed-in tariff

GDI Gross Domestic Income

GDP Gross Domestic product

GO Gross Output

GVA Gross Value Added

GHG Greenhouse gas

HHI Herfindahl-Hirschman index

HICP Harmonized index of consumer prices

HS Harmonized System

IEA International Energy Agency

ISO Independent system operator

ITO Independent transmission operator

LM Langrage multiplier

LRMC Long run marginal cost

MS Member State

NAP National allocation plan

NBP National balancing point

NGO Non-Governmental organisation

NUEC Nominal Unit Energy Cost

OECD Organization for Economic Cooperation and Development

OU Ownership unbundling

PV Photovoltaic

RCA Revealed comparative advantage

RES Renewable energy sources

RTB Relative trade balance

RUEC Real Unit Energy Cost

TSO Transmission system operator

TTF Title transfer facility

TYNDP Ten year network development plans

USD US Dollar

VAT Value added tax

WIOD World Input-Output Database

WFD Water Framework Directive

This report was prepared in the Directorate-General for Economic and Financial Affairs under the direction of Marco Buti, Director-General, Servaas Deroose, Deputy Director-General, and Anne Bucher, Director of the Directorate for Structural Reforms and Competitiveness.

The production of the report was coordinated by Emmanuelle Maincent (Head of Unit - Economic Analysis of Energy, Transport, Climate Change and Cohesion Policy).

The main contributors were Ricardo Amaro, Paul Arnoldus, Fotios Kalantzis, Emmanuelle Maincent, Jerzy Pienkowski, Andras Rezessy, Mirco Tomasi, and Arthika Sripathy.

Ricardo Amaro, Vittorio Gargaro, Andras Rezessy, Arthika Sripathy and Mirco Tomasi provided statistical support. Editorial assistance was provided by Vittorio Gargaro.

The report has benefited from useful comments and suggestions received from colleagues in the Directorate-General for Economic and Financial Affairs, Directorate-General for Agriculture and Rural Development, Directorate-General for Climate Action, Directorate-General for Energy, Directorate-General for Enterprise and Industry, Directorate-General for Environment, Joint Research Center, Directorate-General for Employment, Social Affairs and inclusion, the members of the Economic and Policy Committee Working Group on Climate Change and Energy, the members of the Economic and Policy Committee and as well as the Agency for the Cooperation of Energy Regulator.

The Council of European Energy Regulator and the Agency for the Cooperation of Energy Regulator are thanked for granting us access to their database.

Comments on the report would be gratefully received and should be sent to:

Directorate-General for Economic and Financial Affairs Unit B4: Economic Analysis of Energy, Transport, Climate Change and Cohesion Policies European Commission BE-1049 Brussels

or by e-mail to ECFIN-SECRETARIAT-B4@ec.europa.eu.

Executive Summary 1

Part I: Energy Costs and Competitiveness 5

Overview 7

1. Unit Energy costs in Europe and the world 8

1.1. Introduction 8

1.2. Assessing Unit Energy costs 8

1.3. Unit Energy Costs: an International Comparison 12

1.4. Unit Energy costs: A sectoral comparison 17

1.5. EU Member States assessment 22

1.6. Conclusions 27

2. The recent development of US shale gas and its impact on EU competitiveness 29

2.1. Introduction 29

2.2. The impacts of the surge in US shale gas on the US energy sector and EU and US energy mix 29

2.3. Electricity and Gas prices: a US-EU comparison 33

2.4. Energy Intensity : a US-EU comparison 36

2.5. Trade 38

2.6. Conclusions 40

References 42

A.1. Data and Methodology 44

A.2. Real unit energy cost in the world 46

A.3. Real Unit Energy Costs & Shift-share excluding refining sector 47

A.4. Additional energy data on EU and US 49

Part II: Energy and carbon prices: assessing the impact of energy and climate policies 51

Overview 53

1. The impact of energy policies on electricity and natural gas prices: an empirical assessment 54

1.1. Introduction 54

1.2. Energy price developments in the EU 54

1.3. The policy determinants of energy prices at EU level 60

1.4. Assessing the impact of energy and climate policies on electricity and natural gas prices 66

1.5. Conclusions 70

2. Assessing the drivers of carbon prices: an empirical estimate 72

2.1. Introduction 72

2.2. Stylised facts: evolution of carbon price 72

2.3. Climate and Energy policy developments 74

2.4. Assessing the drivers of carbon prices 77

2.5. Conclusions 81

References 82

A.1. Electricity and Natural Gas Price Model and Variables Description 85

A.2. Carbon Price model and variables description 87

Part III: Renewables: Energy and Equipment Trade Developments in the EU 89

Overview 91

1. Renewables development in the EU and the world 92

1.1. Introduction 92

1.2. Evolution of renewable Electricity in EU-27 and its main economic partners 92

1.3. Support Schemes and renewables development 95

1.4. Conclusions 100

2. Renewables competitiveness development: the case of wind and solar equipments 102

2.1. Introduction 102

2.2. Renewable components and equipment trade flows 102

2.3. International competitiveness of EU solar and wind energy industries 109

2.4. Conclusions 111

3. Energy trade balance and Avoided fuel costs 112

3.1. Introduction 112

3.2. Total energy trade balance 112

3.3. Avoided costs of imported fuel 113

3.4. Conclusions 117

References 119

A.1. Data description for the model measuring the drivers of trade in solar power and wind equipment 121

A.2. Data description for assessing avoided imported fuel costs 122

Statistical annex 123

LIST OF Tables

I.1.1. Average % annual change 1995-2009 - Manufacturing 16

I.1.2. Sectoral breakdown: decomposition of RUEC and annual growth rates 1995-2009 19

I.1.3. Sectoral breakdown: decomposition of RUEC and annual growth rates 1995-2009 20

I.1.4. Average % annual change 2000-2009 - Manufacturing 27

II.1.1. Results of Electricity price model 68

II.1.2. Results of Natural gas price model 70

II.2.1. Descriptive statistics of EUA, fuels and electricity price changes (%), 2008-2012 74

II.2.2. Results of the carbon model 80

III.1.1. Renewable electricity support instruments in member States 96

LIST OF Graphs

I.1.1. Real Unit Energy Costs as % of value added, manufacturing sector 12

I.1.2. Real Unit Energy Costs as % of gross output, manufacturing sector 13

I.1.3. Real Energy Price levels - Manufacturing 13

I.1.4. Energy Intensity levels - Manufacturing 13

I.1.5. Average annual change 1995-2009 - Manufacturing 14

I.1.6. Shift share analysis of manufacturing sector RUEC growth 15

I.1.7. Decomposition of Real Unit Energy Costs - Manufacturing 24

I.1.8. Annual Growth Rates 2000-2009 - Manufacturing 25

I.2.1. Natural gas production in the US and share of shale gas on total gas production 30

I.2.2. Energy mix US 30

I.2.3. Energy mix, EU 30

I.2.4. Energy Import Dependency 33

I.2.5. Wholesale natural gas prices in Germany, Japan, UK and US compared with crude oil price 34

I.2.6. Indices of real gas prices for end-users 35

I.2.7. End-user gas prices for industry 35

I.2.8. End-user electricity prices for industry 35

I.2.9. Indices of real electricity prices for end-users (2005=100) 35

I.2.10. Energy intensity of industry 36

I.2.11. Share of some Energy Intensive Sectors (EIS) and share of Manufacturing in GDP - 2001-2012 37

I.2.12. Energy intensity of industry, selected sectors 38

I.2.13. Energy trade balances as % of GDP, total and per energy source - 2001-2011, EU-27 and US 39

I.2.14. Current account balance, external balance for goods and bilateral balance for goods, 2001-201 - US and EU-27 40

I.A3.1. Real Unit Costs manufacturing sector including vs. excluding coke, refined petrol & nuclear fuels 47

I.A3.2. Shift-share analysis for the manufacturing sector including vs. excluding coke, refined petrol & nuclear fuels 48

I.A4.1. US Energy domestic production by source, 2000-2011 49

I.A4.2. EU-27 Energy domestic production by source, 2000-2011 49

I.A4.3. Electricity mix US, 2002-2011 49

I.A4.4. Electricity mix EU-27, 2001-2010 49

I.A4.5. Household expenditures for energy products, 2003-2010 - EU-27 and US 49

I.A4.6. Electricity prices for industrial consumers and households for the European countries in the OECD and for the US 50

I.A4.7. Energy consumption of industry breakdown by sources - US 50

I.A4.8. Energy consumption of industry breakdown by sources, EU 50

II.1.1. EU-27 Average domestic and industrial retail electricity price, wholesale price and crude oil price evolution 2004-2011 55

II.1.2. EU average change per electricity tariff component between 2008 and 2011 55

II.1.3. Retail and wholesale electricity average price changes by Member State 2004-2011 56

II.1.4. Retail electricity prices - Households and Industry 57

II.1.5. Average ratio of Industrial to Household electricity prices, relative to the EU-27 average, 2004-2011 58

II.1.6. EU-27 average domestic and industrial retail natural gas price and crude oil price evolution 2004-2011 58

II.1.7. Retail natural gas price evolution by Member State 2004-2011 58

II.1.8. Retail natural gas prices - Households and Industry 59

II.1.9. Average ratio of Industrial to Household natural gas prices, relative to the EU-27 average, 2004-2011 60

II.2.1. Evolution of EUA Futures prices 73

II.2.2. Evolution of carbon price, fuels and electricity prices over 2008-2012 73

II.2.3. Decomposition of Carbon Price Changes over 2008-2012 80

III.1.1. Share of Solar PV, Wind, Hydropower and other renewable sources in EU-27 gross electricity generation 92

III.1.2. Share of renewable sources in gross electricity generation by Member State in 2003, 2007 and 2011 93

III.1.3. Share of solar PV, wind, hydropower and other renewable sources in gross renewable electricity generation in 2011 93

III.1.4. Share of EU-27, US, China, Japan and Brazil in world net renewable electricity generation 94

III.1.5. Share of Eu-27, US, China, Japan and Brazil in world net electricity generation - solar PV (a) - Wind (b) 95

III.1.6. EU Member States with the highest support to renewable energy sources, 2010 96

III.1.7. Share of rewewable sources (excluding hydropower) in gross electricity generation and RES electricity support in EU Member States -2010 100

III.2.1. EU-27 exports and imports of solar components from Extra-EU 102

III.2.2. EU-27 exports and imports of wind components from Extra-EU 103

III.2.3. EU Member States intra and extra-EU imports (M) and exports (X) of solar components and equipment in 2012 108

III.2.4. EU Member States intra and extra-EU imports (M) and exports (X) of wind components and equipment in 2012 108

III.2.5. Average share of EU-27, US, China and Japan in world's total, renewable, solar and wind patents from 2000 to 2011 109

III.2.6. Average share of EU Member States in EU-27 total, renewable, solar and wind patents from 2000 to 2011 109

III.2.7. Average Revealed Comparative Advantage Indexes of solar and wind industries in the EU-27 Member States from 2007 to 2011 110

III.2.8. Average Revealed Comparative Advantage Indexes of solar and wind industries in the EU-27, USA, China and Japan from 2007 to 2011 110

III.2.9. Average relative trade balance Index of the solar industry in the EU-27, USA, China and Japan 110

III.2.10. Average relative trade balance Index of the wind industry in the EU-27, USA, China and Japan 111

III.2.11. Relative Trade Balance Indexes of solar and wind industries in the EU-27 Member States from 2007 to 2011 111

III.3.1. EU-27 trade deficit in energy products and crude oil prices, 2000-2012 112

III.3.2. Member States trade balance in energy products as % of GDP, 2012 113

III.3.3. Avoided imported fuel costs thanks to renewable electricity - 2010 115

III.3.4. Avoided imported fuel costs thanks to renewable electricity by Member States - 2010 116

III.3.5. Renewable electricity generation and avoided imported fuel costs - 2010 116

III.3.6. Avoided total fuel costs and imported costs thanks to renewable energy, 2010 117

III.3.7. Avoided fuel costs thanks to renewable use in heating and transport by Member States, 2010 117

LIST OF Boxes

I.1.1. Real Unit Energy Cost (RUEC), Nominal Unit Energy cost (NUEC), Energy Prices and Energy Intensity 10

I.2.1. Potentials and Uncertainties for Shale Gas Exploration in the EU and in the US 31

II.1.1. Third Energy Package 62

II.1.2. Literature Review 66

II.1.3. Methodology and Data 67

II.2.1. Literature on the interaction between energy and climate polocies 76

II.2.2. Methodology and Data 78

III.1.1. Renewable Energy Policies in the main EU economic partners 94

III.1.2. Electricity tariff deficit in some Member States 97

III.1.3. Renewable and Employment 99

III.2.1. Components in wind and solar industry 103

III.2.2. Measuring the drivers of trade in solar power and wind equipment 104

III.3.1. Assessing avoided imported fuel costs 114

Since 2008, the EU has made a huge leap forward in promoting the transition to a low carbon economy

In recent years, the EU has set an ambitious agenda to foster the transition to low carbon economies. The Climate and Energy Package adopted in late 2008 sets an EU-wide 20% greenhouse gas emission reduction target for the 27 Member States by 2020, 20 % share of energy from renewable sources in EU gross energy consumption by 2020 and a 20% decrease in primary energy use by 2020. At the core of this strategy is an objective of achieving greenhouse gas emissions reduction while improving security of supply and promoting the emergence of new green sectors. The recent crisis has not put a brake on this level of ambition as these 20/20/20 targets are part of a broad coordinated exercise of economic and fiscal policies in the context of the European Semester.

Energy costs matter…

Recently, the cost of energy has emerged as an important dimension of international competitiveness of European industries, in particular in light of the "shale gas revolution" taking place in the US. Energy matters for the competitiveness of our economies as it affects the production costs of industries and services and the purchasing power of households. Energy costs are not only driven by the type of fuel mix used and consumed, but they have been influenced by our energy policy choices as well as by technological evolutions that can contribute to reducing our energy needs. This report provides analysis and evidence for the economic impact of energy developments in the EU and Member States over the past years. It could contribute to discussions about economic aspects of energy and climate policies and how they can best contribute to fostering the transition to low carbon economies.

…but the EU manufacturing has been successful in reducing its energy intensity

The comparison of energy costs in Europe and Member States and in the rest of the world helps assess our economies in terms of energy cost competitiveness. Chapter I.1 develops unit energy cost indicators that bring together the energy price and the energy intensity dimensions. One salient feature is that the dynamics of energy costs has been positive in the EU, but also in the rest of the world. Another salient characteristic is that, in a global context, the EU manufacturing sector exhibits a low level of energy costs relative to both output and value added. This positive outcome is mostly explained by the low energy intensity of the sector. The EU manufacturing sector has so far responded to energy price increases through sustained energy intensity improvements, thus maintaining its relatively favourable position. Although not visible over the longer period (1995-2009), the latest period analysed (2005-2009) shows that these improvements have been driven partly by restructuring towards sectors with lower energy costs as energy intensive industries have been more affected by energy cost increase pressure. In addition, Member States with high share of energy intensive industries are most exposed to unfavourable unit energy costs developments.

High energy prices should remain a concern, taking account of the increasing EU-US energy price gap.

Against this background, one cannot ignore the recent spectacular development of the production of shale gas and oil in the US which has started in 2009-2010 and is often seen as a major competitiveness threat in the near future. Chapter I.2 provides a focus on more recent developments in the US and EU. While the surge in US shale gas has led to marked changes in the US energy sector and a reduction in the US energy trade balance in GDP terms, the impact on the EU is limited at the moment as no major shift in the EU-US goods trade balance nor significant divergent trends in the overall production structure of manufacturing industry are observed and can be ascribed to the shale gas revolution. However, this should not imply complacency on the widening EU-US energy price gap as the full impacts may become visible only after some delay. Moreover, energy efficiency improvements may slow down in the EU and speed up in US due to diminishing low cost options, and increased policy effort. Consequently, high energy prices for EU industries should remain a policy concern, even more so in case the EU-US energy price gap will continue to increase.

It is therefore strategic for the EU to see whether and how energy prices have been affected by policy developments. This report analyses three important components of energy cost – electricity and natural gas retail prices, and carbon prices. EU electricity and gas markets have been fundamentally reshaped by the significant energy and climate policy initiatives over recent years, in the areas of market opening, renewables penetration, climate change mitigation, and security of supply. The report explores the impact of these policy reforms on end-user electricity and gas prices as after all, these are what industries and households are ultimately paying. The report also looks at carbon prices as it is expected to provide the price signal to change our consumption behaviour and reduce our carbon footprint.

Market opening in electricity and natural gas has brought significant downward price effects. Renewable support has contributed to increasing electricity prices…

Analysis shows that while fossil fuels still remain key drivers of electricity and natural gas price formation, market opening and competition appear to have significant downward price effects for both household and industrial consumers. In both markets, empirical estimates confirm that EU energy policies, such as unbundling of networks and market opening lower retail prices. In addition to these positive developments, natural gas and electricity prices are also affected by specific factors. In the natural gas market, security of supply plays an important role. High import dependency and low diversification of imports can significantly contribute to increasing end-user prices for industries and households. Hence Member States which rely on one foreign source are likely to be exposed to higher prices. In the electricity market, support to less mature renewables technologies has translated in higher electricity prices for both industry and households segments. Furthermore, in some Member States, the burden has not been evenly shared across consumer segments, i.e. industries and households.

… while renewable production, among other factors have negatively affected carbon prices.

By contrast, the carbon price is not found to have any statistical significant impact on electricity retail prices. The latest data on carbon price evolution show that its level is far lower than what was expected when the Energy and Climate Package was adopted in 2008. As it is, although the carbon price is seen as one of the key pieces for the transition to low carbon economies, it fails to provide a strong price signal for consumption behaviour and for investments in clean production technologies. The empirical estimate carried out in chapter II.2 analyses the main drivers of carbon prices and shows that economic factors have played a major role in driving carbon prices in phase 2. Without any doubt, the recent economic crisis has contributed to lowering the demand of allowances, contributing to a large part to the ETS market imbalance, hence the decrease in the carbon price. However, the European carbon market is not isolated from other shaping factors such as the fuel switching behaviour of the conventional power producers and the renewable penetration among other drivers. There is evidence that the deployment of renewable production has also contributed to a lesser extent to this ETS market imbalance, therefore lowering the carbon price. Such results show the importance of economic factors in driving carbon prices, but highlight the interplay between energy and climate policies and ultimately the trade-offs policy makers are confronted to when designing climate change and energy policies combining market instruments and support mechanisms.

Compared to the rest of the world, the EU has been successful in developing wind and solar energy

Finally, the Energy and Climate agenda provides a comprehensive regulatory and policy framework that favours the emergence of new green sectors. This means that energy markets in the context of well-designed policies, can offer many opportunities for growth and jobs ([1]). The report scrutinises the development of new technologies and energy sources - solar and wind - and their impact on trade flows as a way to assess one dimension of competitiveness. Chapter III.1 provides an overview of what happened in the EU and other parts of the world. In Europe, the support to renewable sectors stepped up from 2007 and has represented a strong opportunity to accelerate the expansion of less mature technologies such as wind and solar. Compared to the rest of the world, the EU has been one of the frontrunner in developing wind and solar energy although other countries have been catching up since.

The EU has developed strong positions in the wind equipment sector…

The expansion of renewables provided opportunities in terms of industrial equipment and trade flows. Chapter III.2 gives a closer look at trade developments in the EU and Member States in the wind and solar sector. Evidence shows that the EU displays strong comparative advantages in the wind industry, but has not managed to develop such position in the solar industry. When analysing the drivers of trade of wind and solar equipment, one interesting result is the role of knowledge in driving trade flows, with the EU export performance being strong in technologies where the EU has a strong portfolio of patents. This suggests that innovation and R&D policies should be seen as key policies in promoting the emergence of new green sectors.

… but the fuel costs avoided by renewable developments are still too low.

Another expected benefit of developing renewable is the impact on the energy trade bill and its contribution to reducing our energy dependence. The EU dependence on fossil fuels is higher than in the US, and the EU27 trade deficit in energy products amounted to 3.2% of GDP in 2012. Chapter III.3 shows that renewables help reduce import fuel costs and contribute to improving the energy trade balance, but only to a limited extent. Nonetheless, the avoided fuel costs are expected to rise in the coming years, due to increasing production of renewable energy in the EU and projected increase in EU fossil import prices.

This part analyses energy cost competitiveness. The cost of energy has emerged as an important dimension of international competitiveness of European industries, in particular in light of the "shale gas revolution" taking place in the US. Energy matters for the competitiveness of our economies as it affects the production costs of industries and services and the purchasing power of households.

Chapter 1 introduces the concept of Unit Energy Costs (UEC). Similarly to Unit Labour Costs, the UEC indicator measures the energy cost per one unit of value added, in a given sector or in an aggregation thereof. This indicator enables to compare the relative importance of energy inputs – or in other words the sensitivity to energy price shocks - of a given sector over time. The UEC indicator brings together two key components of energy competitiveness: the value of energy inputs and energy intensity.

Chapter 2 analyses the impacts of the development of shale gas, always through the same integrated approach, i.e. observing the parallel evolution of energy intensity and energy prices in the EU and in the US. It discusses how the introduction of shale gas has affected the US and EU energy sectors, the development in the EU-US energy price-gap and in the trade balances for the EU and US in terms of energy trade, of current accounts and trade of goods.

1.1. Introduction

Energy is a key input in many production processes. For this reason, its costs represent a competitiveness factor for manufacturing industry, with the intensity of use next to the energy price as the major drivers. However, another equally important factor is the intensity of its use. In order to provide a more comprehensive assessment of the role that energy plays in determining industrial competitiveness, these factors shall be looked at in combination, the same as it is done for other inputs such as capital and labour.

The objective of this chapter is to assess energy cost competitiveness using unit energy cost indicators. Section 1.2 describes the concept and methodology used to build these indicators. Section 1.3 provides an international comparison of unit energy costs in Europe and other parts of the world. Section 1.4 focuses on sectoral developments while section 1.5 assesses Member States unit energy costs development. Conclusions are presented in section 1.6.

1.2. Assessing Unit Energy costs

1.2.1. Introductory remarks on the role of energy in the production process

Energy is a key aspect of competiveness. This follows from the energy's essential role in the production process of goods and services. Hence, an economic analysis of energy cost competiveness cannot limit itself to energy prices but needs to consider indicators which inform on how energy prices and energy use affect production decisions. Energy costs, energy productivity and energy intensity are such indicators which can be analysed.

The role of energy in production can be empirically analysed by using analytical frameworks firmly based on economic theory. Often, the production function is employed in such analysis, as it expresses in a mathematical form how the output of the production process is related to the production inputs. Two basic assessment methods rely on the production function concept, namely growth accounting and econometric studies on the production function. Decomposition based on the input-output method has a close relation to both methods.

As regards the first method, growth accounting is an empirical method which allows the identification of the sources of growth of output. Under the conventional assumptions of constant returns to scale and production input prices equal to their marginal productivity, it is possible to derive from a further unspecified production function that output growth is a weighted average of the growth of the production inputs with the cost shares of the various inputs as weights plus a remainder term called "multi-factor productivity" generally associated with technical progress. However, growth accounting as a method cannot be used to analyse the causes of changes in energy costs, intensity and productivity.

Growth accounting is more complicated at industry level than at macroeconomic level since intermediate deliveries between industries and also within a given industry serve both as input and output, rendering it more difficult to link the industry "multi-factor productivity" terms to economy-wide measures of productivity (Hulten 2009). For a growth accounting analysis at macro level, production output can be expressed in value added ([2]) since the costs of intermediate inputs cancel out against the gross income of delivering these inputs in the derivation of GDP (which thus equals GDI). At industry level, however, the intermediate deliveries do not cancel out, so one can argue in favour of gross production rather than value added as the appropriate output variable. For instance, O'Mahony and Timmer (2009) present as basis for industry-level growth accounting the so-called KLEMS production function which has gross production as output variable and capital (K), labour (L), energy (E), materials (M) and services (S) as production inputs. The contribution to overall growth by each production and intermediate factor is given by the product of its share in total cost and its growth rate. As observed by Hulten (2009), the weights for the primary production factors, capital and labour, are smaller than is the case for a "value added" production function, since industry gross output is bigger than industry value added. Hulten (2009) also notes that the gross output approach is sensitive to the degree of vertical integration of an industry, as a vertical merger of an industry with some of its suppliers could lead to the statistical elimination of intermediate flows. The same reasoning applies when an industry decides to outsource some energy-intensive parts of the production process either within the same industry or to other industries in the same country or to low-energy cost countries. While Hulten (2009) observes that the gross production approach is tainted by statistical problems regarding intermediate deliveries, he recalls that the choice between value added or gross output should take account of the specification of technical change. Hence, he cautions against the use of value added as industrial output variable since "it implies (improbably) that efficiency-enhancing improvements in technology exclude material and energy" (ibidem, p28).

The second method using the production function concerns direct econometric estimation of the production function (or, relatedly, the cost function) at industry level. This allows for estimating the output, substitution and price elasticity for the different input factors such as energy. The economics literature provides a wide array of studies varying considerably in aggregation level, in the coverage of sectors, countries and time period; and estimation method. Also the standard assumptions of constant returns to scale and competitive pricing (i.e. the absence of mark-ups) can be relaxed (Ecorys & CE, 2011, ch.4) Often the production function used has the shape of a translog function and mostly gross production is the output variable of choice, but value added is occasionally used as well, mostly for data availability and data quality reasons. For example, Krishnapillai and Thompson (2012) estimate for the US a production function for industrial value added, distinguishing capital, labour and electricity as production inputs; the estimated price elasticity suggest that electricity, capital and labour are substitutes.

The analytical framework underlying the input-output-table allows for a rigorous analysis of differences in industrial cost structures either over time or over countries / branches of industry. The point of departure is total gross production at industry level. One can directly relate the change in output to the corresponding changes in the cost shares of the various primary and intermediate inputs (up to the desired level of aggregation), such as for energy as a whole. However, this leaves out the indirect effects underlying the changes of the intermediate inputs. More formal decomposition methods allow for assessing the relative role of changes in input prices and input quantities in the overall change of sectoral costs. Fujikawa et al. (1995) compare the cost structure for industry sectors in Japan and US; they derive from the price version of the input-output model a decomposition of cost differences into a primary input price component, a primary input technology component and an intermediate input technology component, all three of which can be further divided into a direct and indirect component (i.e. following from deliveries from other sectors). The role of energy in relative productivity developments between countries has been studied with such decomposition methods, among others by Jorgenson and Kuroda (1992).

In addition to these elaborated analytical methods, one can also directly compare (unit) energy cost levels and developments over time and /or between countries outside of the input-output framework, hence without any restrictive assumption on the relation between output and the defined inputs. This allows much more freedom in choosing the output indicator, gross production, value added or even other indicators. These statistical decomposition exercises tend not to be reported in the economics literature, unless it involves an innovation in method. Among others, the US Department of Energy (2003) decomposes the index of energy use into the multiplicative relation of an activity index, an index on structure (changes in the composition of the economy or sector at hand) and an index of energy intensity or productivity. This index approach only accounts for changes relative to a base year and not for difference in levels (in the base year). One of the advantages is that one can choose for each of the (sub)-sectors / activities in the sector under study the best output variable possible.

(Continued on the next page)

Box (continued)

In this chapter, the approach proposed uses the input-output table as a starting point but it is not based on input-output-analysis. Compared to the range of methods presented above, the decomposition of energy costs proposed here is relatively straightforward. The comparison is between many countries whereas the literature, as reviewed above, tends to focus on a single or only a few countries. Because of the lack of clear guidance from the literature whether to use value added or gross production and for reasons of data availability and quality, the unit energy cost concept used here has followed the convention of using value added as benchmark (Box I.1.1). This seems fairly unproblematic since this decomposition is statistical and not embedded in a theoretical framework. Moreover, such a convention underlines the direct analogy with the study of unit labour costs and its split labour costs per worker and labour productivity. However, the analogy should be handled with care as energy is an intermediate input and not a primary production factor.

1.2.2. Unit Energy Costs: Concept and Methodology

This section introduces the concept of Unit Energy Costs (UEC). Similarly to Unit Labour Costs, the UEC indicator measures the energy cost per 1 unit of value added, in a given sector or in an aggregation thereof. This indicator enables to compare the relative importance of energy inputs – or in other words the sensitivity to energy price shocks - of a given sector over time ([3]). The analysis focuses on the manufacturing sector and 14 subsectors of manufacturing as these sectors are characterised by a relatively higher use of energy than others. Services are not analysed due to their low energy intensity([4]).

As Unit Labour Costs combine wages and labour productivity, the UEC indicator brings together two key components of competitiveness: the value of energy inputs and energy intensity, which is the reciprocal of energy productivity. In addition, in order to differentiate between pure energy-related effects and macroeconomic developments such as fluctuations in the exchange rate and inflation differentials, a distinction is made between Real Unit Energy Cost (RUEC) measuring the energy-related effect and Nominal Unit Energy Cost (NUEC) which incorporates both components (See Box I.1.1 for more details). The RUEC can then be decomposed into the real price of energy inputs – deflated with the value added deflator, hence helping to measure energy inflation above the inflation of the given sector – and energy intensity.

To summarize the different factors of NUEC:

NUEC = RUEC * nominal effect = real energy price * energy intensity * nominal effect

While the nominal effect is important from an international competitiveness perspective as businesses make their decisions on the basis of nominal values, the nominal effect of this decomposition is determined by factors that are not related to energy markets such as monetary policy, inflation expectations, financial market and labour market developments and exchange rate evolution. This analysis focuses on the energy-related effects, therefore it concentrates on the RUEC while the NUEC is presented only to illustrate how nominal developments complemented the pure energy effect.

The RUEC and NUEC indicators should be interpreted in comparison among different countries. While the level of RUEC indicates the importance of energy inputs and sensitivity to energy price shocks, an increase that is greater than in other countries can signal an increased vulnerability of this sector to energy costs, but it could also reflect a restructuring of production towards more energy intensive production processes. Therefore, it is necessary to analyse the level and evolution of the price of energy inputs and energy intensity as well. Moreover, to address the issue of potential restructuring on changes in the RUEC, a shift share analysis is carried out, which is a common method to disentangle the effects of restructuring from the growth of an aggregate indicator (see below).

1.3. Unit Energy Costs: an International Comparison

This section analyses the developments of energy costs and their drivers for the manufacturing sector in a global comparison.

1.3.1. Real Unit Energy Costs

As mentioned above the level of Real Unit Energy Cost measures the amount of money spent on energy sources needed to obtain 1 unit of value added. Their evolution thus combines the energy component of the sector's inflation and the energy intensity of the sector.

Compared to its main economic partners, the EU manufacturing industry had in 2011 the third lowest RUEC in terms of value added after Japan while the US, after the hike of 2008, falls back to the just below the level of the EU in 2011 (Graph I.1.1). China, Russia and other major economies such as Brazil and Indonesia show substantially higher values than the EU ([5]).

The evolution and levels of energy costs over value added, and energy costs over gross output in manufacturing are broadly similar across developed countries such as the EU, US and Japan. This prominent feature is to a large extent explained by the industrial specialisation pattern towards high valued added sectors. By contrast, this is not the case for developing countries. A part of this difference can be explained by the fact that countries such as Russia, China or India and Brazil have more energy intensive production structures, specialized in sectors where energy inputs play a comparatively bigger role. Moreover, these production processes are often characterized by lower value added. This is confirmed when looking at the difference between the energy costs as a percentage of value added (RUEC) and as a share of gross output (Graph I.1.2). For the EU, Japan and the US, the RUEC are around three times higher than the share of energy costs in gross output. For countries such as China, India and Brazil the RUEC are four to five times higher, implying that the difference between gross output and value added for these countries is greater. The exception is Russia where the difference of RUEC and the share of energy costs in gross output is similar to that of the EU.

Graph I.1.1: Real Unit Energy Costs as % of value added, manufacturing sector

Source: Commission Services based on WIOD database.

Graph I.1.2: Real Unit Energy Costs as % of gross output, manufacturing sector

Source: Commission Services based on WIOD database.

It is interesting to note that, since 2006-2007, real energy costs as a share of gross output in the US increased much more than in the EU and this evolution has been confirmed in 2010-2011. As the levels of RUEC expressed in terms of value added are similar, this may imply that the US are able to extract higher value added from their production than the EU.

The EU's RUECs have steadily but slowly increased over time, a trend however that is also observed in the other major world economies. This signals the increasing importance of energy cost pressure on the manufacturing sector's value added on a global scale: for all the countries considered the energy costs have, as a matter of fact, increased proportionally more than the value added. If the refinery sector is excluded from the calculation of the RUEC (Appendix 3) the levels decrease substantially (more than halved) and the ranking of the countries changes with the US displaying the lowest level of RUEC, followed by the EU and Japan ([6]). This result indicates the importance of the refining sector in the US and it also highlights the fact that in the other industrial sectors, less dependent on oil, the RUEC level is higher in the EU than in the US. However even excluding the refinery sector, the EU RUEC remains among the lowest in the world.

1.3.2. The drivers of the Real Unit Energy Costs ([7])

The RUEC is decomposed into real energy prices and energy intensity.

Japan and the EU are the two regions where the real energy prices are the highest in levels. However the evolution of real energy price has been similar for the four countries considered and it appears highly linked to the global oil price's fluctuation. With the oil price hike of 2008 however Japan and the US have registered a more severe increase in real energy prices than the EU and China signalling their greater sensitivity to oil prices.

Graph I.1.3: Real Energy Price levels - Manufacturing

Note: Energy prices deflated with value added deflator of the manufacturing sector (in 2005 USD) Source: Commission Services based on WIOD, ESTAT and World Development Indicators databases.

Graph I.1.4: Energy Intensity levels - Manufacturing

Note: including feedstock Source: Commission Services based on WIOD, ESTAT, OECD and World Development Indicators databases.

At the same time the EU and Japan have the lowest levels of energy intensity while the US and China ([8]) show considerably higher levels. China and to a limited extent the US have been converging towards the European and Japanese levels. It is to note that graph I.1.4 shows energy intensity including feedstock. The level and trends of energy intensity would change if feedstock were excluded as shown in chapter 2 (graph I.2.10). Considering only final energy consumption, the catching up process of the US seems to have halted after 2009 while the EU performance keeps improving. The difference reveals another potential vulnerability for the EU industry, that is the cost pressure on EU industries stemming from the supply of energy sources to be used as raw material.

Graph I.1.5 summarizes the annualised growth rates of RUEC and of their two drivers.

Graph I.1.5: Average annual change 1995-2009 - Manufacturing

Note: Energy Intensity includes feedstock Due to data limitation the assessment of Energy intensity and Real energy prices stops at 2009. Therefore to allow comparability the growth rates of RUEC have also been computed only up to 2009. Source: Commission Services based on WIOD, ESTAT, OECD and World Development Indicators databases.

Japan is the country that faced the fastest increase in RUEC during the 15 years considered. A result that was brought about by a large increase in real energy prices compensated only partially by very little improvements in the terms of energy intensity. This indicates that the country suffered from strong energy cost pressure that was not compensated via a reduction of energy intensity.

China on the other hand shows the slowest increase in RUEC despite the fastest increase in real energy prices; substantial energy intensity improvements have counterbalanced the upward pressure of the real energy prices. China started from very high levels of energy intensity and had therefore greater margins to improve.

The EU and US have evolved in a very similar fashion and the increase in RUEC has been almost the same in the two regions. On average the real energy price increase has been slightly faster in the US than in the EU and was compensated by an equally slightly faster improvement in energy intensity performances (bearing in mind that the absolute levels of the two indicators are very different). The EU and the US have followed therefore very similar patterns where the differentials in real energy price levels have been matched by equally distant levels of energy intensity which translated in almost equal levels of RUEC.

1.3.3. Disentangling the effect of industrial restructuring on the growth of RUEC

It is also interesting to analyse to what extent the developments in energy costs of the manufacturing sector were driven by (1) energy cost pressures apparent in all subsectors and/or (2) a restructuring taking place among subsectors. For instance when facing strong energy cost pressures, the industry may respond by reallocating resources from sectors with high energy costs to others with low energy costs. This would then result in a decline in the market share of high energy cost industries, while those with low energy costs would see a rise in their share.

In order to investigate the effects of these two factors, a shift share analysis is carried out. The RUEC in the total manufacturing industry can be interpreted as the weighted average of the RUECs of the subsectors making up the manufacturing sector with the weights being the shares of subsectors in total manufacturing value added. This way, changes in the RUEC of aggregate manufacturing can be broken down into two distinct effects: a change in the RUECs of subsectors (energy cost effect) and a change in the shares of subsectors in total manufacturing (restructuring effect) along with a dynamic interaction component of the two effects ([9]). In particular, the shift-share analysis decomposes the growth of RUEC into the following three components ([10]).

Within subsector effect: This shows what would be the growth of RUEC of the total manufacturing sector if the shares of the subsectors had stayed unchanged throughout the period of analysis. Therefore this effect shows the pure energy cost pressure filtering out the effect of restructuring.

Restructuring effect: This measures the contribution of changes in value added shares of the different subsectors to overall manufacturing RUEC growth keeping the RUECs of subsectors unchanged. This component therefore shows the static restructuring effect. For instance a negative restructuring effect could show that the share of industries with high energy costs has fallen, thereby reducing RUEC growth.

Graph I.1.6: Shift share analysis of manufacturing sector RUEC growth

Source: Commission Services based on WIOD.

Interaction effect: This term captures the dynamic component of restructuring by measuring the co-movement between RUECs and value added shares. If it is positive, it signals that energy costs are rising in subsectors that are expanding, and/or they are falling in shrinking sectors, i.e. the two effects complement each other. If it is negative, then RUEC growth is positive in shrinking sectors, and/or negative in expanding sectors, i.e. the two effects are offsetting each other. A negative interaction effect could signal that businesses in a country are reallocating resources from high to low energy cost sectors in response to rising energy costs.

Looking at the shift share analysis of manufacturing sector RUEC growth in the period 1995-2011, the main result is that the bulk of RUEC growth in EU27, Japan and China were driven by the within effect; i.e. energy cost increases within sectors (Graph I.1.6). There is no evidence of a significant restructuring effect in the EU during this long period. In contrast, RUEC growth in the US was dominated by the static restructuring effect, i.e. by an increase in the share of high energy cost industries, particularly of the coke and refined petrol industry. Overall these developments may signal an increased specialisation of US manufacturing in high energy cost production with respect to other countries ([11]).

Table I.1.1: Average % annual change 1995-2009 - Manufacturing

Note: Energy Intensity includes feedstock. Due to data limitation the assessment of Energy intensity and Real energy prices stops at 2009. Therefore to allow comparability the growth rates of RUEC have also been computed only up to 2009. Source: Commission Services based on WIOD, ESTAT, OECD and World Development Indicators databases.

The picture is changed if the shift share analysis is decomposed into three shorter periods. The period 1995-2000 was characterised by a marked increase in RUEC dominated by the within subsector effect in the EU, US and Japan. The period 2000-2005, however, brought significant differences with the US being the only country with a negative within subsector effect. At the same time the US showed a very large positive restructuring effect which was mitigated to some extent by a negative interaction term. Overall this indicates that the US started specialising in high energy cost production already in this period ([12]). Finally, the last period – 2005-2011 – includes the beginning of the development of shale gas in the US as well as the peak in oil prices of 2008 and the subsequent fall in 2009 and has brought a significant adjustment and restructuring on a global scale. While the RUEC of the EU rose only moderately, this was due to a limited restructuring – both static and dynamic – away from high energy cost sectors offsetting a pure energy cost effect which was substantially higher than in the other countries. In the US, RUEC increased visibly less than in the EU over this period. Once again a positive restructuring effect can be observed, and is brought about by the continuous growth of some energy intensive sectors, in particular coke and refined petrol. Japan saw a positive within subsector effect with a positive restructuring effect and its RUEC grew more than in the US and in the EU. Finally, China experienced positive but modest within subsector effect and a similarly modest negative restructuring effect.

The shift share analysis of the manufacturing sector excluding the coke, refined petrol and nuclear fuel sector helps to single out the relevance of this sector in the evolution of the RUEC and of the industrial composition of the countries (Appendix 3). The restructuring effect observed with the full data set essentially disappears once the refinery sector is excluded. This is most evident in the US where in the period 1995-2011 the shift share analysis reported above in Graph I.1.6 displays a very big positive restructuring effect while excluding the refinery sector this effect is no longer present. This points to the increased relevance of this sector in the US economy over the past years which is also confirmed when looking at the growing contribution of the sector to the total industrial GVA of the US. Another important observation can be made looking at the period 2005-2011 which includes the shale gas production surge. By excluding the refinery sector highly dependent on oil products, the RUEC growth in the US is actually negative. This is probably due to the substantial reduction in electricity and gas prices which shale gas has made possible. In the EU the difference between the shift share analysis with or without the refinery sector is also significant. For a start the growth of RUEC is greatly diminished, over both the longer period 1995-2011 and the shorter period 2005-2011. This implies that oil price dynamics play a major role in determining the energy costs of the manufacturing sector. The less dependent a sector is from oil products the less it appears to be exposed to real unit energy costs increase. The second observation is that once the refinery sector is excluded from the analysis the small negative restructuring effect observed over the period 2005-2011 disappears, implying that it was mostly related to this sector ([13]).

1.3.4. Nominal Unit Energy Costs

Table I.1.1 presents the decomposition of the different elements of NUEC and can be read from left to right in an (approximately) additive manner. The nominal effect represents the difference between RUEC and NUEC and it measures the combination of sectoral inflation and exchange rate fluctuations.

The table shows that nominal developments have added some pressure to the energy costs of the EU over the period 1995-2009 as compared to the US and Japan as shown by the higher average growth rate of nominal effect for the EU than for the US and Japan. With US dollar being the common currency of comparison, the nominal effect of the US is close to 0 ([14]). On the other hand Japan has gone through a period of internal deflation which resulted in a negative nominal effect partially offsetting the evolution of the RUEC. China experienced the lowest annual change in RUEC complemented by a sizeable increase of the nominal effect and therefore has experienced the fastest increase in NUEC. This means that other sectoral price and exchange rate dynamics have added upward pressure to the pure energy-related effects captured by the RUEC in China.

1.4. Unit Energy costs: A sectoral comparison

A more disaggregated analysis involving 14 manufacturing subsectors shows that most of these subsectors in the EU have a generally low unit energy costs per value added in an international comparison ([15]).

Certain sectors in the EU show however a significant vulnerability because of their high RUEC levels and/or RUEC growth rates in a global comparison, indicating elevated sensitivity to energy-cost pressures (Table I.1.3 and Table I.1.2). Overall the sectoral analysis confirms that the low unit energy costs level for the total manufacturing industry of the EU hides a substantial heterogeneity among subsectors. This highlights the need for more disaggregated sectoral analysis as it is possible that some subsectors of manufacturing show high vulnerability to energy inputs despite the fact that energy costs are very low for total manufacturing. A more detailed split could reveal even more vulnerabilities within sectors. In this sense the top-down approach applied here – from a high to a medium level aggregation – should be interpreted as complementary information to more disaggregated sector-specific analyses.

In the food, beverages and tobacco sector the RUEC of the EU were the second highest in 2009. They showed a similar pattern to that of the US, but both of them were performing significantly worse than China and Japan. Energy intensity improvements in the EU have been rather limited but Japan and the US deteriorated their performances. The real energy price increased faster in the EU than in either Japan or US although in absolute levels the EU is still below Japan. Compared to 2011 the RUEC of the EU have increased while in the US they have decreased, this was however matched in both countries by a small decline in the share of the sector in total manufacturing value added.

The textile industry of the EU has performed substantially worse than that of the US and Japan in terms of RUEC and their level is also higher than in China, both in 2009 and in 2011. The energy costs of the Chinese textile industry showed a marked upward trend and reached similar levels to that of the EU at the end of the sample. The increasing trend of China and the stable trend of the US could be a sign of outsourcing although data availability does not allow the assessment of the evolution of energy intensity and real energy prices in the two countries. The good performances in terms of energy intensity in both the EU and Japan have been met by opposite trends in terms of real energy prices which translated into similar annual increases of RUEC.

The developments in the leather and footwear sector are in many ways similar to those of the textile industry. The EU, Japan and China have reached similar levels in the second half of the sample period in terms of RUEC. The US reached a considerably lower level by 2009, and again the opposite trends between the US and China raises the possibility of potential outsourcing. As with most other sectors, Russia exhibited by far the highest levels of RUEC throughout the entire period. Both the textile and leather sectors have experienced a sharp decline in the share of manufacturing value added in Japan, Russia and US, while the decline in the EU and China was much less evident during this period. Data from 2011 confirms the trend of the previous period.

In the wood and wood product industry the EU has shown the second lowest RUEC following Japan. The pattern of marked improvement in 2009 for the US is not visible in this sector, in fact, RUEC was trending upwards in US over the entire period of analysis, much so than in any other of the five countries. China was slightly above the EU while Russia was fluctuating at a considerably higher level. Unlike for other sectors, the energy intensity performances of the EU and Japan have deteriorated but have been matched by a moderate decrease in real energy prices similarly to Japan. In the US the increase in real energy prices has been much faster than the decrease in energy intensity. In 2011 however the RUEC in the EU, Japan and China continues to increase while the opposite happens in the US.

Table I.1.2: Sectoral breakdown: decomposition of RUEC and annual growth rates 1995-2009

Note: Energy Intensity includes feedstock. Due to data limitation the assessment of Energy intensity and Real energy prices stops at 2009. Therefore to allow comparability the growth rates of RUEC have also been computed only up to 2009. Source: Commission Services based on WIOD, ESTAT, OECD and World Development Indicators databases.

In the pulp, paper and printing sector the EU has been performing in line with the US with Japan also reaching similar RUEC levels at the end of our sample. China and particularly Russia showed higher levels of RUEC. The almost stable performances in terms of energy intensity in the EU means that the increase in real energy prices has been therefore almost symmetrically translated into higher energy costs for EU industries although the trends in the US and Japan are broadly comparable. As for the other sectors, data for 2011 show an increase in RUEC for EU, Japan and China while the opposite is true in the US and to a lesser extent Russia.

The production of coke, refined petrol and nuclear fuel is the sector that shows the worst performance in the EU with RUEC several times above the levels of US, Japan, China and Russia. RUEC in this sector showed a steep upward trend

Table I.1.3: Sectoral breakdown: decomposition of RUEC and annual growth rates 1995-2009

Note: Energy Intensity includes feedstock. Due to data limitation the assessment of Energy intensity and Real energy prices stops at 2009. Therefore to allow comparability the growth rates of RUEC have also been computed only up to 2009. Source: Commission Services based on WIOD, ESTAT, OECD and World Development Indicators.

in the period 1995-2009 in the EU unlike in any other country analysed here which indicates an increasing vulnerability. Looking at energy costs as a share of output – not reported here – would show a somewhat better relative performance of the EU suggesting that this sector is suffering not only from high energy costs but also from low and drastically worsening value added in a global comparison. The oil-price shock of 2008 had a significant upward effect on the RUEC of all the five countries, the EU however further increased its RUEC in 2009 while in the other four countries a reduction took place, bringing the levels back to pre-2008. However, the share of the sector in manufacturing valued added for the EU was and remained very small. At the same time the sharp increase of the share in Russia and the US need to be recorded as it signals the growing importance of coke and refinery activities in these two countries. Data for 2011 show that while in the EU the RUEC have further increased, an inverse trend is observed in the US where the sector reached almost 10% of total manufacturing value added.

In the chemicals and chemical products sector the EU has shown the lowest RUEC together with the US in the period of analysis ([16]). The low levels of energy costs of the EU and US significantly outperformed the other countries and also present the lowest growth rates. In 2011 RUEC increased in both regions. Russia and China showed the highest levels of RUEC throughout most of the period of analysis. A marked improvement is visible in Russian RUEC in the years of the Russian financial crisis (1998-99). This pattern is visible for many other sectors as well, but the improvement was only temporary and RUEC returned to pre-crisis levels in the following years. For the EU the fast increase in real energy prices which outpaced that of the US and to a lesser extent that of Japan, was counterbalanced by significant improvements in energy intensity which both in levels and progress way outperform the two competitors.

In the rubber and plastics sector, during the period 1995-2009, the EU has performed relatively well together with the US and Japan, while China and especially Russia exhibited much higher levels of RUEC. However the EU registers in 2009 higher RUEC than Japan and US and has the highest growth rate since 1995 mostly driven by the deterioration of its energy intensity. Looking at the components of RUEC it is to note that the EU had in 2009 the highest levels of energy intensity (compared to Japan and US) and unlike the other two countries did not record any improvement. The EU compensated partially with a lower real energy price than both Japan and US and with lower growth rates. In 2011 the RUEC in the EU and Japan continued to increase while in the US they significantly reduced, at the same time the contribution of the sector to the manufacturing value added remained broadly unchanged.

In the non-metallic mineral sector and the metals sector the EU showed a much lower level of RUEC than Japan, China and Russia. The EU, however, was performing worse than the US and the gap in favour of the US has increased also in 2011. RUEC growth rates in the EU have been anyway the lowest among the five countries, mostly driven by energy intensity good performances. Energy intensity in the EU was in 2009 the lowest and it has experienced the most significant improvements while for Japan it actually deteriorated. At the same time, while the level of real energy prices is comparable in 2009 the EU experienced faster growth rates than both Japan and the US.

In the sector of machinery the RUEC of EU, Japan and US have had comparable very low levels in the entire period. The US is the country with the lowest level of RUEC and the only one for which the growth rate is negative. This positive evolution has been mostly driven by a decrease in real energy prices while energy intensity slightly deteriorated. US RUEC further decreased in 2011 while in the EU they remained stable. This happened in a context of increase in share of the sector in total manufacturing value added, in both regions. China has shown a moderately increasing trend and reached a level that is substantially higher than that of the other three economies. Russia in turn exhibited the highest RUEC in this sector but lower growth rates than China and also Japan. Energy intensity in the EU decreased rapidly but on the other side real energy prices increased at almost the same pace. In the US conversely energy intensity did not improve but real energy prices decreased by an average of only 1% per year.

In the electrical and optical equipment sector the EU, US, Japan and China started from similar levels of RUEC but have shown a remarkable divergence in the period of analysis. This concerns primarily the US and China, where the opposing trend again suggest the possibility of outsourcing of energy-intensive processes from the US to China. The EU exhibited a relatively constant RUEC which put it at the second lowest level after the US in 2009. Japan showed a mild increase over the period, while Russia fluctuated again at a substantially higher level. The dramatic collapse in energy intensity matched by an almost equally fast increase in real energy price in the US tends to confirm the assumption that the country may have experienced a substantial relocation of energy intensive activities. However the simultaneous increase in the share of the sector in the manufacturing value added signals that the US industry focused on innovation and higher valued added activities. Japan also presents similar features. This trend is confirmed also by looking at 2011, where the share of the sector in the manufacturing value added further increased while RUEC decreased. The EU also recorded remarkable improvements in energy intensity although compensated by a significant increase in real energy prices.

In the sectors of recycling and transport equipment the EU has shown a significantly higher RUEC than the US and also of Japan, a gap that has further widened in 2011. In transport equipment the performance of the EU was more or less in line with that of Japan. China was fluctuating at a higher level and Russia at an even higher level in the transport equipment sector. However the collapse of energy intensity registered in Japan in the transport equipment sector could be the consequence of a drastic industrial restructuring and outsourcing of the most energy intensive activities in favour of lower energy intensive production with comparatively greater value added. EU RUEC in 2011 decreased slightly while an increase was registered in the other countries. On the other hand in recycling the EU has worsened its energy intensity performances while recording only a moderate increase in real energy price. The US shows the opposite picture, rapidly falling energy intensity matched by an increase in real energy prices which resulted in small decrease of RUEC over the 15 years considered.

In sum, the sectors that are most exposed to energy price shocks in terms of high RUEC levels in the EU are coke and refined petrol, chemicals, non-metallic mineral, metals, rubber and plastics. Coke and refined petrol stands out with much higher RUEC levels than in other countries and a growth rate that is also among the highest ones. This indicates significant vulnerability of this sector, though its share in total manufacturing value added of the EU has been low and stable. In contrast, US, Japan and Russia have seen a significant increase in this share. In the other four sectors with high energy cost vulnerability (chemicals, non-metallic mineral, metals, rubber and plastics) the EU shows RUEC levels that are generally comparable with those of Japan. The EU levels are, however, noticeably higher than the US in chemicals, non-metallic mineral, and metals. Nonetheless in all four sectors the figures of the EU remain substantially lower than those of China and Russia. In terms of the growth rates of RUECs, the four sectors in the EU perform generally in line with other countries with some variability observable.

Data for 2011 show that for all sectors the RUEC have generally increased in all countries, except in the US where the picture is more mixed and most sectors actually recorded a decrease. Although EU RUEC are above the US for all sectors in 2011, they are similar for total manufacturing due to the different composition of the manufacturing value added in the two regions. It is nonetheless interesting to note that two of the four sectors in the EU where the contribution to the manufacturing value added has increased are among the most energy intensive sectors such as: coke and refined petroleum products; basic metals and fabricated metals.

1.5. EU Member States assessment

The evolution of RUEC for EU Member States ([17]) between 2000 ([18]) and 2009 is in general characterised by an upward trend. With the exception of a handful of countries most Member States saw their RUEC increase on average by 47%. The biggest increases in percentage terms were recorded in Ireland (89%) followed by Malta (70%), Sweden, France and Belgium (around 60%). The upward trend is broadly confirmed with the data for 2011([19]) with the exception of Ireland and Germany where RUEC have been reduced. Looking at the evolution between 2000 and 2011 the Member States with the greatest percentage increase were France (144%) Belgium (124%) and Finland (111%). On the other hand Cyprus, Slovakia, Romania and the Czech Republic recorded a decrease in RUEC.

The heterogeneity in levels is rather wide. For some Member States the RUECs are sensibly lower than the EU average while others on the contrary display levels that are significantly higher, not only than the average but also than the levels of their main international competitors (Graph I.1.7). In absolute terms Ireland and Malta, together with Luxembourg, Slovenia and Austria, display the lowest levels of RUEC in 2000, 2009 and 2011. The highest levels were reached by Bulgaria which however recorded a percentage increase well below the EU average (7.9%, between 2000 and 2011) and Lithuania, followed by the Netherland, Greece, Belgium and France.

The evolution of energy costs at Member States level is analysed in combination with the trends of energy intensity and real energy prices presented in Graph I.1.7.

Graph I.1.7: Decomposition of Real Unit Energy Costs - Manufacturing

Note: Energy Intensity includes feedstock. Due to data limitation the assessment of Energy intensity and Real energy prices stops at 2009. Therefore to allow comparability the growth rates of RUEC have also been computed only up to 2009. Source: Commission Services based on WIOD, ESTAT and OECD.

The Member States with the highest levels of energy intensity in 2009 were Lithuania, the Netherlands and Slovakia. However, it is to note that Bulgaria had until 2006 the highest level of energy intensity, but lack of data for 2009 does not enable a full comparison ([20]). The lowest levels of energy intensity are found in Slovenia, Luxembourg and to a lesser degree Latvia, Austria, Germany and Italy. At the same time real energy prices were the highest in France, Slovenia and Italy, while Estonia, the Czech Republic and Slovakia enjoy the lowest real energy prices, sometimes even below the US levels.

Graph I.1.8: Annual Growth Rates 2000-2009 - Manufacturing

Note: Energy Intensity includes feedstock. Due to data limitation the assessment of Energy intensity and Real energy prices stops at 2009. Therefore to allow comparability the growth rates of RUEC have also been computed only up to 2009. Source: Commission Services based on WIOD, ESTAT and OECD.

By looking at the growth rates, some new Member States (Czech Republic, Poland, Slovakia and Slovenia) stand out in terms of energy intensity improvements and, for the Czech Republic also for the low rates of real energy prices growth. These factors contributed to determine a negative growth of RUEC for these countries; except for Slovenia where the upward pressure of real energy prices determined a minor increase in RUEC. In some Member States (Italy, Spain and Luxembourg), despite worsening performances in terms of energy intensity, a moderate increase (a decrease in the case of Luxembourg) in real energy prices resulted in RUEC growth rates below the EU average and also the US. By contrast, some Member States such as France, Sweden and Finland report fast growing real energy prices, well above the EU average, which were not offset by sufficient improvements in energy intensity, hence a growth rate in RUEC well above the average of the EU and the US.

As said, an increase in Real Unit Energy Costs means that the amount of money spent on energy sources to obtain one unit of value added has increased and this negatively weights on the margins of the sector. The growth rates of NUEC presented in Table I.1.4 show to what extent other macroeconomic dynamics, such as sectoral price inflation and exchange rate fluctuations, have either exacerbated or alleviated the growth of RUEC.

Spain had the fastest growing NUEC in the EU followed closely by a group of other Member States which present all similar features, i.e. an high increase of the nominal effect well above the EU average (with the notable exception of France where the NUEC growth is more linked to the energy costs components). Conversely the lowest increases in NUEC have been in Poland, the Czech Republic and Slovakia. However only in the case of Poland this result can be ascribed mostly to the very low growth of the nominal effect. In Czech Republic and Slovakia the improvement in their performances must therefore be found in the energy components, notably in remarkable reductions of energy intensity.

1.6. Conclusions

Table I.1.4: Average % annual change 2000-2009 - Manufacturing

Note: Energy Intensity includes feedstock. Due to data limitation the assessment of Energy intensity and Real energy prices stops at 2009. Therefore to allow comparability the growth rates of RUEC have also been computed only up to 2009. Source: Commission Services based on WIOD and ESTAT databases.

The results shown above indicate that the EU manufacturing sector has enjoyed some of the lowest Real Unit Energy Costs together with Japan and similarly to the US. This means that to obtain 1 USD of valued added they have spent a lower amount of money on energy sources than Russia or China. In addition, the evolution of RUEC plotted in Graph I.1.1 shows that the EU have suffered relatively less than other countries the oil price shock of 2008 which has on the other hand affected severely both Japan and the US. This impact is also clearly shown in Graph I.1.3 where real energy prices are presented. This may be the outcome of the energy mix composition of the US industry compared to that of the EU, since the US industry is more reliant on oil products than EU manufacturers ([21]).

The trend of the EU RUEC could also be determined by an industrial structure based on higher value added production. The relatively higher real energy prices may have induced EU manufacturers – together with Japan and US – to specialize in higher value added product categories with lower energy intensity while conversely the industry in countries such as China, Russia, India, Brazil lead by competitive energy prices may have opted for more energy intensive production activities with a comparatively lower value added.

The RUEC levels for the entire manufacturing sector in 2011 signal a continuation of the upward trend for all the countries. It is to note however that the EU overtakes the US, by a very thin margin, and China further converges towards the US, Japan and the EU.

The improvements of the EU industry in terms of energy intensity have helped to offset the increase in real energy prices. Despite the already low starting point the EU manufacturers have steadily improved their energy intensity performances converging towards the Japanese levels. The US and China have been catching up but the difference in absolute levels remain substantial.

The sectors that are most exposed to energy price shocks in terms of high RUEC levels in the EU are coke and refined petrol, chemicals, non-metallic mineral, metals, rubber and plastics. Coke and refined petrol stands out with much higher RUEC levels than in other countries and a growth rate that is also among the highest ones. This indicates significant vulnerability of this sector, though its share in total manufacturing value added of the EU has been low and stable. In contrast, US, Japan and Russia have seen a significant increase in this share. In the other four sectors with high energy cost vulnerability (chemicals, non-metallic mineral, metals, rubber and plastics) the EU shows RUEC levels that are generally comparable with those of Japan. The EU levels are, however, noticeably higher than the US in chemicals, non-metallic mineral, and metals. Nonetheless in all four sectors the figures of the EU remain substantially lower than those of China and Russia. The growth rates of RUECs of the EU in the four sectors are generally in line with other countries with some variability observable.

In 2011 data confirm that for all sectors, EU RUEC are higher than in the US. While this points to additional cost pressure on EU firms it is however to be noted that some typically energy-intensive sectors (coke and refined petroleum and basic metal products) have incremented their shares in the manufacturing value added of the EU.

The situation of Member States, is heterogeneous. On the one hand countries such as Bulgaria, Lithuania and the Netherlands have the highest levels of RUEC therefore their production structure is more sensitive to energy cost pressure and any increase in energy prices not matched by improvements of energy intensity may severely affect the margins of their manufacturing sectors. On the other hand countries like Italy and Luxembourg have experienced a worsening of their energy intensity performance which was however met by moderately increasing real energy prices. The growth of their RUEC has been therefore modest and their absolute levels remain low. More vulnerable in this sense appears France where the very fast growth in real energy prices was not sufficiently counterweighted by significant improvements in energy intensity. The growth rate of RUEC in France is well above the average although its level is still relatively low. Finally for some countries, especially Spain, the nominal effect led to a fast increase in NUEC. These dynamics are outside the scope of the present study but have nonetheless added cost-pressure on the Spanish manufacturing sector exacerbating the energy cost component.

2.1. Introduction

The previous chapter on Unit Energy Costs presented an empirical analysis based on the WIOD Database which provides data only until the year 2009 for some of the indicators (namely energy intensity and real energy prices) and for 2011 for the Real Unit Energy Costs.

The period after 2009 has however been marked by important events, some energy-related and some not. The development of US shale gas belongs to first category. It has changed substantially the energy system of the US and by consequence it has widely impacted on the global energy markets. The extent of these changes and their implication for the EU are the subject of this chapter. The economic and financial crisis that spread after 2008 is instead part of the second category of events, not energy-related. The economic recession that has affected the EU economic economy has however made more urgent the need to look at energy prices for consumers and industry, in a context of lacklustre domestic demand and loss of competitiveness.

The surge of the US shale gas ([22]) and the corresponding fall in energy prices for US manufacturers has reignited the debate on the EU's industrial competitiveness and has led to calls for policy changes aimed at reducing the energy costs for EU firms, either through reducing the stringency of energy and carbon policies or through stepping up EU gas production including shale gas ([23]).

This chapter will endeavour to assess impacts of the development of shale gas through a step-by-step comparison between the EU and US, using data from Eurostat, OECD and the US Energy Information Administration. Section 2.2 discusses how the introduction of shale gas has affected the US energy sector. The impacts are assessed through an EU-US comparison on the energy mix and on the energy import dependence. Section 2.3 addresses the development in the EU-US energy price-gap. The disparity in energy intensity and some reflections on the impacts on the production structure in the EU and US are presented in Section 2.4. Finally the developments in the trade balances for the EU and US will be discussed in section 2.5. The chapter is concluded by some preliminary remarks and open questions for future discussions.

2.2. The impacts of the surge in US shale gas on the US energy sector and EU and US energy mix

Many observers have noted the strong surge in US gas production and consumption because of what has been coined the "shale gas revolution." As depicted in Graph I.2.1, shale gas was already produced in the US in modest amounts at the turn of the century, but it became significant after the middle of the last decade.

The exponential growth in production volume started to profoundly affect the make-up of the US natural gas supply from 2007/2008 onwards. By 2011, the US has become the biggest gas producer in the world, ahead of Russia, while shale gas constitutes now over one third of the natural production in the US (while only about 5% in 2005).

The current impact of shale gas on the overall make-up of the US energy sector has been significant but it should not be overstated, both as regards the net impact on the domestic gas sector and as regard the changes in the energy mix. Shale gas has revived the domestic natural gas sector whose production had stagnated earlier in the decade, and since a few years shale gas is also replacing domestic supply of conventional natural gas.

Graph I.2.1: Natural gas production in the US and share of shale gas on total gas production

Source: Commission Services based on Energy Information Administration, US.

Over the period 2000 – 2011 natural gas production has increased by almost 20% and since the historic low in production in 2005 it has increased by almost 27%.

However, the share of natural gas in the US energy mix has only increased by 2 percentage points between 2000 and 2011, while it increased from 18% to 25% in the electricity mix (Appendix 4, Graph I.A4.3).

Graph I.2.2: Energy mix US

Note: Expressed as share per source in Primary Energy Consumption Source: Energy Information Administration.

Graph I.2.3: Energy mix, EU

Note: Expressed as share of source in Gross Inland Consumption Source: Eurostat.

The resurgence of gas as primary energy source in the US should be seen against the background of changes in the US consumption and production of the other primary energy sources. Graph I.2.2 on the US energy mix in the period 2000 – 2011 shows a similar increase in importance of renewable energy sources: its consumption share has risen from 6% in 2008 up to a share of 9% in 2011. On the other hand, a relative decline of oil and coal as primary energy sources is observed with their shares falling over the decade from 39% to 36% for oil and from 23% to 20% for coal.

These changes in shares reflect changes in domestic production levels: renewable energy generation has increased by 49% in the past ten years and natural gas, as already mentioned above, by 20%. Coal production has fluctuated but in 2011 it had decreased by 2% compared to 2000. In 2011 natural gas has for the first time overtaken coal as first source of energy produced in the US. Oil production after a period of slow and steady decline, culminated in 2008 has picked up again but in 2011 it was still 3% less than in 2000 (Appendix 4, Graph I.A4.1).

Together with renewables, US shale gas has undoubtedly contributed to significantly reducing the energy dependence of the United States and hence to decreasing their exposure to global commodity prices fluctuation and geopolitical risks.

As depicted in Graph I.2.4, the US energy import dependency has reached 18% in 2011, the lowest point since 2000.

(Continued on the next page)

Box (continued)

Graph I.2.4: Energy Import Dependency

Source: Commission Services based on Energy Information Administration and Eurostat.

However, the fall in energy import dependency started around 2005 and hence somewhat before shale gas production levels became significant. This can be explained by the expansion of renewables and by the start of the increase in overall gas production.

In sharp contrast to the US, the EU's import dependency has increased from 46% to 52% between 2000 and 2010 ([24]). This reflects the combination of a decline in domestic energy production and an increase in energy consumption, even when taking account for the abrupt contraction of economic activities in 2008.

The production decline over the decade concerns all primary energy sources except renewables. EU gas and oil production have fallen by a quarter and 40% respectively. However coal, because of its sheer volume (still larger than for all other energy sources combined), has been the major driver of the overall decline with a production fall over 10%. In contrast, renewables increased their output in caloric terms by 72%.

Since the EU energy mix has similar make-up and trends as the one of the US (with a higher share of nuclear power as the major difference), the rise in consumption has been met by increasing imports. Natural gas provides an apt illustration: the increase of consumption share by 2 percentage points over the decade has prompted an import increase of more than 45%, whereas the US has satisfied the increased demand mainly from domestic sources (gas imports in monetary terms decreased by 56%, compared to their peak in 2005).

There is another recent phenomenon triggered by the development of shale gas and observed mainly between 2011 and 2012: the US have decreased their consumption of coal, exporting their excessive production and reducing their imports. This has driven coal prices down. As gas has became relatively more expensive and coal relatively cheaper in Europe a substitution is taking place: gas consumption declined by 7% while coal consumption increased by about 20% between the first half of 2011 and the first half of 2012. Notably imports of coal from the US increased substantially especially in some Member States: looking at the first half of 2012, Germany, Italy and the Netherlands respectively imported 37%, 83% and 86% more hard coal from the US than in the first half of 2011 ([25]). This shift raises evident climate change concerns as currently carbon prices are too low to offset the comparative advantage of coal over natural gas.

2.3. Electricity and Gas prices: a US-EU comparison

In the developed world, gas is increasingly seen as an attractive substitute for oil as it is a relatively clean source of energy and also because it has become relatively cheap (Graph I.2.5). For the purposes of this analysis, however, it is not enough to look at the gas spot market price, for a number of reasons.

First, unlike oil, there exists no global wholesale market and no global reference price for natural gas. In the European Union the majority of natural gas is supplied through bilateral long-term contracts which are negotiated between two parties, importer and exporter, and traditionally indexed to the price of oil. Currently, half of natural gas supply in the EU is still indexed to oil while across the EU a wide variation in import prices of piped gas and LNG has been observed ([26]). This is remarkable as at the same time a growing share of gas is traded on spot-markets ([27]) where short-term contracts are concluded on the basis of the market price determined by actual demand and supply. Spot market prices in the EU have been constantly lower than long-term contracts' prices, at least since 2005 ([28]).

In addition, gas can be used directly for heating or other purposes but can also be used as a primary energy source for electricity generation: in both regions, the share of gas in the electricity mix is currently around 25% and it has increased with a similar pace over the past ten years. Consequently, the wider impact of shale gas on energy prices can be illustrated by looking at the electricity prices.

In both the US and in the EU, spot-market gas prices have progressed in a similar fashion over the past decade and have followed the movements in the oil price, as depicted in Graph I.2.5. In 2005, however, these gas prices have started to clearly fall below the level of the oil price. Between 2008 and 2009 they fell significantly in both regions, likely as a consequence of declining demand due to the economic downturn.

Graph I.2.5: Wholesale natural gas prices in Germany, Japan, UK and US compared with crude oil price

Source: European Commission (2012).

The fall in energy consumption has led to an excess supply of gas on the gas markets around the world and both US and the UK spot markets temporarily converged, trading at around 4/5 USD/MBtu in mid-2009, while the German hub prices fell less evidently, trading still above 8 USD/MBtu in 2009. From 2007 onwards, the US gas spot price has fallen under the price level of the other gas spot markets, which most likely reflects the effect of the surge in domestic shale gas supply. This becomes quite clear after 2009, when energy consumption picked up again following the recovery of the economy.

Statistics from more recent years show that while the US spot prices remained low (around 4 USD/Btu in 2011), the EU spot prices (both in the UK and German hub) kept increasing([29]). Wholesale gas prices have continued to rise in the EU while economic activity contracted and consequently natural gas consumption in the EU has been declining: the first half of 2012 represented the EU's lowest first half year consumption of the last ten years. It was 7% and 14% less than the first half of 2011 and 2010 respectively ([30]).

The continued rise in EU wholesale gas prices despite the slump in gas demand and the lower gas spot prices vividly depicts the kind of vulnerability the EU is exposed to due to its high import dependency: as the Asian markets offer higher returns ([31]) and more robust demand, gas producing countries have increased their trade with Asia lowering supply to Europe. As a consequence wholesale gas prices in Europe have increased while in the US, which now can rely more heavily on domestic production, prices have remained low. US prices were shielded from potential upwards pressure from export demand because of export restrictions (generally expected to be gradually lifted). Furthermore, the impacts on the EU have been further aggravated in this context due to the oil-price indexation of many long-term gas import contracts.

The evolution of end-user's prices ([32]) for gas (Graph I.2.6 and I.2.7) follows a pattern similar to that of the wholesale market.

Graph I.2.6: Indices of real gas prices for end-users

Note: "Real" price indices are the current price indices divided by the country specific producer price index for industrial prices, and by the consumer price index for the household sector. Source: OECD - Electricity Information (2012).

Graph I.2.7: End-user gas prices for industry

Note: For the US prices it was not possible to identify a specific consumption band. The EU prices are for the consumption band I3 (I3.1 and I3.2 until 2006) that is between 10,000 and 100,000 GJ. Prices are nominal and the exchange rate used is from OECD. Taxes are included. Source: Energy Information administration and Eurostat data.

A significant gap between the EU and the US starts appearing in 2006, prior to the development of shale gas but coinciding with the divergence observed between the oil price and the natural gas prices on the wholesale markets in the various regions in the world.

While the EU gas end user prices seem to stick closer to the oil prices and increased from 0.022 EUR/KWh in 2005 to 0.035 EUR/KWh, the US gas prices declined from about the same starting point of the EU in 2005 to 0.010 EUR/KWh in 2011.

On the other hand, the impacts of the fall in the gas price on electricity end user prices is much less evident yet it can still be observed. As shown in Graph I.2.8, electricity prices in the US have historically been much lower than in the EU.

Graph I.2.8: End-user electricity prices for industry

Note: For the EU prices refer to average of consumption bands Ie If Ig until 2007, after 2007 consumption band ID. Prices are nominal and the exchange rate used is from the OECD. For the US no consumption band was available. 2011 provisional data. Taxes are included. Source: Eurostat and Energy Information Administration.

Graph I.2.9: Indices of real electricity prices for end-users (2005=100)

Note: "Real" price indices are the current price indices divide by the country specific producer price index for industrial prices, and by the consumer price index for the household sector. Source: OECD - Electricity Information (2012).

The gap has been persistent at least since 2001 (Graph I.2.8). Also in this case, the price difference predates the development of shale gas.

The price differential has however been widening in the past few years as the European prices increased over the period (although not in a linear manner) while the US prices remained more or less constant.

The development of US shale gas is likely to be at the root of this widening gap mainly because its increased energy independence and export restrictions in the US has to some extent sheltered them from fluctuations on the global energy markets; in addition it has reduced the supply costs of gas for electricity generation. At the same time the EU energy dependence has increased and this has led to a higher exposure of the EU to energy prices volatility.

Finally it is to note that shale gas prices in the US do not fully reflect external costs as the current regulatory regime exempts shale gas projects from a number of pieces of federal environmental legislation, including the provisions of the US Safe Drinking Water Act.

2.4. Energy Intensity ([33]): a US-EU comparison

Over the past years, the European industrial sector has been able to successfully decouple its performance in terms of value added from its energy consumption. The remarkable wide energy price gap between EU and US should be considered next to the equally remarkable energy intensity gap between the two regions.

The EU industry's energy intensity has been substantially lower than its US counterpart. In addition it has improved by almost 19% between 2001 and 2011 while in the US the improvement over the same period was only 9%.

Graph I.2.10: Energy intensity of industry

Note: Final energy consumption industry divided by gross value added in 2005 reference year, ktoe in billion of euros. Source: Eurostat, Energy Information Administration, Bureau of Economic Analysis USA.

It appears that the increase in the European energy prices is likely to have provided manufacturing industry with the incentive to improve their energy intensity in order to limit the cost of their production inputs. Conversely, the relatively cheaper energy supply in the US did not provide similar incentives.

The development of shale gas has exacerbated this difference as it has further lowered electricity and gas prices. This seems to have halted the gradual improvement in the energy intensity of the US industry: after 2006 energy intensity performances remained constant and actually started to slowly deteriorate in the last two years considered.

There appear no significant divergences in the production structure between the two regions which can explain the marked difference in energy intensity performance between EU and US industry. First, the general picture of the EU-US energy intensity divergence also emerges when looking at various branches within manufacturing industry (Graph I.2.12).

Second, in terms of contribution to GDP, the European manufacturing sector is still larger than its US counterpart, although the difference seems to have become smaller during the decade.

A similar convergence can be observed in the energy intensive industry sector, whose GDP share has become smaller in the EU than in the US but the difference in size seems to slightly widen only in 2011.

Graph I.2.11: Share of some Energy Intensive Sectors (EIS) and share of Manufacturing in GDP - 2001-2012

Note: For the EU-27 energy intensive sectors include Fabricated metal products, Basic metal, Other non-metallic mineral products, Chemicals and chemical products, Coke and refined petroleum products, Paper and paper products, Mining and quarrying. For the USA, energy intensive sectors include Mining, Non-metallic mineral products, Paper products, Petroleum and coal products, Chemical products, Primary metals, Fabricated metal products. Source: Own calculations on Eurostat and US Bureau of Economic Analysis.

The better performance of the EU's manufacturing industry in terms of energy intensity has therefore happened in the context of comparable overall production structures. Nonetheless, a certain process of restructuring away from energy intensive sectors is observed in the EU from 2005 (see the shift-shares analysis carried out in chapter 1). Graph I.2.11 corroborates this insight as it shows that it is around 2005 that the share of energy intensive sectors in the US exceeds that of the EU. However as shown in chapter 1 and Appendix 3 this is largely driven by the increased importance of the refinery sector in the US economy.

This suggests that while European business as a whole has been able to compensate for the higher energy prices through improvements in energy intensity and possibly also through other non-energy-related efficiency gains - facilitating the substitution of energy with other production factors ([34]) - the energy intensive sectors have been relatively more strongly affected. Yet the restructuring started already before the development of shale gas and might therefore accelerate as the energy price gap widens. .

Graph I.2.12: Energy intensity of ind