The week of July 4, 2022: Germany’s gas crunch, China, climate, and much, much more.
The week of July 4, 2022: Germany’s gas crunch, China, climate, and much, much more.
I t seems strange to recall it now, but there was a time around the late 1990s when Germany (partly because of the immense burden of reunification) was seen as the sick man of Europe. As in the past, it reinvented itself. The combination of labor-market reforms, wage restraint (the two correlate less than conventional wisdom has it) and, above all, the concealed devaluation represented by the switch into the euro (which boosted German competitiveness within the euro zone and outside it) were all essential steps in creating the successful export-led growth that has come to define the German economy.
But there are increasing signs of trouble.
Walter Russell Mead, in the Wall Street Journal (June 27):
In recent years, the German economic miracle depended on a combination of industrial prowess, cheap energy from Russia, and access to global markets, particularly in China. Today every one of those pillars is under threat. German mastery of automobile technology through a century of engineering is challenged by the shift to electric vehicles. The chemicals industry, in which German technology has led the world since the 19th century, is coming under environmental challenges as global competition intensifies.
Those challenges are exacerbated by the loss of cheap and secure Russian natural gas. Green energy, despite massive German investment, will be unable to supply German industry with reliable and cheap power for a long time. In the meantime, the alternatives to Russian pipeline gas are expensive and controversial. Nuclear power gives Greens the willies; coal is unbearable; liquefied natural gas requires long-term commitments and massive capital expenditures.
Beyond that, Germany’s economic relationship with China is changing for the worse. China was long the ideal customer for German products. Its newly affluent middle class fell in love with German luxury cars. Its rapidly growing manufacturing sector voraciously consumed German machine tools and other capital goods. But China’s growth is decelerating. Its maturing industrial economy seeks to compete with high-end German producers, often based on tools reverse-engineered from German imports.
Germany has done well out of that relationship with China — so well that it is now unhealthily dependent upon it.
Reuters (June 30):
Inflation would spiral even further in Germany if it weren’t for business with China, Volkswagen Chief Executive Herbert Diess said in a media interview published on Thursday.
“Germany would look completely different” if it turned away from China, Diess told the Spiegel weekly, adding that such a move would harm growth, wealth and employment.
For Merkel’s Germany to have built up a dangerous reliance on not one, but two, authoritarian (and not necessarily friendly) states looks, as The Importance of Earnest’s Lady Bracknell might have said, a lot like carelessness. Worse, there are clear signs that Germany has used its export-driven prosperity as an excuse to coast in other areas of its economy, notably in digitalization, but elsewhere too. A few years back I wrote an article comparing, in some respects, Merkel’s Germany with the era of stagnation in Brezhnev’s USSR. Nothing I have learned since has changed my mind.
Stock markets are not everything (and Germany is famous for the performance of its privately held businesses). Nevertheless, it says something that, as Ralph Schoellhammer reports for Unherd:
Measured by market capitalisation, only one German company makes it into the top 100 worldwide, and German market capitalisation as a share of global market capitalisation has shrunk to 1.97%, an all-time low.
Complacency has been compounded by the Energiewende, a wasteful and reckless binge on renewables made nuttier still by the rejection of nuclear power for reasons that amounted to little more than superstitious dread.
And indeed, the immediate crisis that Germany is now facing is on the energy side, something, if anything, that Mead understates, but then he was writing a couple of weeks ago, and matters have deteriorated sharply, if predictably, since then.
Wolfgang Münchau, in the Spectator (July 2):
Gazprom, the monopoly supplier of piped Russian gas, has been giving Germany a taste of what life might be like, should Moscow play nasty. It recently halved the amount of gas sent through the Nord Stream 1 pipeline, using bogus technical excuses. Germany, which still relies on Russia for more than a third of its gas, is now realising it may have to cope with a total gas embargo – and a cold winter. Last week its gas risk level was raised to stage two, a state of ‘alarm’.
Putin may keep the gas flowing at a reduced volume. But what if he cuts Germany off altogether? To say that Germany has made itself reliant on Russian gas doesn’t quite capture the enormity of what is going on. Germans need Russian gas to heat their homes. The country’s heavy industry depends on Russian hydrocarbons. According to Robert Habeck, the German economy minister, any sudden stop in Russian gas flows would trigger a domino effect: an economic crisis which he compares to the 2008 collapse of Lehman Brothers.
Habeck is also [German chancellor] Olaf Scholz’s deputy chancellor and the Green party’s most senior representative in the German government. He has been quite emphatic about how vulnerable his country is to Putin turning off the taps. ‘Companies would have to stop production, lay off their workers, supply chains would collapse, people would go into debt to pay their heating bills and people would become poorer,’ . . .
Germany aims to have its gas reserve containers 90 per cent full by the winter – up from 60 per cent now.
Habeck has warned that if Russia continues supplying gas at the current rate, (unspecified) “additional measures” will have to be taken to reach the 90 percent target. He has described Russia’s move as “economic warfare” and stressed that there is nothing irrational about it: “After a 60% reduction, the next one logically follows.”
Münchau:
Germany’s gas regulator recently published seven scenarios for winter and spring. Six involve critical shortages. Only one envisages capacity at a moderately safe 25 per cent in the winter (and 40 per cent in the summer). But that is the scenario in which the Russians honour all the gas storage requirements under German law. In other words, there is zero room for any deviations. So if Putin keeps the gas flowing at a diminished rate, Germany could experience massive shortages this winter. This may well be Putin’s sweet-spot option. He could inflict damage, and still get most of the money as Russian gas sells at massively inflated prices.
Putin has previously resisted using gas and oil as diplomatic weapons even during earlier wars. When he annexed Crimea, the gas kept flowing through Ukraine. What is different this time is that the EU, US and UK have all placed sanctions on Russian fossil fuels. Habeck has set himself the target of reducing Germany’s Russian gas consumption to zero within two years – though he stands little chance of achieving that given the absence of alternative suppliers.
Under the circumstances, it is easy to imagine that Putin will either switch off the flow, or (there are technical reasons why switching it off entirely can cause difficulties) reduce it even more. Russia is, as Münchau points out, “awash with cash.” Thanks to higher energy prices, its current-account surplus could, he argues, double to some $250–300 billion this year. If the war in Ukraine is still dragging on into the winter months — as seems reasonably likely — it would make sense for Putin to use a brutal energy squeeze to spur the EU to force Ukraine to cut some grubby deal with Moscow. The EU’s determination to wean itself off Russian gas as soon as it can (which, incidentally, is not tomorrow) means that Moscow is running no risk of alienating a client that would otherwise be good for decades. Moreover, bullying the EU to bully Ukraine into some sort of “peace” would generate a political and, given the direct and indirect cost of the war to Moscow, economic return.
There is no getting away from how damaging the consequences of such a squeeze on Germany could be, ranging from restrictions on heating and hot water in homes to shutdowns in industry after industry, neither a recipe for social calm nor continued support for Ukraine.
As Germany tries to free up gas for transfer to its reserves by reducing consumption, it is getting an early taste of what may lie ahead.
The Financial Times (July 8):
Germany is rationing hot water, dimming its street lights and shutting down swimming pools as the impact of its energy crunch begins to spread from industry to offices, leisure centres and homes. . . .
The GdW [the Federation of German Housing Enterprises] said the Ukraine war will push up energy prices for consumers by between 71 per cent and 200 per cent, amounting to additional annual costs of between €1,000 and €2,700 for a one-person household and up to €3,800 for four people, compared with 2021 levels.
As it is, Schoellhammer notes:
Electricity prices have been surging to an all-time high, with current 1-year forward electricity contracts clocking in at EUR 340 per MWh. Just to put this number into perspective, for the last three decades this value never surpassed €100 per MWh. In other words, the year 2023 will see electricity turning from a utility into a luxury good for many Germans.
The Wall Street Journal (July 5):
The fertilizer industry is particularly exposed to the current volatility because it uses gas as a raw material, said Christopher Profitlich, a spokesman for SKW Stickstoffwerke Piesteritz GmbH, one of Germany’s leading fertilizer manufacturers.
“A shortage of gas would mean we would not be able to produce fertilizer, meaning that farmers would not be able to produce enough food, and this would push global prices up and create a shortage of foodstuffs,” Mr. Profitlich said.
SKW also produces the fuel additive AdBlue which is used by over 90% of trucks that make up Germany’s complex road-based logistical chains, as well by vehicles critical for emergency services and construction.
“Without AdBlue, engines would stand still,” Mr. Profitlich said.
At Bavaria-based porcelain maker Rosenthal GmbH, a stop in supplies would bring production to a complete standstill. White porcelain is typically made by heating materials in gas-fired chambers known as kilns temperatures over 2,000 degrees Fahrenheit. Gas is currently the only energy source that can ensure that process, said Mads Ryder, Rosenthal’s chief executive.
“A cutback or even a halt to gas deliveries would mean that we would have to stop our entire production immediately and that would have considerable economic consequences for the company,” he said.
While the industry is exploring alternative sources like hydrogen, it would take at least 10 years before these offer a viable alternative, he said.
“There is very little creative freedom here in ceramics,” said René Holler, general manager of the German Association of the Ceramic Industry.
At brewer Brauerei C. & A. Veltins GmbH & Co. KG, gas is also an essential part of the whole beer production process.
The kettles for the brewing process are heated with the help of gas, which is also needed to achieve the necessary kettle pressure. The company then needs glass bottles, and natural gas is also indispensable in glass manufacturing. In total, Veltins says it would need 50 million bottles this year, whose costs are already up some 80% since April.
“To put it plainly: no beer without gas,” said Veltins spokesman Ulrich Biene. . . .
At chemicals giant BASF SE, a significant fall in gas supplies could lead to the closure of the world’s largest integrated chemical complex spanning some 200 plants. Such a shutdown would reverberate beyond the company, which sits at the beginning of most industrial supply chains, from cars to toothpaste. A throttling of BASF’s ammonia output, a key ingredient in fertilizers.
Henkel AG, the maker of consumer products including Persil laundry detergents, said it was looking at ways to switch to alternative energy sources and is considering increasing working from home options for employees to save on energy and heating costs.
German steelmaker Thyssenkrupp AG is heavily reliant on gas for its blast furnaces. “A switch from natural gas to oil or coal is not possible in our production processes, or only to a negligible extent,” the company said in a statement.
Yasmin Fahimi, the head of the German Federation of Trade Unions has recently warned that problems with the gas supply could lead to the “permanent collapse” of certain industries, specifically citing aluminum, glass, and chemicals. “Permanent” may be an overstatement, but Fahimi’s comment will have caught Chancellor Scholz’s attention. The trade unions are close to his SPD, and Fahimi herself was an SPD member of the Bundestag.
Faced with the prospect of an economic (and, undoubtedly, political) crisis in Germany (and what that could mean to the U.S., as economic contagion spreads out from the EU’s most important economy), it’s unclear what the Biden administration could do to keep Berlin in line if, indeed, it was even willing to do so.
Thinking back to Habeck’s warning of another Lehman moment, at least one domino is beginning to topple. Uniper, Europe’s largest importer of Russian gas, has asked the German government for help. Its problems (which are unlikely to be unique) stem from the fact that the slowdown in gas flows from Russia is reportedly costing the company as much as €30 million or, take your pick, €40 million a day (the company’s problem is that it cannot pass on the higher cost of the gas it has to buy to fill the gap left by Russia to clients with whom it has long-term supply contracts). Some estimates are that a bailout could amount to as much as €9 billion, probably in the form of debt finance and an equity infusion, plus a mechanism enabling Uniper to pass on (one way or another) some of the higher prices it is paying for its gas to its clients, whatever the long-term contracts may say. Failure to agree on some sort of rescue deal will mean that Uniper will have to draw down some of its gas reserves, a move that goes directly against Germany’s current effort to fill those reserves up.
In another sign of the times, Germany has (unexpectedly) reported its first monthly trade deficit since 1991. The amount (which relates to May) was not large (around €1 billion), and similar news would attract little attention if it concerned other EU countries, but coming from the EU’s export powerhouse, well . . .
Oh yes, the Nord Stream 1 pipelines have for some time been scheduled to undergo their annual maintenance between July 11–21. No gas will flow through the pipelines during this period. The question now is how much will flow afterwards.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 74th episode David is joined this week by Matthew Hennessey, author of the wonderful new book, Visible Hand, and a deputy editor at the Wall Street Journal. They talk all things economics, especially the kind of economics that people actually care about and understand.
The Capital Matters week that was . . .
Energy
Last month, an over-pressurized pipeline at a liquified natural gas (LNG) plant in Quintana, Texas, caused an explosion that led to the partial shutdown of the facility. The plant is not expected to be able to return to full production capacity until late 2022.
This constraint and the fact that existing U.S. contracts designate a majority of LNG for export to Europe and China spell bad news for consumers. Amid already elevated fuel and energy prices, we’ll likely see our energy bills jump even higher . . .
China
During a bizarre, military-style ceremony that highlighted Huawei’s ties to China’s security state, the tech company launched a new internal business unit focused on developing artificial-intelligence-powered surveillance technology. The new unit will be focused on streamlining the embattled Chinese company’s efforts to become a worldwide leader in cutting-edge AI surveillance technology that can be deployed by cities around the world.
The ceremony puts the lie to Huawei’s global public-relations and lobbying campaigns that strive to dispel the well-founded notion that its ultimate loyalties are with the Chinese Communist Party . . .
Recent inflation has prompted the White House to deliberate, once again, whether to end the Trump-era tariffs on Chinese imports. Although no decision has been made, perhaps we should view the question through Benjamin Franklin’s famous lenses to find better alternatives.
In an often-cited — and sometimes misconstrued — quote, Franklin said this: “Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety.” Partisans love to use these words against one another, but let’s avoid doing so, and instead apply the idea rationally to trade . . .
By and large, businesses are responding to the negative incentives that Xi Jinping’s government has given them. It seems that the Shanghai Covid lockdowns were a turning point for many executives. As I wrote in April, those lockdowns made clear that the Chinese Communist Party values its political power and ideology more than foreign business. To many observers, that was clear long before then, but anyone in denial could not deceive himself any longer.
Perhaps counterintuitively, this means U.S. transportation systems are only going to be more important in the future. Many see issues such as port congestion as arising due to overreliance on Chinese production, but that’s not quite right. Whereas port congestion is currently driven by the importation of finished goods, more production occurring in the U.S. could mean congestion from importation of basic materials. There are also plenty of countries that stand to benefit from businesses leaving Xi behind. Indonesia and India, in particular, are looking to capitalize, and imports of finished goods from those countries would cause congestion just the same as imports from China . . .
Intellectual Property
Last month the World Trade Organization fractured the global rules protecting intellectual-property rights knows as TRIPS. Though the decision was unanimous, it was set up by the Biden administration. And there’s more fracturing to come . . .
Climate
But should the idea of climate-change “analysis” entering into central-banking policy “horrify” Republicans? Yes.
As, for example, economist John Cochrane (repeatedly) and HSBC dissident Stuart Kirk have argued, the idea that climate change itself (the interventions of climate policy-makers is a different matter) will pose any material systemic financial risk is, to put it bluntly, absurd. The Fed should concentrate on its existing mandate, rather than try to extend it to a place where it has no business going. If Congress wishes to expand the Fed’s remit to enable the central bank to recast itself as a climate warrior, that would be a mistake, but it is Congress’s mistake to make, not something that the Fed has any right to do on its own behalf. The FT might not like that, but democracy is what it is . . .
Supply Chains
As overall import levels continue to rise and the peak shipping season begins, shippers have been routing more traffic away from California and toward ports on the Atlantic Ocean and the Gulf of Mexico.
This trend has been ongoing for quite a while (I first noted it last October), but a new piece in the Journal of Commerce explains the issue in full. There are many more ports on the East Coast and the Gulf Coast than on the West Coast, but each of them has a much smaller capacity than the Los Angeles/Long Beach complex that handles most West Coast shipping . . .
In labor disputes in the transportation sector around the world, one thing is clear: Unions have the upper hand.
Mark Szakonyi of the Journal of Commerce writes that “containerized supply chains are ripe for industrial action” right now. The pandemic magnified the importance of transportation workers, he says, as the flow of personal protective equipment became a major issue. With global consumer inflation around 7 percent, those workers are going to demand significant pay increases. Unions are also pushing for improvements in working conditions and schedules, after many workers put in long hours over the past year due to a shortage of labor . . .
ESG
To take a step back (and to oversimplify), there are two halves to the inflationary equation. Too much money. Not enough goods. As Henderson and Joffe argue, pressure from investors who have adopted an ESG approach (a type of investor, I would add, that stretches far beyond those offering a specifically designated ESG product) can lead companies to operate in a way that, economically, is suboptimal. Put another way, that is likely to mean that they produce less than they otherwise would, or (and this too would put upward pressure on prices) their production is not as efficient as it could be . . .
The Economy
As the Federal Reserve continues to tighten rates in response to inflation, it seems that we may already be in the midst of a recession. The Bureau of Economic Analysis just revised the GDP figure for the first quarter of 2022 to an annual rate of -1.6 percent while the Atlanta Fed’s “nowcast” estimate for the second quarter of 2022 is at -1.9 percent.
Should the latter number prove accurate (or anything like it), the economy would meet one definition of recession, as it would have undergone two consecutive quarters of negative GDP growth. Financial markets are already being hit by the prospect of an economic slowdown (equity-market indices like the S&P 500 have taken a hit of almost -20 percent in the first half of 2022). It seems as if the only question remaining is how severe the recession will be. In part that will be determined by how much tightening will be required to bring inflation back to the Federal Reserve’s 2 percent long-run target . . .
Antitrust
Tracy Miller & Andrew Mercado:
As the Federal Reserve raises interest rates to try to curb inflation, politicians such as Senator Elizabeth Warren have criticized the central bank’s approach. It’s true that rising interest rates make it harder to borrow money and could lead to a recession and rising unemployment. However, these critics believe that rising interest rates won’t bring down high gas or food prices, which they claim are at least partially caused by greedy corporations taking advantage of quasi-monopolistic power and collusion. For example, economist Hal Singer argues that the government should pursue “anticompetitive conduct by companies in concentrated industries” to bring down inflation.
If firms have monopoly power, or something akin to it, the prices they charge may be excessive. But Warren, Singer, et al. misunderstand an inflation problem which is not just about high prices. If anything, overzealous antitrust policy could backfire . . .
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