In my recent post about Europe’s gas crunch, I referred to an article by Bloomberg’s (indispensable, yes, I’ll use that adjective again) Javier Blas.
In the course of the article, in which, among other matters, Blas indicated how natural gas prices were now reflecting “extreme danger” for this winter “through 2023 and, increasingly, into 2024.”
In Blas’s view:
The market is right to reprice the gas curve; the only question is why it took so long. There’s further risk ahead: At some point, Moscow will completely turn off the tap, probably just before the winter, to try to bring the German economy to its knees. That’s an outcome the market hasn’t priced yet.
In the most recent Capital Letter I looked at the way that Russia had been restricting the flow of gas to Germany (down at the time of writing the Letter by about 60 percent). This had, I noted, been described by Robert Habeck, the German economy minister, as “economic warfare.” Habeck had stressed that there was nothing irrational about it: “After a 60% reduction, the next one logically follows.”
Well, indeed.
Looking at where things stood, I argued that it was:
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 [writing in the Spectator] 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.
Blas looks at the same issue, and, as noted above, believes that Putin will conclude by switching off the tap entirely “probably just before winter”.
Blas’s reasoning is worth looking at in full:
Russia may want to keep some gas flowing to preserve its long-term leverage. From a game-theory point of view, that makes sense. Once Russia stops shipments completely, it can no longer apply pressure. Tactically, Moscow is likely to keep some gas moving, retaining the option of cutting or slowing flows whenever it chooses.
Moreover, Nord Stream 1 is the main route for Russian gas into Europe indexed against the TTF contract [a European benchmark price for natural gas], according to Goldman Sachs. Not reopening the pipeline after the maintenance shutdown will limit the profit that Gazprom, the Russian state-owned gas giant, enjoys from sky-high gas prices.
Russia has clearly written off its gas relationship with Europe. For now, however, the Kremlin will continue to enjoy the best of both worlds: high revenue and compelling leverage. To achieve its objectives, Russia needs to continue selling some gas into Germany, but at reduced rates, as it’s currently doing.
But, as stated above, Blas believes that Putin will ultimately turn off the taps. The beginning of winter seems like a reasonable bet as to when. Europeans are already scrambling to take steps to alleviate the storm to come, steps that are unlikely to be enough to stave off trouble.
Writing in the Daily Telegraph, Rachel Millard runs some numbers, The background against which she is writing is that on July 11 the Nord Stream 1 pipeline was shut down for annual maintenance. It should reopen on or about July 22 (please note that occasional extensions of the shutdown are not unusual, as those working on maintenance discover something that needs fixing), but will it?
Blas guesses yes (for now), although he doesn’t seem to expect that the flow will resume at anything like normal.
Millard:
The “base assumption” among many analysts is that Nord Stream 1 will start flowing again to at least 40pc after maintenance. Russia needs the revenue, and its gas fields need an outlet. While in the long run Russia wants to pivot sales to China, this will require very large infrastructure development, notes Jacob Mandel, senior associate at Aurora Energy.
That base assumption seems fair enough for now, but for how long? Russia does not need the cash, and the economic return from forcing an early end to the war would, as I mentioned before, be considerable. The idea that it will hold off turning the taps until it has ready to complete the pivot to China strikes me as highly unlikely. This pivot will, as Aurora Energy’s Mandel indicates, take quite some time to complete.
And in the meantime?
Millard:
[E]ven re-starting the pipeline at the lower 40pc rate seen in recent weeks will not be enough. Experts believe storage sites will only be able to get to 70pc full by the end of the year unless the rate is increased. Europe is already buying almost as much as it can from the global market in shipments of liquified natural gas (LNG). Flows from Russia across Turkey and Ukraine have not risen to compensate for the Baltic Sea loss, notes Tom Marzec-Manser, head of gas analytics at ICIS.
Germany is among the most-exposed to gas cut-offs, as it got about half of its supply from Russia in the months before the war. The heavy industry that powers its economy is vulnerable: Chemicals-maker BASF alone accounts for about four percent of annual consumption. . . .
“Should we enter into a gas shortage situation, we would have to decide where, possibly geographically differentiated, the bottleneck exists, and which consumers would therefore need to be curtailed,” the head of Germany’s energy regulator, Klaus Mueller, said on Monday. European laws say that households, hospitals and care homes should be protected in that case.
Other countries are also getting ready. Austria and Denmark are both urging business and households to cut consumption. Finland and the Baltic states will postpone maintenance on gas pipelines, Reuters reported. The Czech Republic will allow coal-fired plants slated for closure to stay open, while Greece is ramping up coal mining. France’s contingency plans could see businesses cut off. “We will determine which companies are of the most strategic importance,” finance minister Bruno Le Maire said last week…
Goldman Sachs predicts a full cut-off of all Russian supplies would trigger a further 65pc hike in energy bills from record highs, bringing them to €500 a month in Europe. A complete halt to Russian gas would push the Euro area into a recession, the bank believes, with growth falling more than 1.25pc in the third quarter in the worst-case scenario.
And any ideas that the effects of such a fall-off in growth could be confined to the economic sphere are, I suspect, wishful thinking.
Under the circumstances, it was interesting to read this (via the Guardian):
Europe is in danger of highly damaging “very, very strong conflict and strife” this winter over high energy prices, and should make a short-term return to fossil fuels to head off the threat of civil unrest, the vice-president of the European Commission has warned.
Quite what all this will do to the willingness of many European countries to stand alongside Ukraine is not hard to guess.