- Hubert Walas
Winter is Coming.
Last summer, French and German electricity contracts for the coming year were trading at around €100 ($118) per megawatt hour. By the end of August, they have risen above €1,000. The Russian invasion of Ukraine has a kinetic dimension, however Russia's weapon of choice against the EU and NATO economies is primarily energy. The high dependence of Europe, primarily Germany, on Russian gas will make the coming winter one of the most difficult in decades.
The Era of Cheap Energy is Over
“We have astronomic gas prices, and we’re still a few months away from when gas demand really peaks during the winter. There’s genuine uncertainty whether there will be sufficient gas to meet demand throughout the winter.” That's the view of Alex Munton, a gas markets expert at Rapidan Energy Group. According to another energy expert, Llewellyn King, the end of this year for Europe is likely to be "the worst winter since the one at the end of World War II, from 1944-1945" and the “era of cheaper energy for Europe is over.” These opinions are becoming more and more numerous within the energy industry.
But why is this the case when not all European countries are equally dependent on Russian hydrocarbons? Why does the United Kingdom, which imports only 4% of its gas from Russia, have the same - or even greater - problems than Germany, which has so far imported more than half of its gas needs from the Russian Federation?
Let's start with the fact that the biggest impact on current energy prices is precisely gas whose costs have skyrocketed. Gas now accounts for ¼ of Europe's energy mix, while before the Russo-Ukrainian War, up to 40% was imported from Russia.
Looking back, it is clear that Russia was preparing the international arena for an invasion of Ukraine as early as 2021 when it began emptying German gas storage facilities. Then after the invasion, it began to gradually reduce its supply, taking advantage of European dependence and high prices that compensated for lower export volumes. Gas availability began to decline.
Germany, which has been buying most of its gas from Russia, now has had to look for other suppliers such as Norway. But if Oslo supplies more gas to Berlin, it will start to run out for other customers such as the UK. While London is particularly vulnerable to such disruptions. The UK produces 42% of its domestic energy by burning gas and this creates a snowball effect. And so we hear that the UK is preparing for possible winter blackouts. And the latest figures from the consulting firm, Auxilione, suggest that the average price of gas could reach £5,000 next year, but currently it is priced at around £2,000.
Gas is currently setting electricity prices in Europe, but this situation is also compounded by problems with other energy sources. Due to the severe drought, many European rivers are recording record low levels contributing to a decline in the efficiency of Europe's network of nucleated power plants, most notably in France, Europe's largest nuclear powerhouse. Also Norway, a major energy exporter, has warned that it will limit energy transfers to Europe if water levels in its hydroelectric plants remain low. Low water levels are also a problem for German inland shipping where 30% of coal, oil, and gas are shipped along the Rhine whose low levels make the problem even more complex.
Russian Weaponization of Energy
It doesn't take much to deduce that this situation is taking its toll on ordinary consumers who are increasingly affected by rampant inflation in Europe. European gas prices are at times 10 times higher than prices in the United States. This shows the importance of the diversification of energy sources built up over the years and resistance to energy blackmail. The highest price for the sluggishness and mental laziness of European decision-makers is now being paid by ordinary citizens. Dependence on Russian hydrocarbons is a bit like dependence on junk food: it's cheap and easy, but after 30 years, you have diabetes, heart problems, and weigh 150kg or about 330lbs. In Europe, such a painful self-realization has hit with full force.
Interestingly, the “McDonalds of hydrocarbons” itself forbids entry for a “gas cheeseburger” to remind you how much you need one. It’s to be taken lightly, but this somewhat clumsy metaphor is all about the Kremlin's gradual reduction of gas exports to Europe and this chart shows it a bit better. First, Moscow halted shipments through the Yamal pipeline which runs through Poland. Over time, Russia also began to cut supplies through what is now the largest transmission channel, Nord Stream 1, by reducing deliveries to 40% of capacity and then to 20% by finding reasons in the form of problems with Siemens turbines. The German government had to perform all kinds of gymnastics to send the turbines to Canada for repair, bypassing sanctions. Still, it was all more of a cat-and-mouse game, as Gazprom announced in early September that it is completely halting Nord Stream 1 gas shipments for an unspecified length of time and still considers the turbines to be bad. The conclusion is simple - Europe needs to prepare that there will be no Russian gas this winter.
The IMF calculated in mid-July that for Hungary, Slovakia, and the Czech Republic, a full cutoff of natural gas from Russia could reduce GDP by up to 6%. Global economic growth would fall by 2.6% in 2022 and by another 2% in 2023.
This is among reasons why protests erupted in Prague against high energy prices and against sanctions hitting Russia. In a similar vein, people were protesting in Lubmin, Germany, where the Nord Stream gas pipeline comes out of waters of the Baltic Sea and into Germany. They demanded that Nord Stream 2, which was blocked by the Reichstag after the invasion, be allowed to operate. Such events are precisely the goal of the Kremlin: to divide Europe. Also, it is very likely that Russian special services, whose overriding goal is to divide Europeans, contributed to the organization of both events.
As if that weren't enough, the Russians are burning their surplus gas. As satellite images show, the Kremlin burns $10 million worth of gas every day, or half a percent of the daily demand of all of Europe, Rystad Energy reports. The agency says that this is also a major environmental problem, affecting the climate near the Arctic Circle.
How is Europe reacting to all this? Starting with Germany, the key in this puzzle, Berlin has raised energy prices by nearly 500 euros and is preparing an aid package of a whopping 65 billion euros. "The alternative would be the collapse of the German energy market, and with it most of the European energy market," said German Economy Minister Robert Habeck. Nonetheless, Habeck and the entire German political establishment continue the policy of moving away from the cleanest and most efficient energy source, nuclear power, which they actually have on hand. Although Germany will leave two of three nuclear power plants being phased out this year in readiness until spring 2023, Angela Merkel's decision to move away from nuclear energy after the disaster at Japan's Fukushima plant remains steadfast. As an aside, the Japanese are paradoxically returning to nuclear power and announcing major investments in the sector to mitigate their domestic energy problems. A year ago, Berlin was producing 12% of its electricity from the nuclear sector. This year, that share has dropped to 6%. Instead Germany is hurriedly installing temporary LNG terminals wanting to import liquefied gas from the United States or Qatar, among others. Meanwhile, some German citizens are prudently gathering wood to prepare for winter. Chancellor Olaf Scholz assured them, "we will survive this winter," and added that Russia "is no longer a reliable energy partner."
On the other hand, the European Commission has announced that it is working on long-term, structural reform of the electricity market. All indications are that the Union is considering to intervene and impose a cap on the price of gas and electricity.
Will imposing limits work? A cap on gas has already been imposed in Spain and Portugal, while France has imposed a cap on the price of electricity. The two Iberian countries pay gas suppliers the difference between the market price and the cap set at 40 euros per megawatt hour. However, this approach has been met with criticism, as in practice, such an arrangement could prove to be a long-term subsidy. This can make it so that caps do not reduce the demand for scarce energy, but may even increase it. This was the case in Spain, where a cap on the price of gas resulted in a 42% increase in production using gas. It seems more rational to leave the supply and demand relationship to the market, and at the same time, support the people most vulnerable to price shocks.
Moreover, Politico reports that the Union is considering levies on excess profits of energy companies that generate electricity from sources other than gas and benefit from the current situation.
Motivating Humiliation
To sum up, we have a serious crisis threatening a major recession. A real threat, according to many, of insufficient gas supply in the winter and the Kremlin dealing all the cards. However, is this really the case? Let's look at the problem from another angle.
In search of anomalies similar to today's, let's look back in history. To do this, it's best to go back 50 years to the 1973-1974 oil crisis, which is what Gregory Brew focuses on in his analysis for Foreign Policy. He explains there that the apocalyptic visions proclaimed today may be greatly exaggerated.
Recall during the oil crisis of the 1970s, Europe experienced profound problems with the availability of oil, the prices of which were skyrocketing on world markets just as gas prices are today. In 1972, Europe's dependence on oil was dramatic, with Western countries using oil to produce about 60% of their electricity, far more than they use gas today. And virtually all of it was imported from the Persian Gulf and North Africa.
Then, in August 1973, Syria and Egypt launched a surprise attack on Israel, triggering a cascade of events resulting in a drop in Gulf oil production and a quadrupling of the price of crude within six months. The crisis is mainly remembered for the long queues in the United States, but it was no less significant for Western Europe. In the winter of 1973, Arab oil accounted for 72% of all Western European consumption. Suddenly, up to 20% of the crude was set to run out, causing massive inflation and a deep recession in 1974. "There is little the Western Europeans can do," reported the CIA at the time.
However, the worst predictions never came true, and the winter went by with virtually no blackouts. The scale of the crisis of the 1970s corresponded to or even surpassed the current one, and, just as then, one today should not succumb to apocalyptic predictions says the author. In the aftermath, Europe set a course for deep diversification of its energy sources. France accelerated its nuclear program and Britain more vigorously developed its North Sea oil exploration projects. However, Europe is not a cohesive organism, so the degree of this diversification has varied. The United States, also severely humiliated by the Arabs in the 1970s, has come a long way toward energy independence and today is an energy powerhouse. As a result, in 2019, the United States exported more energy than it consumed for the first time in 70 years.
You react differently when your mother is lecturing you and differently when you have a knife up to your neck. This situation, while extremely painful in the short term, may in the long term prove to be the stimulus Europe has long needed.
Despite the existing anti-nuclear sentiment in Europe, especially in Germany, there is nevertheless more confidence in pro-nuclear policies. France, Slovakia, Finland, and the UK are in the process of putting up new units of nuclear power plants. While the Czech Republic, Hungary, Poland, Romania, and Slovenia are in the planning to build new ones. Where there is no bet on nuclear, a lot of pressure will be put on renewable energy sources. There could hardly be a better motivation for such action than the current crisis. Short-term pain can turn into long-term gain. At this point, European policymakers should take Winston Churchill's maxim to heart: "Never let a good crisis go to waste."
Finally, let's return to Russia and the popular, in some circles, narrative that the Kremlin is winning the energy war. Yes, Moscow has its “energy weapon.” However, it is important to remember that it is a double-edged sword. The Kremlin's current massacre of the European energy market is, in practice, a finite resource, as is...gas. Russia capitalizes on its advantages in the short term, but in the long term, it pays with something much more valuable: trust. Moscow is, in some blind rage, striking back and alienating the European Union, which is its biggest customer and strategic partner, and thus demolishing what it has worked for over the years. This may, in a way, explain the failure of Germany's energy policy. Rational Germans could not imagine the possibility that Moscow would start cutting off its most important branch, hydrocarbons to Europe, on which the lion's share of its economy rests. But the Russians are doing it, and are thus are helping Europe decide to reject Russian energy altogether.
Also, we have the first tentative signs that things may not be as bad as some are predicting. The filling of German gas storage facilities is going surprisingly well, and these have already reached the filling level required in November. What’s more, following the Russian decision to completely halt supplies via the Nord Stream 1 pipeline, the markets first reacted with a sharp 33% price increase. However, at the time of writing, after a few days, the price of gas fell back to the levels before the announcement of the complete suspension of Nord Stream 1. This is decidedly not what Vladimir Putin was hoping for.
The coming winter is bound to be difficult. However, facing reality may bring lessons that will prove far more valuable than a few months of inconvenience. Meanwhile, Russia's place in the international energy system is changing fundamentally and, in the long-term, definitely not in its favor.
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