As tensions mount between Russia and western powers over the invasion of Ukraine, a critical question is how much natural gas will flow through Nord Stream 1, a vital pipeline between Germany and Russia.
Europe’s largest economy and other eurozone nations are deeply dependent on the gas that flows through the pipeline, which closed for maintenance this month. While media reports indicate it will reopen at reduced capacity, speculation has swirled that it could remain shuttered.
A full shutdown, while not their base case, could drive European household energy costs up by about 65% to around €500 ($512) per month, according to estimates by Goldman Sachs Research. Industries like chemicals and cement in Germany and Italy might have to cut their gas usage by as much as 80%. The euro-area economy would likely shrink by more than 2% through March 2023, with GDP in Italy and Germany declining as much as 4% and 3% respectively.
Even before the pipeline was closed for annual maintenance, gas supply through Nord Stream 1 had already reduced by more than half, raising questions over Europe’s energy security. We spoke with two experts in Goldman Sachs Research — Alberto Gandolfi, who leads the European utilities team, and Christian Schnittker, a European economist — about their expectations for Russian gas flows to the rest of the continent and how the squeeze on the commodity is filtering through the economy.
Firstly, can you give us some background on the European energy sector: How much gas does Europe get from Russia?
Alberto Gandolfi: About 25% of European primary energy consumption is from natural gas. So, natural gas is a very important commodity. And just to be clear: the gas market was already quite tight in January 2022. Not only was there a strong bounce in consumption and demand as several countries came out of lockdowns during the pandemic, but there hasn’t been an influx of new energy supply projects. This meant that gas prices were high even before Russia’s invasion.
Then the war started and this created two clear issues. The first was around affordability. Russia did not initially reduce gas flows through the Nord Stream 1 pipeline but obviously the risk premium in the market started to lift prices. All of this continued escalating until a few weeks ago, when we noticed that Russian gas flows into Europe started to decline significantly, especially into Germany. Russia claimed this was due to technical issues, but Germany labelled the gas reduction as politically motivated. Ultimately, by lowering the gas flow into Europe, Russia is able to indirectly or not so indirectly influence the benchmark TTF gas price (an index that determines market gas price) and essentially create an affordability problem in Europe.
The second issue is that this change in gas flow creates an energy security problem. If Europe receives half, or even less, of the gas it’s supposed to, gas rationing may become more prominent into the autumn. Gas consumption in winter is about two-and-a-half times the level it is in summer and as we move into winter, if Europe doesn’t get enough Russian gas, it could be problematic for countries like Italy and Germany. While Italy has been looking for alternative energy sources, Germany doesn’t have as many options and we estimate it could mean a 65% industry curtailment in Germany if flows stopped coming entirely.
There has been annual maintenance going on at Nord Stream 1, which makes this situation even more difficult to understand. How do you expect Russian gas flows to impact countries like Germany going forward?
Christian Schnittker: On July 11th gas flows from Russia via Nord Stream 1 fell to zero, which is down to annual maintenance that happens at this time every year. The key date will be July 21st as that is when the maintenance is scheduled to end and we should have some clarity on the direction that gas flows will go. Our analysis points to a significant hit to activity — especially in Germany and Italy — if gas flows don’t go up after that.
Germany is highly exposed to this issue and that’s why we see Germany in our scenarios at the forefront of this issue. A little under half of German gas is used for household heating and cooling, about a third is used for industrial use and the remainder is for other uses.
Our current baseline — and all of this depends on what happens after July 21st — is that we get back to the status quo, we get back to 40% of flows through Nord Stream 1. The risk case is that Russian gas flows are curtailed entirely. There are also two upside scenarios, one where it gets back to 65% of gas flows or even 100%.
In our scenarios of subdued gas flows over the next year, TTF prices and inflation levels will remain elevated, which will ultimately lead to a slowdown in consumption. On the production side, gas intensive industries will likely see a cut to gas supplies and that, in our baseline scenario, will push Germany into a recession.
However, if gas flows did drop to zero, the outcomes become more severe: utility bills will go up; consumers will experience a real confidence shock; and there will be a curtailment in industrial gas demand in order to preserve household heating ability. In this case, we see Germany going into a deep recession, with negative quarter on quarter growth next year and growth in Germany as a whole at only 0.1% in 2022 and -1.6% for 2023. Elsewhere, we see large hits to output in Italy, too, but smaller impacts in France and Spain.
A total curtailment of Russian gas from Nord Stream 1 sounds alarming. How could this impact ordinary people?
Alberto Gandolfi: If the worst case scenario does happen, and Russian gas falls to zero, there are two big implications. The first one is a spike in procurement costs which would essentially mean a 65% increase in power and gas bills from the high levels of today. It’s a significant increase for families.
The second implication is really about volume. There is not going to be enough gas around for industries, so gas intensive companies working across chemicals, glass, paper, steel, cement, etc., will be impacted and will need to reduce production there, which could trigger things like furloughs.
The affordability issue will be felt much more in winter; this is when the actual euro spend per family will be felt. If flows go to zero, it’s going to compound and winter is going to be really, really tough both for families and the economy. But let’s not forget to say here we don’t know if flows will go to zero. At the moment, the base case is that flows remain sub run rate, like between 30-50% below normal, but they don’t go to zero.
Is there anything European countries like Germany can do to alleviate the impact of this crisis?
Christian Schnittker: This challenge is different from COVID-19. During the pandemic, restaurants and retail were shut down for lockdown, but once they reopened, things would bounce back relatively quickly. That’s what we have seen over the last couple of years. This issue over gas is complicated as it requires more structural change. It’s a longer-burn issue in some ways and that’s why we have a negative outlook for 2023.
If gas flows do dwindle, greater fiscal support from governments might be required, furlough schemes might be reactivated, and we may see more support for households, low income households and even some corporates.
Across Europe, we have already seen measures like price caps and greater fiscal support for consumers. In France, for example, they effectively capped electricity and gas prices roughly since the end of last year for consumers. This means consumers take less of a hit.
If things do take a turn for the worse, governments could step up and pay more excess energy costs and recoup it in the future through higher network charges or higher taxes. This would basically smooth the hit out over the time. In Germany, the discussions are ongoing and the broader response is a work on progress, but I imagine there will be an approach ready in July, when flows resume for Nord Stream 1.