Russia’s Failure To Reopen Nord Stream Pipeline Would Cripple Germany’s Economy

The critical Nord Stream 1 pipeline that supplies Germany with natural gas is currently shut down for what Russia describes as “routine maintenance.” It is set to reopen on July 21. Still, some officials believe that the politicization of energy and Russia’s desire to cause chaos in Europe in retaliatory response to sanctions following its invasion of Ukraine could lead to a delay in the reopening or even an indefinite closure of the pipeline.

Germany and many other European countries are still heavily dependent on energy imports from Russia. A further cut in supply could lead to a host of economic, social and political consequences and wreak havoc on the European economy. How did Germany, a country known for its meticulous planning and engineering, find itself in such a precarious situation?

First, it is essential to understand the degree to which Germany depends on Russia for energy. In 2021, about 35 percent of crude oil, 55 percent of natural gas and roughly half of hard coal imports came from Russia. While Germany has made an effort to grow the share of renewables in its energy mix, it is still highly dependent on imported fossil fuels.

The Current Situation Could Have Been Avoided

Several strategic failures have made the energy crisis situation in Germany worse. For years, many of Germany’s allies have warned of the potential consequences of relying on Russia for its energy imports. Such warnings were ignored, with Germany proceeding to double down on its relationship with Russia with the development of the Nord Stream 2 pipeline. Of course, in hindsight, the reliance on a geopolitical adversary, if not to Germany specifically but certainly to the West as a whole, was dangerous. The lack of desire to diversify oil and gas imports proved unwise.

The lack of diversification was compounded by what now looks like another strategic failure: the desire to close all nuclear power plants by the end of 2022. Germany currently gets roughly 11 percent of its electricity from nuclear power compared to nearly 30 percent twenty years ago. By comparison, atomic energy provides approximately 70 percent of electricity in France. What drove Germany to abandon its nuclear efforts? The 2011 disaster in Fukushima, Japan, changed everything. It prompted the Merkel government in June 2011 to shut down eight nuclear plants for good and limit the operation of the remaining nine to 2022. The decision was popular at the time with the populace but forced the government to pursue other alternatives to meet its energy needs. Hence, the push for renewables.

In 2021, renewables provided 41 percent of the gross energy used in power production. Onshore and offshore wind was the largest contributor, followed by solar, biomass and hydropower. Germany has made significant progress in the development of renewable power and has mandated a continued aggressive transition. The Renewable Energy Sources Act was enacted on July 1 of this year. The new laws set a target for renewables to meet 80% of electricity demand in the country by 2030.

The transition to renewables is a European trend that will lower carbon emissions and ultimately reduce dependency on fossil fuel imports from Russia. Unfortunately, there is no way to accelerate the move to address the short-term energy supply/demand imbalance. As a result, Germany is temporarily altering its near-term energy strategy.

Near-term Steps to Address the Energy Shortage

If adding more renewables to the mix is not an immediate solution to the problem, there are still steps Germany can take to alleviate some of the stress. The government is tackling the issue from multiple angles.

Contingency Planning

Germany recognizes that the energy crisis can get materially worse. As a result, it has created and articulated a contingency plan dependent on the severity of the shortages. The plan’s three phases go from the Early Warning Phase, followed by the Alert Phase, with the most severe situation called the Emergency Phase. The Alert Phase was triggered on June 24 in response to a reduction in gas supplied from Russia (in mid-June, Russia’s state gas firm Gazprom cut gas flows through Nord Stream 1 to just 40% of the pipeline’s capacity). The Alert Phase seeks voluntary cooperation of industry and households to lower electricity demand. The Emergency Phase sees government-imposed electricity rationing.

Return to Coal

As undesirable as it may be to the environmentalists, Germany is temporarily switching back to coal as an energy input. This week, a bill is set to pass that fires up ten coal-fueled plants and six oil-fueled plants. Furthermore, 11 coal plants that were scheduled to be shut down in November will be allowed to remain open. For a country that has set such aggressive renewable targets, the fact that Germany is reopening coal plants should highlight the seriousness of the energy shortage.

Increase LN
LN
G Imports

Securing and developing the ability to import LNG is also part of the plan. An abundance of shale gas reserves in the United States makes it a natural geopolitically-friendly partner in the energy war. Following Russia’s invasion of Ukraine, the E.U. reached a deal with President Biden to deliver an additional 15 billion cubic meters of LNG to the E.U. in 2022. The problem is that trade in LNG, or liquid natural gas, requires specialized infrastructure that is currently not in place.

Environmental concerns are also associated with building new pipelines to supply LNG terminals. In addition, the massive capital investment required to develop the infrastructure may not be viable long-term in a world committed to reduced demand for fossil fuel.

Canada is a good example. Despite its significant natural gas resources, there are many challenges in building new LNG terminals. There have been 18 such facilities proposed, but none yet exist. LNG Canada in British Columbia is the only export terminal under construction, but it’s not expected to be operational until 2025.

One solution is through the deployment of floating LNG terminals (FRSU). German energy companies RWE and Uniper plan to lease three floating LNG terminals (FSRU) that could be used to import liquefied natural gas and might be operational in time to provide some relief for next winter.

Seek New Sources of Supply to Increase Storage Levels

Russia currently provides roughly 35% of German supply — down from the 55% it supplied before it invaded Ukraine. Germany, and other European nations, have turned to countries such as Norway, Algeria and Qatar to address the shortfall.

Norway is Europe’s second-largest gas provider but is already running close to full capacity. Still, it has hiked gas production in response to the European shortages and is expected to increase its gas sales by 8 percent this year. Algeria was already exporting gas to Europe before the war broke out via pipeline to Italy and Spain. Italian energy giant Eni inked a deal earlier this year to gradually increase gas flows starting this year and eventually reach nine bcm of extra gas per year by 2023-24. As for Qatar, the new supply will come in the form of LNG. Qatar had already begun expansion of its LNG export efforts, but Europe won’t benefit from the additional supply until its LNG infrastructure is developed.

Unfortunately, most of these alternatives won’t come online for several years. If Russia were to cut off supply tomorrow, these new sources of gas can’t be tapped. That is why Germany is aggressively trying to replenish national storage levels. At the end of the first week of July, gas storage facilities in Germany were filled at 64.6 percent, according to the Federal Network Agency (BNetzA). The country seeks to reach a storage level of 90 percent before winter. That should provide a buffer, but if Nord Stream 1 is not turned back on, it will be challenging to hit that target.

What Happens if Nord-Stream Does Not Reopen?

According to Vice-Chancellor Robert Habeck, Germany can become independent from Russian natural gas by summer 2024. That suggests that if Russia wants to leverage its situation as Europe’s gas provider, it needs to do something before the energy transition is complete. This is why a geopolitical escalation using energy is a real possibility.

If gas supplies were totally cut, the consequences would be devastating. The German industrial machine would grind to a halt and the German population would suffer tremendously.

“Companies would have to stop production, lay off their workers, supply chains would collapse, people would go into debt to pay their heating bills,” said German Vice- Chancellor, Robert Habeck in a recent interview.

Germany would likely immediately move to the Emergency Phase of its contingency plan. Clean Energy Wire thinks “protected customers” will be prioritized if gas rationing is enforced. These include households, small businesses like bakeries, supermarkets, and essential social services, such as hospitals, schools, police stations and food producers. Half of Germany’s 43 million households are heated with natural gas, so prioritizing households, especially in the winter, would be critical. Still, according to BNetzA, families could see a tripling of their heating bill next winter.

Therefore, the industrial sector will likely take the brunt of the pain via electricity rationing. Production cuts and layoffs would follow, especially in energy-intensive industries like chemicals, steel, fertilizers and glass. Shortages for manufactured goods would develop, creating further stress on the global supply chain. The higher prices for energy and finished goods would add to inflationary pressures that are already disrupting the global economy.

A study from the University of Mannheim estimated that the repercussions of a gas cut could lead to an 8 percent loss in GDP. A paper prepared by a research consultant, Prognos, for the Bavarian Industry Association, predicts that if Nord Stream1 does not reopen and Russian cuts off Germany entirely, the German economy would shrink by 12.7 percent. If inflation were to accelerate, there would be little the European Central Bank could do to address such a rapid decline in growth.

In the short-run, if Nord Stream 1 does not reopen, the cost to the German people and the economy would be severe.

Why Would Russia Cut Off the Supplies Now?

Germany is aggressively trying to replenish gas supplies in the short run and moving away from Russian gas in the long run. Russia is aware of this stated effort. It knows Germany and most of the rest of Europe will not be an export market in the not-so-distant future. It is not hard to believe that Putin would want to use its existing economic leverage while it still can.

Russia knows the consequences for Germany are horrendous and might try to extract something in return for keeping the supply flowing. Besides, Russia is in strong financial shape right now. In fact, despite the sanctions, Russia’s oil exports are larger than before it invaded Ukraine. The five-week rolling average of crude exports has increased 9% since February.

As a result, Russia’s current-account surplus hit a record of $70.1 billion in the second quarter of 2022, with revenue from energy and commodity exports rising as imports shrank due to U.S. and European sanctions. More than half of these shipments are going to China and India, where energy demand continues to grow and sanctions have not been imposed. In May, China’s crude imports from Russia surged 55 percent from a year earlier. China’s imports of Russian LNG also jumped, rising 22 percent on the year. In India, crude oil imports from Russia have jumped over 50 times since April and now account for 10 percent of all imported crude from overseas. Clearly, there are other buyers of Russian energy.

If Russia wanted to retaliate against Europe and the West for the imposition of sanctions, now would be an opportune time to do so, from its perspective. Russia has found alternate demand sources for its oil & gas faster than Europe could find new sources of supply. Unfortunately for Europe, Putin is holding the better poker hand right now. But as the world has come to learn over the last two decades, Putin is far from predictable. The world will just have to wait and see what happens. In the meantime, everyone is focused on July 21 — the date Nord Stream is supposed to reopen. Until then, expect a lot of uncertainty in European financial and commodity markets.