What Happens if Russia Stops Exporting Gas to the EU?

Summary

• Russia has cut piped gas supply to the EU by almost two thirds since the war in Ukraine began. With scheduled pipeline closures looming, worries about a total stop have increased.
• If consumption patterns remain unchanged and Russian gas stopped now, the EU may run short of gas before the end of the year.
• Households are the largest users of gas, but reining in their usage may be difficult. Instead, demand management would likely seriously weigh on industrial activity.

Market Implications

• The cutting of gas supply to the EU would present an existential threat to many European industries. It would weigh particularly heavily on German chemicals.
• A collapse in risk asset prices would be the initial reaction, but we would also expect to see increased momentum behind joint-EU spend and ECB easing to offset some of the pain.

Russia Is Cutting Gas Exports to the EU

Russia has cut its flow of piped gas to the EU by around two thirds since it invaded Ukraine (Chart 1). The moves have come in response to Western economic sanctions and compound the bloc’s growing energy crisis. Now, with looming closure of the Nord Stream for annual maintenance (11 -21 July), worries about a total stop have increased.

The EU Depends Heavily on Russian Energy

As we noted early in the crisis, the EU relies heavily on Russian gas, coal and oil (Charts 2 and 3). Russian natural gas imports account for 40% of its total usage. We also explored how EU citizens and businesses could take small steps to insulate themselves from the exposure. Now, however, with a rising risk of acute shortages, more extreme action may be required.

Diversifying Gas Supply Is a Logistical Nightmare

LNG has been unable to plug the gap in piped gas since the war began (Chart 4). Reports that the UK’s National Grid (25% of the continent’s ability to receive LNG) may cease gas supply to Europe if shortages persist only add to those worries. Mid July will see annual scheduled cuts to flows via Nord Stream. As this nears, we expect to hear increased worries around whether they ever turn it back on again…

This is a serious issue. Coal and sea-borne oil are comparatively easy to replace, but with gas, the EU is stuck to Russia via its existing infrastructure. As it stands, Germany and Eastern Europe act as hubs for redistributing Russian gas to other EU nations. Even if the EU could buy enough gas to replace Russian supply, it cannot reach its destination if it does not enter the system there.

How Much Gas Has the EU Stored?

Weekly data from AGSI+ shows the EU has around 102bcm of gas storage, currently filled about 57% (c.65bcm). This is about 4pp less than typically filled at this time of year and far below the EU’s 85% year-end target (Chart 5).

The picture varies widely by country (Chart 6). 10 EU countries have no significant gas storage capacity, while five account for around 75% total storage (Germany, France, Italy, Austria, the Netherlands). Current capacity usage ranges from almost 100% (Portugal and Poland) to less than 45% across much of South East Europe.

How Long Will the Stock Last?

From 2015-2019, the EU consumed around 400bcm of gas per year. Consumption is highly seasonal, with a peak in January (c.50bcm) and a trough in August (c.20bcm). Production also shows seasonality, sitting around 5bcm for much of the year with a slight rise in winter (Chart 7). This leaves a pattern of import requirement roughly similar to consumption.

Historically, roughly 50% of imported gas has come from Russia. Consequently, in the event of a total end to Russian imports from July, we can estimate on average a 27bcm shortfall per month absent a mitigating policy.

From a standing start of c.65bcm storage and if consumption remained as-is, that suggests EU gas would run out sometime in mid-November (Chart 8).

This is a very simplistic, extreme scenario, but the point is clear: the EU economy cannot exist in its current form without Russian gas. A great deal of substitution to coal, LNG or non-Russian gas is possible. But if Russian supply remains very low, demand management will likely be necessary.

In the extreme example above (where supply diversification is minimal), we can calculate what percentage of demand must be cut to delay running out of gas (Chart 9). The IEA estimates gas consumption will decline in Europe by 6% this year, but that would still only delay the inevitable to December. France has mooted a reduction in energy usage by 10% in two years. This is a pretty heavy step, but France uses comparatively little gas (Chart 10).

Meanwhile, across much of the EU, the largest user of gas tends to be households. Reining in this usage is tricky. Back in March the IEA estimated reducing thermostats across the EU by 1° Celsius could save 10bcm this year. Four months later, this effect would be smaller. It is difficult to force households to reduce their energy consumption through legislation, and, simply letting the increased price dissuade them from heating their homes is politically infeasible. Instead, governments have done the opposite, in subsidising their energy consumption.

How Bad Could Demand Management Be?

Perhaps a more practical alternative would be to manage down industrial output in the most gas-intensive sectors. Taking Germany as an example, Chemicals manufacturing consumes the most gas directly (Chart 11). This strongly suggests that if demand management happened, it would involve reducing industrial chemical production. This would be a big step.  Chemicals account for the third-largest industry in Germany and employs 400,000 people. In other words, it would be a massive hit to the economy.

Perhaps unsurprisingly, then, recent analysis by Prognos commissioned by the Bavarian Industry Association (VBW) has put the potential cost of a total stop in gas flow at 12.7% of GDP (€193bn), affecting up to 5.6mn workers. No matter the details, shutting down large swathes of the economy would be incredibly damaging, with knock-on effects likely reaching every aspect of the bloc.

What Would That Mean for Markets and Policy?

Should the gas supply problem escalate quickly, the natural expectation would be for European gas price to rise dramatically. Energy shortages would mean new selloffs in risk assets, while a blowout in credit spreads would be highly likely. The uncertainty around how policy should respond to this would also add to this panic sell – much as it did in 2020.

Like the initial response to the Covid crisis, the European policy response has so far been limited in its cohesion. The EU’s REPowerEU plan is ambitious but still largely reliant on national policy alignment and voluntary cooperation. This has meant limited progress in diversification from Russian sources.

Following the experiences of Covid and the European sovereign debt crisis,  momentum behind EU-led solutions would probably grow quickly. If pragmatism prevails, it could provide the ground for even greater joint-EU spending. Similarly, while the ECB is currently focused on normalising monetary policy, the response would likely be to pivot strongly towards capping credit spreads and increasing support for the economy. On this basis, while the knee-jerk reaction might be sizeable for risk assets, the effect may be relatively short-lived.

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank. He holds a BA in Economics from Durham University, and an MSc in Economics & Social History from the University of Oxford.