Vladimir Putin must think the leaders of Europe were born yesterday. The Russian president has made it perfectly clear that he will use tight restrictions of natural gas supplies as an economic weapon in the coming winter, but European politicians and central bankers still talk of a Russian embargo as a mere possibility.
There is virtually no way to escape a Europe-wide recession, but it need be neither deep nor prolonged. It is also Russia’s last economic card. So long as Europe ensures that its economies survive the cold season, Russia’s blackmail will have failed. It will not claim victory in Kyiv on the backs of shivering households in Vienna, Prague and Berlin.
For sure, the European economy is vulnerable. With the Nord Stream 1 pipeline operating at 20 per cent of capacity and other pipelines to eastern Europe under threat, some countries face physical gas shortages this winter. Even with European storage of gas higher than last year, according to the IMF, a full Russian gas embargo would leave Germany, Italy and Austria 15 per cent short of desired levels of consumption. The Czech Republic, Slovakia and Hungary would see shortages of up to 40 per cent of normal consumption. All European countries would face soaring prices. Already, European wholesale gas prices are close to €200 a megawatt hour, compared with pre-crisis prices of about €25, eight times lower.
When prices of an imported necessity soar, real incomes and households’ ability to spend money on non-essentials inevitably fall. Recessions are all but impossible to avoid. This was the conclusion of last week’s gloomy but realistic Bank of England prognosis. It will soon be replicated by official forecasters in the eurozone. Even France, with its extensive use of nuclear power, will not find an escape route, because its power sector has its own reliability problems and it is deeply integrated into the wider European economy.
The nightmare that Europe must avoid is energy nationalism when Putin turns the screw. If cross-border trade is curtailed and industry is provided no lifelines, Putin will pit the unemployed in one country against the freezing in others. This would reinforce his self-image as the continent’s powerbroker, able to raise or lower the pressure on Europe and Ukraine by pressing a few buttons in gas pipeline pumping stations. But such a bleak outcome is not inevitable. The most important defence is substitution.
Already, Germany has replaced much of its gas imported from Russia with liquid natural gas supplies, delivered on ships to the Netherlands or Britain and pumped to German storage facilities. By December, it will be operating the first of four LNG floating storage and regasification units its government has leased.
Despite protesting otherwise, European industry is rapidly altering production processes to substitute electricity and other fuels for gas where possible, or importing semi-manufactured goods from outside the EU where access to gas is plentiful. Gas-hungry ammonia for the fertiliser industry need not be produced in Europe, for example. Real-world evidence of industries acting to reduce consumption is growing across the continent.
In electricity production, coal is sensibly being temporarily reprieved, despite the environmental consequences, and Germany is finally considering slowing its premature closure of the nuclear industry. Renewable electricity generating capacity in Europe is expected to increase 15 per cent this year, further reducing reliance on Russian gas.
After substitution comes solidarity within Europe. IMF modelling showed that more cross-border sharing of gas could reduce losses in the worst affected countries significantly, almost halving the hits to the economies of central and eastern Europe at low cost to those allowing gas to flow. As cross-border infrastructure improves, the ability to pump gas eastward from western Europe, which has much better access to LNG, will in future almost eliminate the economic effects of a gas embargo.
Finally, households have to play their part. Conservation this winter will be everything. Publicity drives have worked in Japan and Alaska to limit energy consumption in the face of shortages. This would be helped by large increases in the cost of energy to give a significant price signal, offset by lump-sum payments for poorer families. Industry alone should not bear the brunt of Putin’s energy warfare.
Such policies could reduce the worst effects this winter from GDP losses of roughly 6 per cent in central Europe to a third of that, with the EU economy taking a hit of only 1.8 per cent, far less than that of the financial crisis, according to the IMF’s modelling.
Most important, any fall in economic output would be temporary. Once endured, it would not persist. Every winter, substitution will improve substantially. Advanced western economies will once again show their resilience and flexibility — this time in the face of a deliberate attempt to create chaos.
Russia’s economy, on the other hand, would be dealt another severe blow. Already significantly undermined by sanctions and unable to import goods necessary for production, it will soon lose its main export sector, fossil fuels to Europe. As Europe recovers from this winter’s recession, that would leave Russia’s economy high and dry — hoisted by its own petard.