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Will Germany have to ration gas?

Germany is currently wrestling with how it will respond this winter if Russia reduces its supply of gas. Moscow and Brussels both understand that the European Union cannot do without some Russian gas this winter.

| 6 min read

This summer, Russia has shown it can cut back deliveries of gas to Europe through the four pipelines that traverse the area.

Flows through Nord Stream 1 have been cut back to 40% of capacity and the pipe will shut for maintenance completely between 11 and 21 July. Clearly, Russia is making enough money on its sales of oil at higher prices to be able to reduce the gas supply. The aim is probably to keep Europe’s storage capacity well below full to increase leverage this winter. The reductions add to uncertainty and have driven prices higher.

Europe cannot do without some Russian gas this winter. There are plenty of plans to increase liquified natural gas (LNG) capacity and to seek more US gas, although that trade has been temporarily hit by the three-week closure of a Texas LNG plant following a fire. This winter, to keep homes warm and factories fully operational, it will still need plenty of Russian gas.

Rationing, with most of the hit taken by industry, seems to be the likely response if Russia uses the ‘gas weapon’. Germany has already moved onto Stage 2 of its Gas Plan, the Alarm Phase. Government help is being given to increase gas stocks, and industrial gas is auctioned to try to reduce demand. There should be two new floating LNG facilities added by year-end, but it takes time to put in LNG conversion capacity.

There will be some grain exported from Ukraine and there is a crop in the ground, despite the war. The loss of the sea route out of Ukraine’s southern ports has greatly restricted the volume of grain that can be moved. There are new attempts to use the rivers and railways to shift more, as the Middle East has been especially reliant on this food.

The war-torn damage to Ukraine and the sanctions damage to energy will continue to disrupt markets this winter. Meanwhile, Ukraine’s allies are considering how to help Ukraine rebuild, as large parts of the country escape Russian attack in what is now largely a more concentrated war in the southeast.

The cost of rebuilding Ukraine

The EU Commission wishes to lead and provide substantial backup in terms of planning and organising the pace and nature of the rebuild. Whilst stressing that Ukraine will be in charge, the EU includes in its four aims for the rebuild “implementing a structural and regulatory agenda with the aim of deepening the economic and social integration of Ukraine and its people with the EU in line with the European path”. It plans to set up a “Rebuild Ukraine” facility and to work with the World Bank, IMF, European Investment Bank and others to raise large sums of money for the task.

Ukraine was already a large borrower from international bodies and has a detailed Association Agreement with the EU which puts it on a path to harmonise with EU law to achieve its aim of membership. Ukraine’s foreign debt is at $127bn, with substantial loans from the IMF and World Bank.

The west cannot yet do without some Russian energy, and Russia still needs some cash from the sales of oil and gas.

The Prime Minister of Ukraine argues for a total investment of $750bn for the rebuild. The EU is currently offering more than €10bn this year. There was a €1.3bn emergency loan in the first half of 2022, and now the promise of a €9bn package. This will be a longer-term loan where the EU borrows the money and pays the interest itself. The EU is seeking both EU budget and member states' guarantees of the capital. The EU will be using its own balance sheet to borrow, a further extension of EU budgetary powers. The European Investment Bank is creating a Trust Fund of up to €100bn to help finance recovery. The EU is examining whether there is a legal way of using frozen Russian assets under sanction to help pay the bills of rebuilding.

Our base case assumes the sanctions war between Russia and the West will continue to be moderated by both sides. Russia needs money from sales of oil and gas to NATO and EU countries, and the West needs to allow banking arrangements to pay for the energy. There have been some disruptions to the gas trade where countries such as the Netherlands, Poland and Bulgaria have refused to accept Russian banking requirements.

The west cannot yet do without some Russian energy, and Russia still needs some cash from the sales of oil and gas. China, India and other Russian trading partners cannot, in the short term, take all the volumes Russia wants to sell. There is a risk that Russia will become more confident of its ability to survive on sales of energy elsewhere and will tighten its use of the gas weapon this winter, which is why Germany and others are making contingency plans for rationing.

Energy and food shortages are driving new policy, with more emphasis on national and regional self-reliance and a wish to rely on friendly countries for supply. This all takes time, as the oil market is truly global and the gas market in Europe was designed around pipeline gas from Russia in large quantities. The problem with high and rising energy prices is that it both increases the inflation rate and slows an economy down through the hit to people’s real incomes and spending power. This makes policy responses by central banks and governments particularly difficult.

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Will Germany have to ration gas?

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