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44 I Cover story bne September 2022
followed up in July by reducing them further to only 20% of total capacity flowing through the Nord Stream 1 gas pipeline. The Kremlin is threatening all of Europe with a huge energy crisis this winter if Russia chooses to cut off all
gas supplies even if Europe’s gas tanks are full at the start of the winter. Only Slovenia and Austria have gas storage tanks big enough to last the whole winter if imports of gas from Russia stop.
Europe has been racing to fill its tanks on time, which reached 75% of capacity on August 17, well ahead of schedule and on track to hit the 80% full deadline before the October 1 deadline set by Brussels. It has managed this by importing a record amount of expensive LNG and also by ramping up the production of European gas produced in the Netherlands
and Norway.
But it has done this at enormous cost. Usually the EU spends a total of $12bn a year on LNG imports, but this year it has already spent $70bn on just LNG, according to estimates by Bruegel, and the winter has not even started.
Despite the comfortable levels of gas in the tanks, gas prices soared again this week to fresh highs above $2,700 per thousand cubic metres on August 16 – ten times their regular levels – on the back of energy crisis fears. Elec- tricity prices are soaring in parallel, even though Europe is not particularly dependent on gas-fired power stations. Power prices are linked to the price of gas as gas-fired power stations cover peak demand while other fuels cover the baseload demand. That means power prices are coupled to the price of gas when demand is high, and with a scorching summer and the pros- pects of a cold winter, power prices are currently closely coupled to gas prices.
Germany has already announced there is likely to be a €1,000 power surcharge for residential homes this winter and in the UK the surcharge could be an even more extreme GBP4,000-5,000 per household. In July it was estimated that just the cost of this winter’s energy crisis could run to €200bn – more
than the cost of reconstruction of the
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physical damage in Ukraine. And given that the energy crisis is likely to repeat itself for at least one more year as Europe looks for new sources of energy, plus it will have to invest into extensive new energy infrastructure, including new pipelines and retooling refineries, the costs could rise to over €1 trillion
in the next three years, according to some estimates.
Commodity prices
Spiking oil prices is another vulner- ability for Europe. After an initial spike in the first months of the war when oil rose to over $140 per barrel, but still short of its all-time high of $168 set in June 2008, it has since fallen back to just under $100 as Russia has found alternative buyers in India, China and Kingdom of Saudi Arabia (KSA) to
take up the slack created by Europe’s reduction in demand and the self- sanctioning.
However, on December 5 the EU plans to halt Russian crude deliveries entirely, followed by refined products by February 5. No one is sure what will happen then. JP Morgan issued
a warning saying that the disruptions to the oil market could send prices sky-rocketing to over $380 per barrel, although other analysts are more sanguine, which would cause a new shock to the global economy.
Putin controls the marginal markets in a number of key commodities.
Russia is also the biggest producer
of fertilisers in the world and while fertilisers have specifically not been targeted in the seven sanctions packages, he is in a position to squeeze this market too. Indeed, Russia has already banned the export of some fertilisers in order to “preserve stocks for domestic use” that has also sent prices to record highs.
If fertiliser exports are halted, not only will that raise costs for farmers around the world, but they will also inevitably reduce the use of fertilisers and that will reduce food production and feed more food-inflation.
Eurostat reports that annual inflation in the EU reached a record 8.9% in July – the highest level it has ever been since the euro was introduced in 1999. Consumer prices in the 19 countries that use the euro rose by 0.1% in July compared to the previous month and by 8.9% year on year, way ahead of the European Central Bank's inflation target of 2%.
Power and food are almost entirely responsible for the increases, says Euro- stat. Electricity prices rose by 4.02% and alcohol and tobacco prices by 2.08%. According to Reuters, even if these most volatile components are excluded, prices were still 5.1% higher in July.
Russia also has the power to send wheat prices back up through the roof.