Russia’s indefinite closure of the NordStream 1 natural gas pipeline to Europe on Sept. 2, 2022 has led to liquid natural gas (LNG) shortages and high prices in Europe. The resulting energy crisis threatens to depress economic output and snarl supply chains, especially of natural gas-dependent industries in Europe and possibly beyond. Europe may, to some extent, replace Russian gas with alternative sources (such as from the U.S.), stockpile sufficient reserves, and build enough import capacity to ensure natural gas is available, but may nonetheless face high prices through 2023.
Supply Chain Impacts
NordStream 1 is the largest pipeline for Russian gas to Europe, though other pipelines remain open. The energy crisis will impact European industrial capacity in key industries like steel, chemicals, ceramics, glass, and fertilizers. There may also be spillover effects, including recession, high energy prices in Asia, and increased likelihood of political unrest.
Reduced Production Capacity of Key Industries
- Steel: Heavy industries are expecting rationing and idling capacity, including ArcelorMittal and Ferroglobe furnaces in Spain and Germany, amid low recent demand for steel and high energy prices. Steel producer ThyssenKrupp could cut production, which may even damage equipment. The U.S. imported 2.5 million tons of European steel in 2020 (12.5 percent of total U.S. imports); more than half came from Germany, down from 5 million tons in 2018. German steel is often used in flat products as well as pipes and tubing.
- Natural gas-dependent industries: According to a study by market research firm ICIS, chemicals, glass, and ceramics sectors account for half of Europe’s natural gas demand. Chemicals that require natural gas as energy and feedstock are likely to increase in price as Europe idles factories and increases chemical imports. The energy crisis will decrease production for German company BASF, the world’s second-largest chemical producer, which relies on the U.S. for approximately 25 percent of its revenue. BASF makes a wide range of chemicals like glues, solvents, petrochemicals, and electronic-grade chemicals for plastics, pharmaceuticals, and automotive industries. Europe’s ceramics and glass industries will likely continue to suffer because high prices have threatened shutdowns since 2021. Notably, Germany is the U.S.’s biggest source of laboratory and pharmaceutical glassware (39.1%), with China second (16.4%) and the Czech Republic third (15.7%).
- Ceramics: Based on available trade data, Italy is the largest source of ceramics for U.S.-based consignees (30.8%), while China is second (30.1%) and Spain is third (10.3%). Beyond household uses, ceramics are used in advanced armor, fiber optics, and electronics.
- Fertilizer: European fertilizer production has increased by 70 percent due to high LNG prices and shortages. Prices of ammonia and urea have approximately doubled since July 2021, while sanctions limit import of Russian and Belarussian potash. As of July 2022, at least 13 fertilizer plants had shut down or reduced capacity, including in Germany, Romania, Poland, and the UK. Among other things, shutdowns threaten high food prices for food security hotspots like Afghanistan, Somalia, and Yemen that, combined with lower grain shipments from Russia and Ukraine, may lead to shortages.
Shipping Constraints
Europe faces constraints due to a shortage of available tankers. LNG must be delivered onshore through terminals via specialized tankers that require, on average, 2.5 years to build, with no free major shipbuilder capacity to take on new orders until 2027. Almost no tankers are available to increase deliveries to Europe, and shortages of available tankers may continue through 2025. Even as Europe funds installation of new LNG terminals through 2023, some import capacity may remain idle due to expansion outpacing the ability of producers and shippers to deliver.
Recession
The LNG shortage combined with inflation-curbing measures could contribute to a recession in European countries with Russian LNG dependency. Multiple projections forecast mild negative Euro area growth rates through at least Q2 2023. Recessions can have a persistent effect on production as companies reduce overhead, capacity, and investment. Limited availability of energy or persistent high energy prices can also force critical industries to cut costs and lay off workers, idling capacity and losing expertise that may take a long time to regain.
Knock-on Effects on Global Energy Prices
- Asia energy price increases: South Asian countries (such as India, Pakistan, and Bangladesh) are grappling with increased natural gas prices affecting local energy availability as LNG is diverted to the more lucrative European market. East Asian countries may also feel the pinch. Based on U.S. Government data, 2021’s top importers by volume of U.S. LNG (using LNG tankers) were South Korea, China, and Japan (followed by Brazil and Spain). Approximately 70 percent of global LNG is locked into long-term contracts and cannot be diverted without breaking contracts or shifting LNG deliveries away from countries with large industrial sectors. Yet U.S. producers—drawn by the higher prices—are reportedly willing to pay penalties for breaking their Asia contracts to export to Europe.
- U.S. energy price increases: The U.S. is itself facing higher natural gas prices with increased costs of heating, manufacturing, and transportation as domestic producers maximize exports to Europe. The U.S. Energy Information Agency (EIA) expects exports and U.S. prices to decrease in 2023.
- Contained impact on Chinese production: High prices led China to cut natural gas imports, affecting industries like heavy trucks and ceramics. However, China is likely to adjust by increasing coal and hydropower generation, limiting long-term effects on production. A Chinese agreement with Russia to buy natural gas may have limited short-term impact because of a lack of transport infrastructure between the two countries.
Increased Public Dissent, Protests, & Political Impact
- Energy price protests: Protests over energy prices have already occurred in the Czech Republic and Germany. The UK also faces huge energy price increases that will likely stoke public discontent. Independent analysts anticipate a higher risk of civil unrest in Q4 2022 driven by energy prices. Unrest can compound uncertainty in supply chains.
- Uncertain European cohesion: Social unrest may strengthen Euro-skeptic parties during elections—which has already transpired in Italy, a major importer of Russian natural gas. This could yield policies that stymie European cohesion to address inflation, or could stall Euro area energy market coordination in 2023 to mitigate effects from the energy crisis.
European Policy Response
Europe is pursuing multiple avenues to minimize the effects of low natural gas availability and high prices, with the expectation that NordStream 1 will remain closed without a settlement to the war in Ukraine and the EU will continue to reduce its reliance on Russian natural gas. Analysts at Goldman Sachs project that these policies will successfully reduce gas prices and limit the energy crisis’ effects in Q1 2023, assuming reduced energy demands.
- Stockpiling: European countries that import Russian gas are building natural gas reserves and are at 83.6 percent capacity based on Sept. 2022 figures.
- Emergency measures: Eurozone countries are discussing emergency measures, including gas price caps and windfall taxes on energy firms. Individual countries like Finland, Germany, and the UK are spending heavily to mitigate price impact on key industries and consumers.
- Rationing: The EU adopted a resolution in August 2022 to voluntarily reduce LNG consumption by 15 percent in Q4 2022 compared to five years’ prior average consumption. Many countries are implementing emergency plans to promote energy efficiency and economical energy while reducing demand.
- Expanding import capacity: Europe at present has capacity to replace only half of Russian gas imports with LNG due to infrastructure and contractual limitations. Germany and the Netherlands will activate seven floating LNG terminals before 2023 to increase LNG import capacity.
- Diversification: In Q4 2022, larger economies like Italy and Germany are more likely to find alternatives to Russian natural gas through LNG import agreements. Eastern European countries like the Czech Republic are most affected and least able to replace Russian gas.
- Alternatives: Europe is likely to increase use of oil, coal, and biomass in the immediate term. Germany also decided to keep two nuclear power plants slated for deactivation online through the winter.
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