Russia’s invasion of Ukraine has further dented global growth prospects, with Europe’s economy facing a severe setback to trade, investment and financial ties with warring countries. Now Europe is facing a partial cut in natural gas exports from Russia, its biggest energy supplier. The prospect of an unprecedented total shutdown is fueling fears of gas shortages, ever-higher prices and the economic impact. While politicians are moving quickly, they lack a plan to manage and minimize impact.
Three new IMF working papers explore these important questions. They examine how fragmented markets and delayed price projections may exacerbate the impacts, the role of the global liquefied natural gas market in moderating the results, and how such factors might play out in Germany, Europe’s largest economy.Our work shows that in some of the most affected countries of Central and Eastern Europe – Hungary, Slovakia and the Czech Republic – there is a risk of a shortage of up to 40 percent of gas consumption and a drop in gross domestic product of up to 6 percent. However, impacts could be mitigated by securing alternative energy supplies and sources, easing infrastructure barriers, promoting energy savings while protecting vulnerable households, and expanding gas sharing solidarity agreements across countries.
What determines exposure?
Dependence on Russia for gas and other energy sources varies greatly from country to country. European infrastructure and global supplies have so far coped with a 60 percent drop in Russian gas supplies from June 2021. Total gas consumption in the first quarter was down 9 percent from a year earlier, and alternative supplies, especially LNG from global markets, are being used.
Our work suggests that reductions in Russian gas of up to 70 percent could be managed in the short term with access to alternative supplies and energy sources and with reduced demand from previously high prices.
This explains why some countries were able to unilaterally stop Russian imports. However, in a total shutdown, diversification would be much more difficult. Bottlenecks could reduce the ability to divert gas within Europe due to insufficient import capacity or transportation constraints. These factors could lead to a shortage of 15 to 40 percent of annual consumption in some Central and Eastern European countries.
Economic impact
We measure impacts in two ways. One is the integrated market approach, which assumes that gas gets to where it is needed and prices adjust accordingly. Another is a fragmented market approach, best used when gas can’t go where it’s needed no matter how much prices rise. However, the estimate is complicated by the fact that intervention in the European economy is already underway.
Using the integrated market approach – as the market remains – to estimate the direct impact to date suggests that this may have represented a 0.2 percent reduction in European Union economic activity in the first half of 2022.Considering the complete shutdown of Russian gas from mid-July, we focus on the impact relative to a baseline of no supply disruption this year. This simplifies the estimation and makes it comparable to other economic research.
We derive a wide range of impact estimates for the next 12 months. Due to the unprecedented nature of the complete Russian gas shutdown, the correct modeling assumptions are highly uncertain and vary between countries.
If EU markets remain integrated both internally and with the rest of the world, our integrated market approach suggests that a global LNG market would help cushion the economic impact. The reduced consumption is distributed to all countries connected to the global market. In the extreme case, assuming no support for LNG, the impact is even greater: soaring gas prices would have to work to reduce consumption only in the EU.
Impacts on Austria and Germany would be less severe but still significant, depending on the availability of alternative sources and the ability to reduce household gas consumption. The economic impacts would be modest, perhaps less than 1 percent, for other countries with sufficient access to international LNG markets.
Exposition of Germany
We dug deeper to understand Germany’s outlook and policy options in the event of a total shutdown. Starting with the baseline outlook in our Article IV consultation – which already includes the existing partial shutdown – we have extended the assessment to 2027 and incorporated additional demand-side impacts stemming from uncertainty facing households and firms, which reduce overall consumption and investment. .
Our estimates suggest that channels of uncertainty would contribute significantly to the economic impacts of total closure. The impacts would peak next year and then taper off as alternative gas supplies become available. A rise in wholesale gas prices could also significantly increase inflation, something we specifically studied in our work on Germany. Simulations also show that voluntary consumer protection could reduce economic losses by one-third, and a well-designed rationing plan that, for example, allows downstream users and industry-intensive industries to bear more of the shortfall could reduce them by up to three-fifths.
Reducing consumption
Countries already encouraging households and businesses to save energy include Italy, where the government mandates minimum and maximum levels for heating and cooling. REPowerEU, the European Commission’s plan, also includes measures to save energy and reduce dependence on Russian fuels.However, there is still a gap between ambition and reality. Forthcoming IMF research shows that many countries have adopted policies that severely limit the pass-through of wholesale prices to consumers. A better alternative would be to allow greater penetration to incentivize conservation while offering targeted compensation to households that cannot afford the higher prices.
Solving challenges
Our research shows that the economic impact of a Russian gas shutdown can be partially mitigated. In addition to measures already taken, other measures should focus on risk mitigation and crisis preparedness. Governments must step up efforts to secure supplies from global LNG markets and alternative sources, continue to ease infrastructure barriers to gas import and distribution, plan for emergency supply sharing across the EU, act decisively to promote energy savings while protecting vulnerable households and prepare smart allocation programs for gas. This is the moment when Europe can build on the decisive action and solidarity shown during the pandemic to tackle the challenging moment it faces today.
For more read: https://blogs.imf.org/2022/07/19/how-a-russian-natural-gas-cutoff-could-weigh-on-europes-economies/
