We use cookies on our website to show you content we think is relevant to you, to manage the technical operations of our website, and analyse our traffic to further improve our website. We may share information about your use of our site with our social media, advertising and analytics partners. By clicking "Accept", you agree to the use of all cookies as described in our Cookie statement or "Do not accept" to only use cookies strictly necessary for the functioning of the site.

Wholesale Banking

A full stop to Russian gas could plunge Europe into a full-blown recession

While Europe cut demand for gas by 15%, Russia also lowered flows through Nord Stream 1. Gas prices are now skyrocketing. Both decisions will result in falling demand for gas. The energy crisis will lead Europe into recession – the question is just how bad will it be?

protestor holding signs of supporting total embargo on Russian gas

Europe has already cut down on gas

Overall gas demand in Europe has come down substantially this year. During the first quarter, gas demand in Europe fell by about 5% compared to the 2017-21 average, partly due to a mild winter. Prices rose further in the second quarter and fuel switching began, so the decline in the second quarter was stronger. Germany, for example, reports that gas demand is down 10-15% compared to the 10-year average in the second quarter, and The Netherlands stood at -30% compared to the 2019-21 average. It shows that many countries have already come a long way in bringing gas demand down. 

Substitutes have been found

The same goes for finding substitutes. The flow of Russian gas to Europe has come down strongly over the first two quarters of this year – on average it has just about halved and recently it stood at as little as a third of normal flows. The decline in Russian flows is the equivalent of about 15% (quarter one) and about 25% (quarter two) of total gas used in Europe historically, as Russian gas is about 40-45% of total gas used. This makes it evident that alongside lower demand, the Continent has been able to substitute a large share of Russian gas with alternatives. Liquefied natural gas (LNG) has been the most prominent, alternative pipeline flows a second, while fuel switching to coal and oil has also contributed. Renewables play a role when compared to the longer-term historical average use too.

More substitutes will become available over time

The crucial question is of course how much of the flow can be substituted. The European Commission’s estimate is that about 60% of Russian gas can be replaced by other energy sources in one year. This makes sense since substitution has been high already and more LNG terminals are being constructed, and more solar and wind power is being installed. We have also seen the debate on fuel switching change rapidly over time. The reopening of coal-fired power plants is now acceptable, and extending the life span of nuclear power plants is no longer taboo in Germany. Reopening the Groningen field is still a no-go in The Netherlands, and the Commission makes no mention of it, but the economic impact of high gas prices for households, and the need to compensate corporates for a lack of gas or automatic stabilisers, which is worsening the government budget, might be offset by the possibility of sky-high returns from Groningen gas for the Dutch state at some point.

Further demand reduction helped by Russia

The current voluntary goal of bringing down gas demand by 15% compared to the historical average, was chosen for a reason. It would offset the remaining gas required from Russia. The 40-45% dependence and the alternatives amounting to about 60% of that, implies 15% of total gas demand not being met. Ironically, the decision by Russia to cut the gas flow through Nord Stream 1 back to 20% again, will help governments reach this goal. It leads to price levels where the market will cut down on demand by itself. So the chance of governments rationing supply may have fallen. Industrial players will decide whether they are still willing to pay the price. As long as they are, they will likely get it. The rest of the world will probably be less willing to pay the same price, as they may have alternatives such as coal at their disposal.

One question is to what extent governments will allow households to be incentivised by prices to lower thermostats and insulate their homes. Winter usage of gas is much higher mostly because of heating demand. Shielding households from higher prices may offset the economic consequences via purchasing power, but will keep up gas demand, which will lead to higher gas prices for all other players, most notably industrial users. This would also negatively impact the cost of living via other energy-intensive products as well as slowing down industrial activity. The price for more expensive gas will have to be paid either way.

The solution may depend on whether socially undesirable effects of costly gas (a high share of spending for lower-income households) can be prevented, while higher-income households would get sufficient incentives to limit their consumption. Remember, higher-income homeowners will often have larger homes, so will use more gas than the average household. Capping energy prices is saving them more money than poorer households. Hungary has reshaped its utility bill support scheme for gas and electricity so that households that are using more gas on a yearly basis than the average household must pay the extra usage at close to the market price. This is seven-times higher than the price for below-average consumption. This may lower the second-round effects, as the financial impact on higher-income households would be mitigated by lower savings.

The strategic game

The crucial question is of course whether gas flows will continue to be interrupted. One could argue that in the face of credible plans to bring down gas use in Europe, the attractiveness of no longer supplying that gas from a Russian perspective falls. Alternatively, cracks in solidarity between European countries would make attempts to try to divide and rule more attractive. So European solidarity is important either way: it helps mitigate the impact of a further reduction in gas supply, but may prevent it from happening altogether. Also, the longer it takes for a cut in flows to happen, the lower the effect as alternatives will be available and storage will have been filled. All parties involved will be aware of this. We expect to witness a game of poker being played out in front of us.

Read more about European gas supply on ING THINK