Nord Stream Hit Adds to Europe’s Economic Woes

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Nord Stream Hit Adds to Europe’s Economic Woes

Governments are investing hundreds of millions of dollars to alleviate the burden of rising gas prices. This may not be enough to stop a severe recession.

The economic impact of the interruption of Russian gas flow is piling quickly in Europe and could eventually surpass the effects of the global financial crisis.

A global recession is likely to be inevitable, a brutal winter is coming to chemical companies, steel plants and car makers depleted of the essential raw materials they require. They’ve joined the households in sounding alarms about the rising costs of energy. The alleged sabotage of Germany’s gas pipeline from Russia has highlighted the fact that Europe is going to have to endure without significant Russian flow.

Based on a model for the European energy economy and market and energy market, this Bloomberg Economics base case is currently a one percent decline in Gross Domestic Product, the slowdown to begin at the end of the third quarter. If the months ahead turn extremely cold and the 27 countries of the European Union fail to efficiently deal with the shortage of fuel the decline could reach as high as five percent.

This is about how deep it was during the 2009 recession. Even if this outcome is avoided, the euro area’s economy is currently poised to be in the third worst recession ever since World War II — with Germany as one of the countries who are suffering the most.

“Europe is very clearly heading into what could be a fairly deep recession,” said Maurice Obstfeld, a former chief economist at the IMF who is now a senior fellow with the Peterson Institute for International Economics in Washington.

The grim outlook is already indicating that just seven months from the start of the conflict in Ukraine government officials are distributing thousands of millions of dollars to families while they rescue businesses and discuss curbs on energy consumption. The rescue efforts could not be enough.

In addition to the pressures on consumers and businesses and consumers, and putting pressure on consumers, the European Central Bank is also pushing the economy to its limits due to its new laser-like approach to tackling rising inflation is driving the most rapid increase rate of interest ever in the history of the institution. ECB president Christine Lagarde said Monday that she anticipates that policymakers will increase borrowing costs during the next few sessions. Market participants are already pricing in the possibility of a 75-basis-point increase at the next meeting of the monetary policy committee in October. 27.

“The outlook is darkening,” Lagarde said to EU legislators in Brussels. “We expect activity to slow substantially in the coming quarters.”

Certain energy industry watchers are warning of a long-lasting crisis that could be more severe than the oil supply turmoil in the 1970s. The final effect of the shortages could be greater than what economic models could predict, Jamie Rush, Bloomberg’s chief European economist, told Bloomberg.

In times of energy shortage industries’ supply chains could collapse in unexpected and dramatic ways. Each business has a threshold at which the high cost of energy will cause them to cease operations. Sectors can be affected by problems with energy-intensive inputs, like fertilizer and steel. For the electricity system, when the blackout begins the situation can quickly spiral out of hand, spreading throughout the grid.

“Our analysis is a sensible starting point for thinking about the channels through which the European energy markets affect the economy,” Rush stated. “But it cannot tell us the impact of system failures.”

For a recollection of the suffering, take a look at the experiences of Evonik Industries AG which is one of the largest specialty chemical companies, with its headquarters in Germany’s western industrial Ruhr valley. In a letter to Bloomberg, the company warned of the damage that could be long-term from the constant expensive costs.

“The basic condition for the prosperity of the German economy, and in particular of the industry, is the permanent availability of energy, also from fossil sources, at reasonable prices,” the company claimed.

There’s no one to blame but it’s not the only one. Volkswagen AG, Europe’s biggest automobile maker, is looking at ways to assist its extensive supplier network across Europe in combat a lack of natural gas, which includes producing more parts locally and changing the capacity of its manufacturing. Domo Chemicals Holding NV, which is the operator of Germany’s second-largest chemical plant and is cutting production in Europe, and Italian truck manufacturer Iveco Group NV has said it has been in contact with suppliers regarding their issues with rising energy costs. Recent data showed that the private sector in the eurozone slowed for the third consecutive month in September. The indicator of buying managers created through S&P Global slumped to its lowest point since the year 2013. In addition, the economic crisis has affected consumer confidence, which has reached an all-time low.

The issue first took form last year, when prices for energy started to increase after the recovery of demand from the Covid-19 virus, and Russian President Vladimir Putin began to quietly limit gas supply to Europe.

The incursion into Ukraine in February threw the economy into chaos due to inflation that was ballooning and an escalating cost-of-living crisis and reductions in industrial production. In early September the gas supply that was still flowing via the Nord Stream 1 pipeline connecting Russia to the west of Europe was been stopped for good.

The pipeline was hit with a drastic decrease in pressure last week. A German security official stated that the evidence suggests an intentional attempt to sabotage and not an issue with the pipeline. Three pipelines’ leaks of gas occurred almost simultaneously in the Baltic Sea, prompting Denmark to announce that it is stepping up security for its energy assets.

Recession Risk

The chance of a recession in the euro-zone over the next 12 months

To put it in perspective the previous year, LNG and gas supply, as well as LNG, accounted for approximately 40 percent of Europe’s demand. While power and gas prices have fallen from the August highs, however, they’re nonetheless more than six times more than the average in certain areas. With that kind of price, many companies cannot survive in the long term without government support.

For Bloomberg Economics the default scenario, based on an array of models that incorporate energy prices, supply, and growth is currently one in which Russian flow is around 10% of what it will be in 2021. It’s pretty grim according to the economists Maeva Cousin, and Rush.

“Even after government support, the real income squeeze is big enough to trigger a recession,” they added.

The “bad luck” scenario features the use of less energy and a winter that’s as cold as 2010 and a low level of renewable energy sources.

“If consumer behavior proves sticky and unity between EU countries begins to break down, gas prices could spike above 400 euros, inflation could approach 8% next year and the economy might contract by almost 5% this winter,” they warned.

The politicians have already opened the floodgates to financial debt to prevent a financial catastrophe in the wake of the pandemic. They also pumped increasing support when the energy crisis began to take hold. Now they must choose whether to further burden the public finances by providing more assistance or face the consequences of permitting the crisis to get out of hand.

The government is under immense demand to take action,” said Dario Perkins who is an economic analyst at TS Lombard in London. “Price caps, as well as liquidity assistance and large fiscal transfers, are likely. The government must help households and business owners or face another recession like the one they avoided in the aftermath of the pandemic.”

  • The European Commission proposed measures to lessen the burden on consumers by removing the sum of 140 billion euros from the earnings of energy companies and imposing mandatory limits on peak demand power and increasing the liquidity of the energy sector.
  • Germany invested eight billion euros into the utility Uniper SE in a government rescue that will exceed hundreds of billions of euros
  • France will allocate the sum of 16 billion euros to keep the price of gas and power at 15% for families and small businesses next year.
  • Cabinet members in Italy approved an aid of 14 billion euros plan for companies hit by increasing costs in Mario Draghi’s last action before September. 25 elections.
  • The Netherlands unveiled a 17.2-billion-euro aid package for households that includes a rise in the wage minimum as well as more taxes on the profits of corporations.

In addition to the red ink to make a total of all the red ink, the Bruegel think tank estimates that as of mid-September, EU governments had earmarked 314 billion euros to ease the effects of the recession on businesses and consumers.

This will have a devastating impact on the regional public finances and Simone Tagliapietra, a researcher at Bruegel has described the plan in terms of “clearly not sustainable from a fiscal perspective.”

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