The energy crisis facing Europe is intensifying. Dependency on gas flows from Russia has created substantial economic vulnerabilities and prospects of supply disruptions are now looming large.
By Hugh Gimber, Global Market Strategist, J.P. Morgan Asset Management
Soaring gas prices have sent electricity prices skyrocketing, yet fiscal intervention will prevent households and corporates from bearing the full brunt of energy costs.
European countries’ vulnerability to reduced Russian gas flows varies widely across the region. Three key metrics are crucial to understanding the gas-related risks facing European countries: reliance on Russian imports, the share of gas in the energy mix and storage capacity.
Gauging Vulnerabilities
If a country has low reliance on imports but a very high share of gas used in the energy mix, then risks are still acute despite the low Russian dependency. This year’s decline in gas imports from Russia is the result of several factors, ranging from political initiatives to supply disruptions (see chart).
The European Commission’s REPowerEU plan – first proposed in response to Russia’s invasion of Ukraine – included aims to reduce the bloc’s dependency on Russian gas by two-thirds this year, but stopped short of an outright ban. Supply disruptions began over the summer when several countries were cut off from Russian pipeline supply after refusing to make payments in Russian rubles.
More recently, Russia has halted flows in the key Nord Stream 1 pipeline completely, while stating that supplies will not resume in full until western sanctions linked to the Ukraine invasion are lifted.
EU Natural Gas Imports From Russia
(Million cubic metres)
(Source: Bruegel, J.P. Morgan Asset Management. Data as of 31 August 2022)
Above-average imports of LNG have helped to plug this supply gap over the summer, with flows from the US accelerating meaningfully. Fortunately for Europe, this has also coincided with a period of reduced LNG demand from China as its economic activity remains subdued.
While we ultimately expect this crisis to turbocharge the rollout of renewables over the medium term, strengthened demand for fossil fuels is inevitable to bolster short-term energy security. For example, the International Energy Agency (IEA) estimates that EU coal consumption will rise by 7 percent in 2022.
The EU appears well on track to filling 90 percent of its total underground gas storage capacity ahead of the coming winter. Yet despite this progress, scenario analysis from the IEA highlights that later this year, storage levels could become dangerously low until February 2023, absent Russian gas flows, as non-Russian imports would be insufficient to cover the shortfall.
The situation is further complicated by seasonality – despite the EU’s storage capacity providing roughly 27 percent of average annual consumption, over 55 percent of annual gas demand is consumed between November and March in a typical year – and by limited infrastructure to transfer gas from west to east within the EU.
Maintaining gas flows from Germany is essential for Switzerland, as three-quarters of its demand is served by the north-south pipeline. An EU gas shortage would therefore have a direct impact on the Swiss economy. Looking forward, if storage capacity is run down to below-average levels in order to survive the winter, restocking during the summer of 2023 could be particularly challenging, especially if Asian demand for LNG is rebounding.
Policy Response
With soaring gas prices having sent electricity prices skyrocketing, government support to prevent the full passthrough of energy costs to both households and consumers is inevitable. Policy support will seek to blunt the impact to growth, but this responsibility will fall to governments, not central banks, as the latter grapple with surging inflation.
Amidst a robust job market and stubborn inflation, our base case sees further rate hikes by yearend in the UK, the eurozone and Switzerland. Even faced with the high likelihood of a recession in 2023, it will be difficult for the central banks to change course until they are much more confident that inflation is heading back towards target.
For the ECB in particular, this determination will be complicated by the varied impact of government intervention across member states.
Earnings Implications
We expect to see some softening in earnings expectations ahead as analysts begin to reflect the deterioration in the macroeconomic outlook. The European materials sector looks particularly vulnerable to gas disruptions, as chemicals companies make up roughly half of the sector.
Meanwhile, the impact on European utilities could vary significantly; those with high exposure to renewables should benefit over time from the strengthened tailwind behind the renewable rollout, while others will come under pressure from government price caps.
On a more positive note, multiples suggest that a substantial part of the gas-related risks are now reflected in equity prices. Investors should stay vigilant to medium-term opportunities that arise amid this winter’s woes - particularly companies critical to the green transition, and global industry leaders based in Europe but with limited economic sensitivity to the region.
- Further insights and additional charts can be found here.
Hugh Gimber
Global Market Strategist, J.P. Morgan Asset Management
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