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Natural Gas rationing & Climate High Yield

15 July 2022

The odds of natural gas rationing in Europe are very high, impacting many sectors of the European economy, but it could also be an opportunity: It should sharply accelerate the transition towards Green energies.

The war in Ukraine

The war in Ukraine is a proxy war of the West against Russia which means that the European economy is a target for Russia. Russia needs both the European energy revenue and to send Europe into a deep recession so that the flow of funding and weapons to Ukraine collapses, goals that are contradictory. Hence, the odds of natural gas rationing heading into the winter are actually much higher than the market assumes.

Russia can probably afford to keep this natural gas embargo for a few months but not much longer. The problem Russia has is that it needs oil prices to be well north of 69 USD (S&P Global) to balance its budget, given its war effort. If oil prices collapse on the back of a squeeze in positions and a global recession, the embargo will quickly fall apart. On the other hand. if the united European front breaks apart, then Russia can selectively provide natural gas to some countries.

Bundesbank’s economic forecast

The German Bundesbank estimated in April that German growth could fall by as much as 5% on the back of a trade and natural gas embargo though up to 2% would eventually reverse. This growth hit comes from the direct and indirect impact on the supply and food chain based in part on an input/output matrix. As a consequence, inflation could surge up to 2% higher in Germany (see Graph below).

Bundesbank economic forecasts 1

Natural Gas usage in the EU 2

1 Source: Nordea Investment Funds S.A. and Bundesbank
2 Source: Nordea Investment Funds S.A. and Climact.com

The dynamics of this shock

Rationing has an impact that is differentiated depending on the sector and company considered and whether the impact is direct or indirect through the supply chain or via demand and more elevated prices. For example, natural gas demand has already fallen 16% in Germany due to high prices and many will be encouraged to reduce their energy consumption. The impact of rationing is both abrupt and sometimes delayed accumulating over time.

Direct impacts are primarily on heating of households and corporates, roughly half of natural gas usage (see Graph above). Natural gas affects also electrical power and industrial production such as heating a chicken factory, the production of fertilizer which affects grain production, or ceramics.

As this rationing could repeat in a multi-year war, it is a permanent shock. Hence, it should lead to structural changes in the European economy rather than incremental adaptations. Governments, households and the private sector will therefore switch to cleaner and reliable energy. It is however an expensive decade long process. On one hand LNG (natgas imports) will rise from the likes of Canada and the US slowing the speed with which some heating is changed. On the other hand, some will replace their source of energy. For example, in new builds, wooden pellets (heating) are now far more likely but they take more space and hence have a significant installation cost like solar energy. All of this will need heavy subsidies. There are many alternatives from electricity, to propane (oil generated unfortunately), solar and wind energy, biomass in rural areas and geothermal energy.

What does it mean?

This Russian shock benefits companies involved in the Green transition. Think of climate engagement as the High Yield of the Green world. These are the companies that are far behind the curve in energy efficiency, want to decarbonize faster offering the highest potential.

 

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