(Bloomberg) -- Germany’s presidential palace in Berlin is no longer lit at night, the city of Hanover is turning off warm water in the showers of its pools and gyms, and municipalities across the country are preparing heating havens to keep people safe from the cold. And that’s just the beginning of a crisis that will ripple across Europe.
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It might still be the height of summer, but Germany has little time to lose to avert an energy shortage this winter that would be unprecedented for a developed nation. Much of Europe is feeling the strain from Russia’s squeeze on natural gas deliveries, yet no other country is as exposed as the region’s biggest economy, where nearly half the homes rely on the fuel for heating.
Chancellor Olaf Scholz’s administration has been slow to address Germany’s vulnerability, only recently laying out targets to cut demand as efforts to secure alternative supplies fall short. With Moscow continuing to tighten deliveries and France struggling to export electricity to its neighbors, little respite is expected and the risks go beyond this winter.
“The challenges we’re facing are enormous and they affect significant areas of the economy and society,” Robert Habeck, Germany’s vice chancellor and economy minister, said after unveiling a plan to pass on cost increases from energy companies to consumers. “But we are a strong country and a strong democracy. These are good prerequisites for overcoming this crisis.”
The Kremlin is likely to keep vital gas flows to Europe at minimal levels as long as the standoff over Ukraine continues, according to people familiar with the leadership’s thinking. That means shortages for the region will likely persist, with gas prices for every year through 2025 having already hit a record this year.
Read more: Kremlin to Keep Up Its Gas Squeeze on Europe, Insiders Say
Rationing and recession are looming for Germany, and authorities have voiced concern about social unrest if the energy shortage spins out of control. The country can’t even count on France, where faulty nuclear reactors are compounding the gas crunch. Electricity prices in Europe’s two-biggest economies surged to records last week.
Russia — historically the European Union’s biggest gas supplier, covering about 40% of demand — has gradually reduced deliveries in evident retaliation against sanctions. The EU’s challenge is to keep energy flowing across borders in a test of the bloc’s unity and its resolve to resist President Vladimir Putin’s aggression.
“Russia’s policy has always been to divide because then they are stronger,” said Martins Kazaks, governor of the central bank of Latvia, the former Soviet Republic that’s now part of the euro area. “If we allow ourselves to be divided, then we will get weaker,” he said in an interview.
Russia’s latest move came last week, when Gazprom PJSC blamed a turbine issue for reducing flows on the key Nord Stream pipeline to about 20% of capacity. In the fallout, gas prices jumped over 30% last week and electricity prices broke one record after another.
Habeck, who oversees energy policy, called Gazprom’s rationale “farcical,” but acknowledged that the situation is serious and renewed his plea for companies and consumers to step up savings efforts. To bridge the gap, his ministry has allowed the revival of mothballed coal-fired power plants in a setback for climate efforts and recommends that Germans install efficient showerheads and wash clothes at cooler temperatures.
If measures to re-balance supply and demand fail, the government has the power to declare a gas “emergency,” which would involve the state taking control of distribution and deciding who gets the fuel and who doesn’t.
While households and critical infrastructure like hospitals are protected from cutoffs, there’s no guarantee room temperatures will be as comfortable. Germany’s biggest landlord already announced plans to reduce heating during the night, and public buildings including the Reichstag in Berlin are turning down thermostats.
The cost increases, which will start filtering through in earnest this fall, add to pressure on the poor. Already around one-in-four Germans has slipped into energy poverty, meaning costs for heating and lighting affect the ability to cover other expenses, according to the Cologne Institute for Economic Research. The government is now working on aid programs for low-income households.
Cold snaps across Europe and Asia would force energy companies to battle for already-tight supplies of liquefied natural gas. The price surge from such a scenario could prompt companies to halt facilities this winter and destroy some 17% of industrial demand for the fuel, according to Penny Leake, a research analyst at consultancy Wood Mackenzie Ltd. “If Nord Stream flows remain at 20%, we are getting close to the danger zone,” she said.
With storage facilities 68% full and top-up rates likely to drop after last week’s pipeline cut, Germany risks falling short of the government’s target of 95% by Nov. 1. The country’s network regulator says reaching that level is hardly possible without additional measures.
The corporate sector is already reacting. A survey of 3,500 companies by business lobby DIHK showed that 16% of industrial firms are considering reducing production or giving up certain operations because of the energy crisis.
BASF SE is one of those. The chemicals giant plans to cut gas-intensive production of ammonia — a key component for fertilizer — after surging costs rendered the business unprofitable. It’s also planning to partially switch power and steam production at its main site in Ludwigshafen to fuel oil, which would help free up gas to sell back to the grid.
It’s not just Germany. High energy prices have prompted fertilizer producer CF Industries Holdings Inc. to announce it would shut one of its UK plants permanently. Cargill Inc., the world’s top crop trader, also closed a British oilseeds processing plant, while in France, supermarkets including Carrefour and Monoprix agreed to reduce energy consumption.
The International Monetary Fund estimates that Germany is at risk of losing 4.8% of economic output if Russia halts gas supplies, and the Bundesbank has pegged the potential damage at 220 billion euros ($225 billion). While it’s sure to be a painful hit, the fear in Germany is that a structural loss in competitiveness will soon follow.
Energy-intensive industries will likely gravitate to regions with reliable renewable-power resources like Germany’s windy coast or solar-rich areas in the Mediterranean, potentially hollowing out industrial regions along the Rhine and in Germany’s south, according to a senior executive at a major German manufacturer. Some chemical-industry executives say production could move to Turkey where there’s access to Azerbaijani pipelines.
“Our economic system is in danger of collapsing,” said Michael Kretschmer, the premier of the state of Saxony from the opposition conservatives. “If we aren’t careful, Germany could become deindustrialized,” he told Die Zeit newspaper, reiterating his call to “freeze” the war in Ukraine and effectively accept Putin’s military advances.
Most Germans support Ukraine — about half say the government should continue backing of Kyiv despite rising energy costs, according to a Policy Matters poll for Die Zeit — but critics like Kretschmer could gain traction as temperatures drop. That would heap even more pressure on Scholz.
Read more: Germany Warns of Lehman-Like Contagion From Russian Gas Cuts
Despite being months into the crisis, his administration just started publicly communicating a goal to cut demand by as much as 20%. And in a sign of the growing urgency, it recently raised its minimum target for gas storage — now 15 percentage points higher than EU-wide levels.
Shortly after Scholz’s government took power in December, dozens of newly-elected politicians in his coalition of Social Democrats, Greens and pro-business Free Democrats had considered talk of Germany’s gas risks a conspiracy theory, but then they saw the facts: reserves at the time would last about 10 days if a cold snap set in.
It was the beginning of a reality check. For decades, Germany’s leadership under Gerhard Schroeder and Angela Merkel argued that cozy energy relations with Russia were an asset rather than a liability. In last year’s campaign, Scholz called US criticism of German policy “false” because it didn’t take into account the entire energy mix. The thinking across much of the country’s political spectrum was that if Russia didn’t cut supplies during the Cold War, it wouldn’t during a conflict with Ukraine.
But with Europe shifting toward renewable power and away from the fossil fuels Russia provides, officials underestimated Putin’s willingness to take advantage of the leverage while he still had it. They also missed a key red flag.
Before the war, a unit of Gazprom controlled about 20% of Germany’s gas-storage capacity, had a significant stake in an Austrian site and held rights to stash away large amounts of fuel in the Netherlands. But the state-run gas giant didn’t rebuild inventories ahead of last winter, a sign that preparations for weaponizing energy had taken place under Europe’s nose.
“If we look in hindsight, we see that months before the war broke out Russia kept gas supplies intentionally as low as possible,” said Ursula von der Leyen, European Commission president and a former German defense minister. “Russia is blackmailing us.”
Read more: War Exposes Europe’s Failure to Heed Warnings Over Russian Gas
Scholz realized Germany had a real problem in the frantic days before Russia’s Feb. 24 invasion, according to people familiar with his thinking. During a trip to Moscow on Feb. 15, the chancellor sat at Putin’s famous long white table, putting him about 6 meters (20 feet) away from the Russian leader for talks aimed at defusing the standoff.
But signs of tension were clear. Despite Putin’s assertion that the Nord Stream 2 pipeline — which was completed and awaiting approval to start operation — was “strictly a commercial project,” Scholz indicated he was prepared to reverse his support in case of an attack.
Only a few days later, Scholz killed the project after Putin dashed hopes for a peaceful solution by recognizing Russian-backed Luhansk and Donetsk in Ukraine’s east as independent states. The halt of Nord Stream 2 prompted Putin’s allies to issue chilling warnings, and soon after that, tanks started rolling toward Kyiv.
But even after hostilities broke out, Germany struggled to react, hemmed in by a longstanding policy of engaging with Russia and industry’s reluctance to give up cheap gas, according to officials involved in EU discussions. That era is over.
“Gazprom, with the disruptions and reductions of supply, has destroyed trust in Russia as a reliable supplier of energy for Europe,” said Mario Mehren, chief executive officer of German oil company Wintershall Dea AG, urging consumers to wear sweaters instead of cranking up the heat. “That is very depressing news.”
Germany now needs support because it didn’t follow EU guidelines to diversify energy sources, threatening to reopen old fault lines in the bloc. Memories of the financial crisis, when Berlin lectured southern member states about their debt, are still very vivid, said the officials, who asked not to be identified because the discussions are private.
Like Germany, Italy was reliant on Russia for more than half of its gas supplies, but it moved quicker to secure alternative sources from countries such as Algeria and Qatar, and its terminals to import LNG shipments gave it flexibility. Ecological Transition Minister Roberto Cingolani said Italy can get through the winter with only minor cuts to its consumption even if Russia completely halts flows.
Germany, by contrast, is in a much tighter situation because of the amount of heating and industrial demand, and its lower storage levels. The country is only now developing LNG infrastructure, but the first floating terminal won’t be ready in time to help this year as the government had hoped, according to German energy giant Uniper SE, which is investing in the facility and is getting a 17 billion-euro rescue package to prevent its Russia-induced struggles from spilling over to the wider economy.
Read more: Germany Moves to Prevent Energy Collapse With $17 Billion Rescue
Still, there are hopeful signs. Mercedes-Benz Group AG said the sprawling Sindelfingen plant, where the company makes the S-Class luxury sedan, can now function without natural gas, a fuel typically used in the paint shop. The carmaker might even have enough excess to help cover shortages elsewhere.
Europe’s solidarity is also holding. A political agreement was reached by EU countries to cut gas use by 15% through this winter if Russia turns off the tap. While there are certain exceptions, the plan makes the reduction mandatory in an emergency situation.
Read more: Europe Is Faking Solidarity, and Putin Knows It: Andreas Kluth
In Ludwigshafen, an industrial hub on the Rhine river, officials are reviewing what critical infrastructure can be kept open in the worst-case scenario. They’re also considering transforming a municipal arena, which normally hosts events from concerts to dog shows, into a “warmth oasis,” with space for hundreds of people to escape the cold for hours at a time.
“We are aware that many people are worried at the moment, and we take these concerns very seriously,” Jutta Steinruck, Ludwigshafen’s mayor, said. “Everyone can already do something of their own accord and save energy wherever possible. Every kilowatt hour we save now will help us in fall and winter.”
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