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Europe’s energy woes are a global worry, Vanguard warns

15 August 2022

A reliance on Russian energy supplies is likely to push the European Union into recession but other parts of the globe including the UK will suffer alongside.

By Gary Jackson,

Head of editorial, FE fundinfo

Large parts of the global economy would be impacted if there were an intensification of the European energy crisis, analysis by Vanguard suggests, with the UK being one of the countries that could be worst hit.

Russia’s invasion of Ukraine and the sanctions from the West that followed highlighted how important Russian oil & gas exports are to the global economy. Europe was especially reliant on Russian energy exports and now faces going into winter with worryingly diminished gas supply.

The map below shows how Russia is the second-largest energy supplier in the world, accounting for 11% of the global economy’s oil and 15% of its gas.

Top oil and natural gas producers


Source: Vanguard, IEA as of 18 July 2022. Note: Refers to 2021 oil and natural gas production.

Jumana Saleheen, Vanguard European chief economist, said: “It doesn’t appear that the war in Ukraine will stop anytime soon. As sanctions continue to hurt Russia’s economy, there is an ongoing fear that Russia will restrict the energy that it supplies to Europe.

“We believe the energy crisis is likely to get worse before it gets better – so much so, that we see a tipping point for the global economy this winter, when demand for heating fuel is likely to rise as it gets colder across the developed northern hemisphere.”

Saleheen noted that the energy threat is most acute on the European mainland, especially in central and eastern Europe because of their high dependence on Russian gas supplies.

Because revenue from gas exports accounts for about 2% of Russia’s GDP, compared with 10% for oil exports, Russia may decide that the smaller revenues means it can continue to ‘weaponise’ its gas supply to increase pressure on Europe.

Since the end of July, the Nord Stream 1 pipeline – through which more than a third of the Russian gas to Europe is supplied – has been reportedly running at just 20% of its total capacity.

Saleheen added that these low levels of gas supply will become a worry if they persist into the long run. Indeed, analysis by Vanguard shows the EU would be pushed into recession if gas flows were to remain below an average of 30% of total capacity for six months – with Germany and Italy among the worst-hit member countries.

“The table below summarises how we expect the euro area economy to perform depending on how gas and oil prices behave over the next few quarters,” she continued.

“Our base case, still, is for Nord Stream 1 gas flows to average between 30% and 60% of capacity over the second half of 2022. A persistent fall in gas flows below 30% would put us in the downside scenario with gas prices spiking, pushing up on inflation and pushing the economy into recession.”

Economic outlook for euro area based on different scenarios for Russian gas exports


Source: Vanguard, Bloomberg as of 29 July 2022. *Based on Dutch TTF natural gas prices, which averaged 98 EUR/Mwh from 1 January 2022 to 30 June 2022. **Based on Brent oil prices, which averaged 105 USD/barrel over the same period.

However, Saleheen warned that this does not mean the effects of Europe’s energy crisis would be limited just to the continent. Any intensification of the crisis would push up global fuel prices and add to inflation, which is already at multi-decade highs.

“As such, a ‘Russian winter’ could make it harder for central banks to tame inflation. It would be yet another unlucky supply-side shock to the global economy,” she explained. “It would risk entrenching economies around the world with the current combination of weak growth and high inflation – potentially pushing them into stagflation.”

Vanguard’s analysis suggests that the UK is the most vulnerable to any rise in EU natural gas prices. The table below shows the correlation between natural gas prices in the euro area and other key commodity markets; a 10% rise in EU natural gas prices could be associated with a 9% rise in UK gas prices.

Asia is the next most vulnerable area, with a correlation of 0.8 between its gas prices and those in Europe.

However, there is a correlation of almost zero between US and European gas prices, partly reflecting the fact that the US is a major gas producer and a net exporter of the commodity.

The spillover from EU natural gas prices is highest in Europe and Asia


Source: Bloomberg and Vanguard as of 28 July 2022. Notes: Correlations are measured by daily change from 1 January 2022 to 28 July 2022. Red indicates a higher correlation and green a lower correlation. *LNG – liquified natural gas.

Saleheen added that there could also be some small knock-on effects on other energy commodities from a higher gas price. As households and businesses look to alternatives to gas, they will push up the price of crude oil, diesel, petrol and coal, which would affect the US economy.

“Restrictions on the flow of Russian gas to Europe are likely to be bad news for energy prices and threaten to tip the EU economy into recession,” the economist finished. “The effects will be felt in global energy markets, particularly in Europe, including the UK, and also in Asia. While US gas prices are largely insulated, US oil prices may not be.”

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