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How Long Before Putin Shuts Off Natural Gas Delivery to Europe?

Here are the two key questions of the day Europe needs to address: How long and what's the economic impact?
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EU Natural Gas Price courtesy of Trading Economics, annotations by Mish

EU Natural Gas Price courtesy of Trading Economics, annotations by Mish

Key EU Natural Gas Points 

  • The long term average of of natural gas price in the EU is in the 12-15 range. It's now 148. 
  • The EU is paying 10 to 12 times its long-term average
  • Since June 8 (blue box) the price rose from 79 to 148, a rise of 87 percent. 

Before addressing what happens if and when Putin shuts off natural gas to Europe, let's take a look at what's happening in the US.

The price units are not the same so it's best to think in percentage terms.

US Natural Gas Price 

US Natural Gas Price courtesy of Trading Economics, annotations by Mish

US Natural Gas Price courtesy of Trading Economics, annotations by Mish

Key EU Natural Gas Points

  • The long term average of of natural gas price in the US is about 3. It's now 5.73
  • Whereas the EU is paying 10 to 12 times its long-term average, the US is now paying about 1.9 times its long term average.
  • Since June 6 (blue box) the price fell from 9.3 to 5.73, a decline of about 38 percent.

EU vs US Since Early June

  • EU: +87 Percent
  • US: -37 Percent

Q: What's going on?
A: Fire!

On June 8, a fire at the Freeport liquid natural gas (LNG) terminal near Galveston,  Texas, shut down the terminal. Freeport is the second largest LNG exporter in the US. It accounts for 15% of LNG exports.

LNG that would be exported to the EU, now won't. That increases the supply in the US and decreases supply to the EU.

The shutdown was expected to last for days. On June 10, the estimate was a few weeks.

On June 30, the Biden administration citing safety concerns said Freeport could not restart without permission. Bloomberg notes that Feeeport now plans to partially resume operations in October.

Freeport must take a series of corrective actions and send weekly updates to agency, according to a federal notice Thursday. 

“It appears conditions exist at Freeport’s LNG export facility that pose an integrity risk to public safety, property, or the environment,” the notice said.

Q: Is Biden playing politics to keep the US price down?
A: Unclear. Freeport has had other safety issues in the past. 

Regardless, Biden certainly is pleased by these developments while the EU takes another supply shock.

With that backdrop let's ponder the first of two key EU questions.

When Will Putin Shut Off Natural Gas Delivery to Europe?

That is likely a "when" not a "what if" question. 

No one can answer other than perhaps Putin. He might not even know because the situation is fluid. 

Timing depends on when the EU expects to fill its natural gas storage for the Winter months. 

The EU telegraphs that answer with daily reports of progress in filling storage facilities. Putin could act now, or August, or later perhaps even taking long-term weather forecasts into consideration. 

Whereas the EU is mostly transparent, Putin operates in a nightmare of fog. He will shut off the gas (or not) at a time of his choosing to achieve his goals. 

Good luck figuring that out because it also depends on the EU's actions to fill storage. 

What's the Economic Impact When the Flow Stops? 

That's the key question. Economic impact analysis is amusing and polarized. 

Eurointelligence discusses the range in Where 'Don't Know' is the Correct Answer.

In our irregular series on scenarios that are not our base case but plausible nevertheless, we will focus today on the impact of a Russian gas embargo on Germany. Our base case sits somewhere between the most extreme estimates of German economic institutes.

Prognos predicts a drop in GDP by 12.7% in the second half of this year, around €200bn, if the gas stops flowing. The premise is that once the Nord Stream 1 pipeline gets serviced on July 11, and the gas flows stop during the maintenance period, it will not come back afterwards. Prognos writes that an abrupt stop would mean that half of German demand would not be met by supply. The main economic impact is through a domino effect.

The secondary effects outweigh the primary by 3 to 1 in their calculation. This is why their forecast is so pessimistic.

The other study cited in Handelsblatt comes to a diametrically opposite conclusion. A joint prognosis by Germany’s leading economic institutes says the governments' efforts to diversify energy supplies were already bearing fruit, and that the effect of an embargo would be minimal. In their most probable scenario, there would be no shortages whatsoever during the winter even if Putin were to cuts the gas. They argue that the improved gas storage is the main reason. In April the gas tanks were 30% full. Now this is up to 58%. They put the probability of a shortfall of supply at only 20%. In that scenario, they arrive at a similar direct economic impact as the Prognos Institute, but they don’t go into the domino doomsday scenarios. In that scenario we are looking at a normal recession. 

When it comes to the future, we can rank our scenarios, and express subjective views, but that is about it. In our own subject base case, Russia will continue to supply gas at reduced volumes until the autumn. Depending on the war, and the size of their current account surplus, they might at this point take a decision to cut supplies altogether. A total cut-off in July, followed by an acute shortage in the winter and an industrial domino effect, is, however, not an improbable scenario.

What we find most useful about these extreme scenarios is not what any of them predict, but the sheer range of expectations between the two. That is telling us that we are dealing with real, raw uncertainty.

Raw Uncertainty 

My expectation is that Putin will shut off [or reduce] supply based on EU progress in filling EU storage facilities. That's information the EU openly provides to Putin. 

I don't have a particular date in mind. But I do know that Freeport just entered into the equation. 

US LNG plants other than Freeport are operating at full capacity. There is no way the US can do more. 

Germany is discussing rationing. If it does so, that moves up the date of Putin's shutoff or further supply reduction. If not, that pushes the date back further. 

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It's possible long-term weather forecasts come into play. Other developments in Ukraine come into play. 

German delivery of weapons to Ukraine come into play. Germany made huge weapons promises to Ukraine, while doing virtually nothing.

If you did not understand why Germany has overpromised but underdelivered weapons to the point of hardly doing anything at all, perhaps you do now. 

There are a massive number of moving pieces, but whereas the US and EU operate in the light of day, Putin operates in a massive fog bank. 

Eurointelligence is between the two extremes and so am I, but that does not make the extremes equally likely. 

A Laughable Explanation of the G7 Oil Price Buyers' Cartel Emerges

It's important to note that a huge decrease in supply as opposed to a total cutoff would cripple the EU while keeping money flowing to Russia. That's more likely than a total shutoff.

These outcomes are all in the hands of Putin. The EU has no control of supply, it is a buyer not a seller of energy.

Yet, the EU thinks of creating a "buyer's cartel".

For discussion, please see A Laughable Explanation of the G7 Oil Price Buyers' Cartel Emerges

Pipe Dreams

The normal recession thesis is a pipe dream of nonsense. Throw that outcome out the window, then pick something in between what remains.

Even if one has faith in a normal-looking recession in the US, the EU has far bigger shocks. It will not have a normal-looking recession.

GDPNow Forecast Plunges to -2.1 Percent, a Recession Has Clearly Started

For a look at where the US stands, please see GDPNow Forecast Plunges to -2.1 Percent, a Recession Has Clearly Started.

In the last three days the GDPNow forecast plunged from +0.7 percent to -2.1 percent, a net swing of 2.8 percentage points.

Also note that the Fed essentially admits it's clueless.

Powell: "We understand better how little we understand about inflation”

Please see Powell: "We understand better how little we understand about inflation”

  • Bloomberg Moderator to Powell: Paul Krugman said on Friday that the number one risk is the Fed could overdo it. Is that really possible?
  • Powell: “Is there a risk we would go too far? Certainly there’s a risk. The bigger mistake to make, let’s put it that way, would be to fail to restore price stability.”

While miracles are theoretically possible (e.g. Putin gets taken out and a new Russian leader wants peace), such miracles are highly unlikely at best. 

Give all the fog in the US, let alone the uncertainties in China and the EU, anyone who thinks they have a big grasp on what further damage Putin can do do supply chain disruptions is fooling themselves. 

Soft landing is out of the question, globally. Risks are hugely skewed to the downside, and it's also best to discard these Powell-speak "softish" landing ideas as well.

Implications for the stock market are severe.

Addendum

I added some thoughts above on the silliness of an energy buyers' cartel and also some changes based on reductions in supply as opposed to a complete shutoff.

One of my readers asked "Isn’t turning off the Gas his bargaining chip? Once he turns it off he’s lost it."

My reply:

Reducing supply to the point of increased pain might meet Putin's objective.

But don't rule out "off". Putin can go off for a week, getting the EU to beg for "on" then do it. 

Off is reversible - At Putin's discretion.

This post originated at MishTalk.Com.

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