Reviews | The fate of German gas prices with Russia’s war in Ukraine

Germany is one of the great trading nations of the world. In 2019, he imported $1.2 trillion value of goods from all over the world. Only about 2% of this total came from Russia. In fact, the Russian Federation, with around 144 million people, was only slightly more important in German trade than Ireland, with around five million people. Normally, therefore, one would not expect a disruption of economic relations with Russia to have a significant effect on the German economy.

Unfortunately, Russia is a key supplier of a commodity that Germany will struggle to replace: natural gas. Almost all of Germany’s natural gas consumption is imported via pipelines, and approximately 55 percent of its gas comes from Russia.

This situation should never have happened; Successive US administrations, dating back to that of Ronald Reagan, have warned Germany not to allow itself to become so dependent on despotic rule. (I witnessed some of these discussions during my brief stint in government in 1982-83.) But here we are. And while democratic nations have imposed a wide range economic sanctions against the Putin regime, restrictions on Russian gas sales remain conspicuously absent from the list.

Yet Russian atrocities – and, to be honest, the startling incompetence of the much-vaunted Russian military as the expected blitzkrieg enters its 20th day of apparent stalemate – quickly changed the political calculus of the response. the West. Three weeks ago, it seemed inconceivable that German politicians would be willing to impose significant pain on their constituents in response to Vladimir Putin’s assault. Now serious discussions are underway about whether and to what extent Germany can wean itself off Russian gas.

A small reduction in gas consumption should not be difficult to achieve. Precisely because the gas was cheap, some is currently being flared on a low priority basis, easily discouraged by moderately higher prices and/or modest regulation. Big discounts, however, are another matter.

Put it this way: A important new study by a group of German economists (there are nine authors, so I’ll just call it Bachmann et al.) estimate that eliminating gas imports from Russia would require reducing gas consumption by about 30% , to about 600 terawatt hours from about 900 TWh. Why not 55%, the Russian share of German gas? Because Germany can probably get a little more gas from other sources and limit the use of gas for power generation by relying more on coal and nuclear power. (Yes, coal must be phased out to save us from climate catastrophe – but not in the middle of a war. It’s St. Augustine’s principle: “Make me chaste, but not yet.”)

However, even a 30% reduction in consumption will be difficult to achieve in the short term. Reducing consumption from 900 to 800 TWh might not be so costly; reducing it from, say, 700 to 600 TWh would be much more painful.

German economists focus on a key economic concept called the elasticity of substitution – basically, the fall in demand for natural gas for every 1% increase in its price. If this elasticity is small, the amount Germans would be willing to pay for a little extra gas once consumption has already been reduced significantly is large, implying that the economic cost of further cuts is also large.

Unfortunately, empirical estimates suggest that the elasticity of substitution for natural gas is low, at least in the short term. It’s not zero: given high gas prices, households will lower their thermostats, consumers will stop buying goods whose production requires burning a lot of natural gas, and so on. Yet the best estimate is that we’re talking about an elasticity of about 0.18, which in turn means (if I’m doing the math right) that the price of natural gas would have to increase by about 600% to reduce the demand 30 percent.

That sounds like a lot, and Bachmann et al. deliberately use an even more pessimistic estimated elasticity of 0.1.

Yet even with these pessimistic assumptions, they find that Germany could, in fact, do without Russian natural gas, precisely because the country currently spends so little on Russian imports. The costs would be significant: German real income could fall by about 2 percent, the equivalent of a moderate recession. But it wouldn’t be the end of the world.

Such drastic action would have been inconceivable a month ago. But Putin seems to be doing something remarkable: reminding the world’s democracies what they stand for. It has already ruined Russia’s reputation as a military superpower; he is now in the process of reducing the economic power he also had.

Ukraine asks broader penalties on Russia.

the penalties so far.

War follow-up.

Oil prices are go back down.

About Chris McCarter

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