The gas tap has reopened – but for how long?

Following the suspension of supply for maintenance work on the Nord Stream 1 pipeline, operation has resumed at limited capacity. But the situation remains uncertain. A recession should be avoidable if Russia continues to supply gas at a steady rate, but not if it cuts off the supply entirely. The latter would have significant implications for various asset classes.

The situation regarding Russian gas supply remains fraught with tension. After the suspension of service for maintenance work, Russia has resumed gas deliveries via the Nord Stream 1 pipeline. At present, it seems that supply will continue at a similar level to before the maintenance break, which equates to approximately 40 per cent of the pipeline’s actual capacity. This means that the scenario regarded as most probable by Union Investment’s experts has materialised for now. Measured by Dutch TTF gas futures, prices in the European gas market initially dropped to just under €146 per MWh (megawatt hour) when supply resumed on 21 July 2022. But on Friday, 22 July 2022, they bounced back to around €163 per MWh. To put these figures into context, gas was trading at around €36 per MWh a year ago.

Going forward, Russia will probably try to keep gas-importing countries on an uncertain footing for as long as possible in order to obstruct political decision-making in EU member states and undermine social solidarity where it can. Its best chance of achieving this objective is to manage the gas supply volume in such a way that importers will face an uncomfortable winter. Inventory levels at gas storage facilities in these countries will thus be the key variable for Moscow’s calculations. The subject of Russian gas supply and the impact of the supply situation on economic growth and different asset classes will therefore almost certainly keep the markets on their toes in the coming months.

  • Uncertain gas supply conditions are keeping the markets on their toes

    The gas tap has reopened – but for how long?

    The gas tap has reopened – but for how long?
    Source: German Federal Network Agency, as at 22 July 2022.
  • Uncertain gas supply conditions are keeping the markets on their toes

    Energy consumption, by industrial subsector

    Energy consumption, by industrial subsector
    Source: German Federal Network Agency, as at 22 July 2022.

Abruptly cutting off the supply would likely trigger a recession

As far as the economy is concerned, a sudden gas supply stop would tip Germany into recession. The scenarios modelled by the German Federal Network Agency project a contraction of between 1 per cent and 5 per cent. The severity of the recession would depend on factors such as the extent to which energy savings measures would impact consumers and businesses and how quickly the government can secure other sources of gas, e.g. via new supply channels and LNG (liquefied natural gas) terminals. At present, the German government is planning for an LNG terminal in Wilhelmshaven to go into operation on 21 December 2022. This would take some heat out of the gas supply situation and thus ease the pressure on the economy.

If Russia keeps the gas tap open, it may well be possible to avert a recession – depending on the volume and regularity of Russian deliveries. One way or another, the coming winter will be challenging. Even if sufficient gas can be sourced, prices will be several times higher than those that consumers and businesses used to pay in the past. The current market price of gas is up fivefold on where it stood one year ago and up ninefold compared with pre-pandemic levels. This price surge is having an impact on metrics such as inflation, consumer sentiment and production conditions in the manufacturing sector.

Strong focus on the utility, chemicals and automotive sectors

What does this mean for the capital markets? News that supply through the pipeline would resume reduced the level of uncertainty in the equity markets, which prompted prices to rise again in recent days. But in the event of an actual gas supply squeeze, the severity of the economic impact would differ significantly from sector to sector. Utility companies would be hardest hit, because they may be forced to cover shortfalls in supply with purchases from other sources in the spot market at much higher prices in order to be able to meet their contractual obligations. The chemicals sector, which accounts for around 30 per cent of industrial gas consumption, would also struggle to cope with supply shortages. By contrast, direct dependency on Russian gas is less pronounced in the automotive sector, but the supply chain disruptions that would likely go hand in hand with gas shortages could put pressure on the sector. Likewise, the financial sector – especially banks – would be affected only indirectly, for example through loan defaults in the manufacturing sector.

In the bond markets, spreads on corporate bonds from the aforementioned sectors can be expected to widen as risk levels rise. Probabilities of default would potentially go up, particularly in the manufacturing sector.

On the monetary policy front, it currently seems reasonable to expect that the European Central Bank (ECB) will continue to normalise monetary policy even if the economy dips into a mild recession. This would put additional pressure on bond prices. However, the market is still pricing in sizeable interest-rate hikes. In the event of a recession, these may be priced out again to some extent, which could support the prices of safe-haven assets.

Commodity prices present a mixed picture

In the commodities markets, a number of different trends could materialise. While the gas price has spiked in recent months due to scarce supply, fears of a potential recession due to gas shortages would generally have an adverse impact on conditions in the commodities markets. Various segments – above all the industrial metals market, but also parts of the energy commodities market – had anticipated these negative prospects to a degree and subsequently recovered again slightly when the pipeline reopened. On Thursday, the oil market came under pressure. This was partly attributable to the fact that some risk premiums were priced out again as deliveries via the Nord Stream 1 pipeline resumed.

Looking ahead, Union Investment’s experts believe that the price of oil, for example, will fall in the coming months. In the near term, industrial metals are also likely to respond negatively to gas shortages in Europe. However, over the medium term, economic growth in China and the transition to clean energy and decarbonisation megatrend will remain the most important drivers of demand. This should also benefit quasi-industrial metals such as platinum and palladium. By contrast, higher interest rates mean that gold has only limited upside potential.

 

As at 22 July 2022.

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