Earlier this week the Nord Stream 1 pipeline was completely shut down by Russian gas company Gazprom. This pipeline is the largest source of natural gas to Europe. Gazprom claimed the closing was due to a “leak,” but a more plausible reason is that it was politically motivated by Putin. Europe’s economic sanctions against Russia pushed Putin to shut down the pipeline with the intent to leverage Europe to lift economic sanctions. Because Putin is still fighting a costly war in Ukraine, China will be stepping in to purchase the gas originally intended for Europe.
This cutoff of supply to Europe will likely have profound economic effects considering the region is on the verge of recession. Many European governments have stepped in with price caps/subsidies to small business and individuals to prevent citizens from falling into poverty and businesses going bankrupt. These price caps on energy costs have worked to date. So far, the five largest European Union economies have spent over $200 billion on this aid. The total aid will likely be smaller than the aid used during the pandemic, but the added debt is occurring at a time when borrowing costs are rising as interest rates steadily climb. Price caps may be a strong tool to alleviate some of the inflationary pressure in the short term, but many governments will need cooperation from mother nature and their own citizens. Bruegel (a research body) published an analysis earlier this week that showed EU household energy consumption only fell by 7% even though wholesale energy prices are 10 times their normal amount for the first half of the year. As we progress into the winter, if citizens don’t manage usage, there may not be enough energy to go around regardless of the subsidies or price caps. Currently, the US is attempting to fill the energy gap that Russia has created.
Not only are governments adding to their debt, but so are European power companies. The spike in oil and gas prices has caused the debt load to balloon to over 1.7 trillion euros in the utility space. Yes, that is a “T” for that figure. There are several utility providers that are in dire need of credit due to margin calls on their energy short positions. Utility providers make a bet against the form of energy they sell to help protect against price decreases in the general market to consumers. But when huge spikes in prices occur, they need to provide capital to maintain their short position that may be impossible to unwind. Germany’s Uniper (one of the largest utility companies) is one of the major players dealing with a margin call. Just last week, the collateral needed to maintain its position increased from 4 billion euros to 5 billion.
To prevent any major economic catastrophe, there will be an emergency meeting on Friday with the EU energy ministers. This meeting should lay the groundwork to alleviate any concerns of a credit crunch/ margin issue in the utility space.
On Thursday, the European Central Bank (ECB) increased its interest rate by .75% to help combat inflation further. This hike is one of the largest since the ECB was created. The risks of recession in Europe are now elevated in the short term.