Germany poised for recession without cheap Russian gas and big trade surplus

LUDWIGSHAFEN, Germany — Taller than lower Manhattan, BASF’s sprawling chemical plant on the Rhine River is a symbol of both German industrial might and how much Europe’s largest economy has to lose in its worst energy crisis in generations.

The plant uses more electricity than Switzerland every day as it produces everything from rubber for sneakers to coatings for cars. But the consequences of the war in Ukraine are demanding a high price. In the second quarter of the year alone, sky-high natural gas prices drove up the company’s energy costs by the equivalent of $776 million.

To contain costs, the plant has begun streamlining operations and reducing energy-rich production of ammonia for fertilizer — compounding a fertilizer shortage on the continent that threatens the global food supply. If the availability of energy in Germany becomes critical in the coming months, CEO Martin Brudermüller warned that the company might have to relocate more production to “plants outside of Europe”.

“We have a war on our doorstep in Europe and an unprecedented energy crisis that is threatening the very existence of European industrial production,” Brudermüller told chemical industry executives last week. He added, “Many of our value chains are breaking up as we speak.”

Russia’s resurgence of war in Europe has triggered seismic shifts in Germany. In the early days of the invasion, the German government moved away from an attitude of military restraint adopted in the shadow of World War II. Officials announced a dramatic increase in defense spending and dropped opposition to arms shipments to conflict zones.

Now the aftermath of the war is forcing a further reassessment of the foundations of modern Germany. The nation prospered and established itself as the economic powerhouse of Europe and the world’s fourth largest economy, relying on the twin pillars of cheap Russian energy and manufacturing exports. But as the German economy sputters — and threatens to drag Europe down with it — the economic model that birthed Deutschland, Inc. has been called into question.

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“We were too dependent on one country – Russia – and now we’re paying for that,” says Claudia Kemfert, one of Germany’s leading energy experts. “Germany has to change, we have known that for a long time. This business model is not really sustainable.”

The severing of Western relations with Moscow has had an outsized impact here. Before the war, Russia supplied more than half of the natural gas consumed in Germany – for industrial production, heating homes and generating electricity. Now that the main line from Russia is shut down, Germany has to look for other suppliers and is paying 7 to 10 times the previous year’s prices.

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At the same time, the country is feeling the effects of its dependence on industrial exports. Germany is the third largest exporter in the world after the USA. But manufacturing accounts for about 20 percent of the economy, compared to about 11 percent in the United States. This makes Germany particularly vulnerable to turbulence in world trade and energy prices.

Energy price shocks, on top of pandemic-related supply chain disruptions and weakening global demand, have already eroded the country’s legendary trade surplus. Economists say Germany faces a recession next year – the International Monetary Fund predicts it could be hardest hit among other major economies besides Russia.

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But the impact would be felt far beyond Germany, especially if a recession coincided with energy shortages.

A German weakening would put pressure on a single eurozone currency. Some economists predict that this could push the euro below par with the dollar for an extended period of time.

Countries in Eastern Europe that are home to suppliers for large German manufacturers and whose economy is closely intertwined with Europe’s juggernaut would be particularly affected.

Manufacturing delays in Germany could also exacerbate pandemic-related issues in the global supply chain, especially for finished goods like cars, medical devices and other specialized industrial products that Germany is known for.

“If we have a recession in Germany, and I think it’s inevitable now, it will affect the broader European economy and the rest of the world,” said Emily Mansfield, European economist at the Economist Intelligence Unit.

For the time being, Germany’s energy reserves are bulging with increased imports from Norway and the Netherlands. France also began sharing its gas with Germany via a newly modified pipeline on Thursday. A terminal for remote deliveries of liquefied natural gas is to be opened next year. Germany also burns more coal and oil.

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Meanwhile, a nation that once berated other countries in Europe for wasteful spending is – much to the chagrin of its neighbors – using hundreds of billions of euros to keep its economy afloat and protect its businesses and consumers from high energy prices, a solution critics might say are fanning the fires of already high European inflation.

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However, full replacement of Russian gas imports will be a costly and complicated process that could see energy prices in Germany soar for years and at least the next 12 months. A particularly cold winter, analysts say, could lead to shortages as early as next year.

“Even if the economy as a whole is relieved by the price brake,” said Peter Adrian, President of the Association of German Chambers of Industry and Commerce, “companies are facing two economically challenging winters. Gas conservation and the efforts of large companies remain central to overcoming the energy crisis.”

Some companies have shut down production of energy-intensive goods such as ammonia and aluminum, switched to imports or relocated production. Other firms are doubling stocks in anticipation of shortages of everything from glass windshields for BMW convertibles to bottles for German beer.

Speira, a German aluminum giant that makes processed metals for fuel-efficient cars, beverage packaging and construction, made the tough decision last month to cut internal aluminum production at its Rheinwerk plant in Neuss by 50 percent. Natural gas prices had risen so much that a ton of aluminum cost only a third of the energy required to produce it.

“This is unsustainable,” said Volker Backs, the company’s managing director. “It’s impossible. That doesn’t just apply to aluminum. That applies to the entire German industry. There is currently no energy-intensive industry that would claim that at the moment [conditions] are sufficient. No one.”

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Citing the “current energy cost environment in Europe,” U.S.-based Trinseo last month announced the possible closure of a chemical plant in Böhlen, Germany, after losing $30 million over the past four quarters. Also in September, the Volkswagen Group warned some of its component manufacturers that it could consider shifting production out of Germany in the medium term if gas shortages persist.

“Politicians must also contain the currently uncontrolled explosion in gas and electricity prices,” Thomas Steg, the company’s head of external relations, told reporters. “Otherwise, small and medium-sized energy-intensive companies in particular will have major problems in the supply chain and will have to reduce or stop production.”

Asked if the government’s proposed interventions allayed concerns, the company said in a statement to the Washington Post that capping the price of gas would help companies “plan ahead” and “ensure production and employment.”

“A final assessment will only be possible once the specific implementation of the measures by the federal government and the Bundestag has been determined,” the company said, adding: “The Volkswagen Group will make full use of the possibilities with its brands and at all locations in the coming months achieve significant savings in gas and energy consumption.”

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How Europe reacts to Russia’s “energy war” in winter

Some countries that were criticized by Berlin in the debt crisis of the past decade are watching Germany’s woes with a certain glee.

“Unlike other countries, the Spaniards have not lived beyond their means from an energy point of view,” Spain’s Energy Minister Teresa Ribera said in July, parroting a phrase German officials once used to describe free-running government spending in Spain, Greece, Portugal and Italy to describe.

In a way, Germany’s predicament is reminiscent of the late 1990s and early 2000s, a period of high unemployment and low growth, when the country was dubbed the “Sick Man of Europe.” There are differences. Germany today has a labor shortage and one of the lowest unemployment rates in Europe. But solving the energy problem could prove just as difficult as the hard-fought labor and work contract reforms that helped Germany flourish in the mid-2000s.

And Germany’s troubles could extend beyond energy to Berlin’s close trade ties with China. The Chinese economy has already slowed. And some experts fear that in the event of a future showdown with the West over Taiwan, the market could become as poisoned as Russia’s.

The German government announced last month it would develop a new trade policy that would reduce its reliance on Chinese commodities and components such as semiconductors, in what officials described as a break with “naivety”.

“Russian gas was a mistake,” said Kemfert. “Our dependence on China could be our next big problem.”

But the hard-working Germans also see a silver lining by saying the energy crisis has revealed the folly of over-reliance on Russian gas, and the pain of backing down now will pay off in the medium term by giving the country and its companies a break stronger, safer and greener energy mix.

In central Germany, for example, pharmaceutical giant Boehringer Ingelheim is putting the finishing touches on a huge new biomass plant that will provide 80 percent of the factory’s energy needs over the next year, mostly by burning old furniture.

An investment of 200 million US dollars, made before the current energy crisis broke out, is now seen by many German companies as the best solution to the current energy crisis.

“This will make us really independent,” says Sabine Nikolaus, the company’s head of Germany.


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