“Winter is Coming- Can Europe Survive?”

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"In Focus" by Jacob L. S. ,

There are some weeks where it is not always clear what the most important geopolitical development was. This was not one of those weeks.?Russian President Vladimir Putin?doubled down?on his failing war in Ukraine, ordering a partial mobilization that would call 300,000 men up for service. Russia also wants its newly acquired territories – over which its control is precarious at best considering Ukraine’s battlefield successes – to hold referenda as soon as next week about whether to join the Russian Federation formally. If Russia considers these regions to have joined Russia formally, will Moscow consider further Ukrainian attacks tantamount to a direct attack on Russia itself, one that could even justify the use of nuclear weapons? Such is the?speculation?in Russian media this week. Less reported but no less important is the news that the Russian government plans to cover the gaping 1.4 trillion ruble hole in its budget deficit by taxing Russian raw material exporters – including 50 percent export duties on natural gas and LNG – for the?next?three years.

One of the tenets of geopolitical analysis is to assume that the actor you seek to understand is not crazy or bereft of reason.?Usually, thinking a political leader is “crazy” is an indication that you have not understood him or her correctly rather than the leader in question having taken leave of their senses. It is becoming harder, however, to avoid such analysis when it comes to Putin. At every step of the way, Putin is pursuing policies that are against Russia’s geopolitical interests.?In last week’s Global Situation Report, we briefly considered whether Russia is on the verge of a 1917-style Russian Revolution – one that saw the ruling Romanov family murdered because Tsar Nicholas II was so out of touch with the suffering of his own people. This week, Putin is a) continuing to lose a war he started and is unable to hide that truth from the Russian people, b) is setting off financial panic by proposing to rob Russian companies to refill the government’s coffers, and c) is suggesting that 300,000 more of Russia’s sons should be thrown into a battle for which they did not sign up and for which they have not been trained. That seems an untenable political situation even in an authoritarian environment like Russia.

Furthermore, Russia’s strategy seems to be to put pressure on Ukraine by driving up commodity prices and especially energy prices for the European countries sanctioning Russia’s economy and arming Ukraine’s soldiers.?Russia is betting that as winter approaches, Europeans will not support policies that lead to higher energy bills. Thus far, Putin has bet wrong?– but instead of utilizing the one advantage Russia has always played so well in the course of its long history – namely, time – Putin is doubling down on his position. Veiled nuclear threats, shotgun referenda on conquered territories, criticism of the Ukraine-Russia grain deal, and vociferous demands for European sanctions to be withdrawn before Nordstream 1 will flow again?only strengthen the European resolve to wean European markets off Russia and to support Ukraine. Look at Italy, where a far-right party is leading in election polls. The far-right has historically been the political faction in Europe most eager for an accommodation with Russia – and has even admired Putin from afar. Not so Giorgia Meloni, whose?support?for Ukraine on the campaign trail has even earned her praise from?Politico’s skeptical pages.

?This raises what is, aside from China’s still-simmering real estate crisis, the most important geopolitical question in the world today, namely,?Can the European Union survive the winter??Germany Economy Minister Robert Habeck answered that question in the affirmative this week, revealing that Germany had filled its gas storage facilities to 90 percent full, and declaring that, "If everything goes well, savings in Germany are high and if we have a bit of luck with the weather, we will have a chance at getting through the winter comfortably.” From crisis to comfort, all in the span of a month! It is, of course, impossible to predict the weather, and that is decidedly not our expertise. But keep in mind that heating degree days in the EU have been in steady decline since 1979; that since 1999, only four years (2001, 2003, 2004, and 2010) have?seen?heating degree days in Europe that were higher than the average; and that a third consecutive year of the La Ni?a weather pattern could?lead?to another winter of milder temperatures and dryer conditions throughout the EU.

Moreover:?the fear over Europe’s energy supplies appears to have been overwrought, at least according to an in-depth International Monetary Fund report?published?earlier this year. The report notes that in 2021, national gas flows from Russia were exceeded by spare capacity from non-Russian sources.

That sounds amazing, but it is also somewhat misleading. European demand for natural gas is not steady year-round and peaks in the winter months. (Note: as heating degree days decrease, cooling degree days have increased – in 20 years, European natural gas/energy demand may reverse its current trend!) So even if on paper the European Union has enough natural gas over a 12-month span, that does not mean it is able to surge supply as demand increases. Europe’s energy infrastructure also prevents member states like Spain, which made the far-sighted decision to build a lot of LNG storage capacity, to come to the rescue of Central and Eastern European states like Czechia, Slovakia, Hungary, Germany and even Italy, which are disproportionately dependent on Russian natural gas. Spain, for example, accounts for 35 percent of the EU’s LNG import capacity – but can only export 10 percent of that capacity to France. And France cannot in turn transmit most of that 10 percent to its neighbors owing to north-south bottlenecks in France’s own transmission system. (As an aside: This is an argument for a unified?European?transmission system in the future, but in the meantime, there will be shortfalls in several European countries even in a best-case scenario.)

Even so, the upshot is that?absent a statistically unlikely cold winter scenario, the European Union as a bloc should be able to scrape together enough energy from a combination of LNG imports, non-Russian natural gas pipeline imports, energy rationing, and increases in power generation from nuclear, wind, solar, and other clean energy sources, to make up for the shortfall from Russia.?The small ways European states are scraping this energy together do not make sexy headlines, but they are more important than the pervasive doom and gloom. As we noted two weeks ago, the Dutch recently inaugurated two floating LNG terminals, each with throughput capacity of roughly 8 bcm/year. Germany is pushing to have at least two of four leased floating LNG terminals of its own online by year’s end accounting for 12.5 bcm/year of supply. A recently announced EU deal with Israel and Egypt could bring an additional 2-4 bcm by year’s end. Finland and Estonia signed a 10-year lease for a floating LNG terminal this?past?June. Remember – the EU does not need to make up for its annual or even monthly consumption. It just has to cover the gap between its current imports and stored natural gas during the winter’s peak months. Additional kilowatt-hours can be found from organic growth in renewable capacity and can even be supplemented by coal, which German utilities have already been doing by looking to the U.S. and Colombia in?recent?months.

None of this is to suggest that Europe will not struggle this winter. Gas intensive industries like fertilizers, chemicals, or even glass production will feel the pain – and how much pain will be determined by this winter’s temperatures (which are unpredictable).?In a worst-case scenario of a particularly bad winter, the IMF estimates European natural gas demand could increase by 30 bcm, which is beyond Europe’s ability to scrape together on the fly. It also depends on whether Putin shuts off gas completely (thus far he hasn’t… Europe is still importing Russian natural gas via Turkstream and Ukraine even though Nordstream 1 and the Yamal pipeline remain shut off).

Europe isn't created equal when it comes to dependence on Russian natural gas. Countries like Ireland, Spain, France, and Finland have options for dealing with a supply disruption if Russia closes off the taps completely.?The list of countries dependent on Russian natural gas and sport gas-intensive industries is short but significant: Germany, Austria, Italy, Czechia, Slovakia, and Hungary.?The IMF predicts these countries could lose as much as 6 percent of GDP in a worst-case scenario. The next few months will offer significant insight into whether the European Union is able to cohere as a unified bloc and support the countries most at risk at the expense of those countries that did not put all their eggs in Putin’s basket – which is yet another reason Putin’s recent behavior is so confusing.?If Moscow’s goal is for Europe to squabble itself into capitulating on sanctions and urging Ukraine to sue for peace, calling up reservists and threatening nuclear war is not going to achieve the end result.

The silver lining in all of this for Europe is that this energy crisis will not become an annual event.?Europe already has options to avert catastrophe?this year, and by next winter, crisis should turn to opportunity as the rapid pivot away from natural gas is supported by increased LNG import capacity and renewable power generation.?Relative to the U.S., European countries have been?paying?a significant premium for natural gas for years. Nord Stream 2 and increased imports of Russian natural gas were supposed to change that, but Russia has demonstrated it is not a reliable actor and forced even Russia-dependent countries like Czechia and Germany to reimagine a vastly different energy future and to make quick moves to make those visions a reality.?This year’s crisis should drive policies that will drive down the cost of energy for European consumers and companies alike in the years ahead – not exactly the legacy Putin dreamed of.