War In Europe: Germany Stares At The Possibility Of Gas Rationing Amidst 41 Year High Inflation

Chernihiv witnessed heavy bombardment last night despite indications by Moscow signalling they will 'drastically reduce' operations near Kiev and Chernihiv. Not that far from Ukraine, at the gate of Asia - Istanbul, peace talks were taking place.

"Nothing very promising in peace talks", said Kremlin. Of all the capitals in the world who were hoping for some progress, Berlin arguably was the one observing the developments most keenly. They have good reason to, considering the fact that they have a lot at stake.

Before the war a scarce number of people in the world ever paid attention to how Germany meets its energy needs but now, Germany energy dependence on Russia has come under significant scrutiny.

Russian President's demands that unfriendly countries pay for gas to Russia only in Rubles has made matters more prickly for Germany. Initially Berlin chose to play it cautious. When UK and US were supplying arms to Ukraine, Germany sent just helmets. Slowly Berlin started perceiving continuation of this policy as untenable and joined the bandwagon/ decided to bear the burden of being in the western alliance (if one is being charitable).

Berlin, for the 1st time since 2nd world war, ditched its policy not supplying nations in conflict with weapons and started arming Ukraine. They also decided to spend more on defence. All this changes ensured that Berlin locked itself in a position where strengthening the Ruble will be seen as betrayal.

Hence the G7, which includes Germany, rejected Moscow's ultimatum of paying in Rubles. Strengthening the Ruble would neuter the western attempt of damaging Russia's ability to wage war. Berlin, understandably, chose not to oblige Russia. Most countries currently pay Russia in either Euros or Dollars.

The question now is this - who is more dependent on whom? Russia on having Europe as a market to fill its coffers or Germany on Russia to ensure it has sufficient energy at a reasonable cost.

Germany faces a particularly self inflicted kind of energy insecurity. Germany's energy policy and security policy have always appeared rather incoherent. It remains in NATO, which irrespective of whether it explicitly spells it out or not, is a military institution whose aim is containing Russia. The underlying assumption being Russia is a threat. In the anarchic playground of geopolitics, a nation doesn't spend significant resources and times to contain a nation it doesn't perceive as threat.

Now, if Berlin even marginally viewed Russia as a threat, which continuing to be a part of NATO and not strongly opposing NATO expansion suggests, why be energy dependent on a nation which is a threat?

To add salt on this self inflicted wound, since 1999, Germany's share of primary energy from Nuclear has been going down, exacerbating its energy insecurity.

The much flaunted renewables do not have the energy density necessary to replace other sources in a significant manner. A basic application of mathematics crystallises this.

Not surprisingly, Germany has now declared that it could soon be facing an energy crisis. Germany's Economy Minister Robert Habeck has stated that this was an 'early warning' and as of now does not suggest that the state will intervene to ration gas supplies. Habeck was quick to add that companies and consumers must reduce their consumption as 'every kilowatt hour counts'.

Habeck said that Germany's supplies were safeguarded for the time being. However, Germany needs to be prepared for an escalation by Russia, he added. Escalation in this case is the possibility that Moscow actually goes ahead with its threat and stops supply to Germany unless payment is made in Rubles.

Today morning, the front month gas price at the Dutch TTF hub trade up over 14 per cent at 124 euros. At the time of writing this article it is at 119 euros. The Dutch TTF hub is an European benchmark for natural gas trading. Due to geopolitical concerns it has traded at elevated level in the past few weeks.

Germany imports around 55 per cent of its gas from Russia. European Union as a whole is dependent on Russia for around 40 per cent of its gas. According to Habeck, Germany will not be able to attain complete energy independence from Russia before mid 2024.

This 'early warning' is the first of three stages in Germany's emergency gas plan. The second stage is - an alarm, which signifies the usual balance has been significantly disrupted but the crisis can be mitigated with market based measures. The third and final stage is - an emergency. This is the point at which Germany's Bundesnetzagentur steps in and rations the remaining gas supplies throughout the nation.

Klaus Mueller, the head of German network regulator Bundesnetzagentur believes that this 'early warning' will help Germany and the European Union to avoid disruption in gas supplies.

Politicians in Germany may blame 'Vlad the terrible' in Kremlin and his war of 'agression' but the truth is that even if one leaves gas aside for a moment, German energy policy overall has been problematic for a long time, with or without the war in Europe. It is likely that the domestic political influence of Greens in Germany played some role in it.

A 2019 report from McKinsey reads, "The supply situation will become even more challenging in the future. The phaseout of nuclear power until the end of 2022, and the planned reduction of coal-fired generation, will gradually shut down further secured capacity. If new generation facilities are not added, the reserve margin will tumble, with consequences that vary considerably....

....from one region to the next. Industrial areas in western and southern Germany will be hit especially hard, as large drains on capacity exist in these regions and high rates of renewable expansion are unlikely there. Furthermore, the shift from dispatchable capacity to fluctuating renewable sources could also lead to problems in situations when demand is high but supply from renewable energy is low."

Germany's chemical industry association has warned that if gas is rationed, production facilities will be shut down for months, which will have a knock-on effect on all other industries such as automobile manufacturing.

Due to higher energy costs, inflation in Germany has surged to a 41 year high of 7.3 per cent. The last time inflation was 7.3 per cent, the calendar read November 1981. That is before the Berlin Wall fell. That is a time when East Germans still probably used the Tunnel 29 to escape Stasi tyranny. The Bundesbank's interest rate was around 11.4 per cent. ECB's main rate remains pegged at 0 per cent as of now. If ECB doesn't raise the interest rate now, inflation will hurt more. ECB's Lagarde must raise the interest rates now.