Stenos Signals #13 - No, Germany is probably not running out of gas

The media is full of doom and gloom around Europe, and even though the situation is admittedly bad, I tend to think that the likely outcome is less bad than feared by many. Here is why!

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Let's get the first thing out of the way… Yes, the energy situation in Europe is bad. But are we really looking into some sort of Zombieland scenario where every European is desperately chasing heating and electricity? I think the answer is no. Just look at the price action from this week in German Power Price 1y ahead. There is so much speculation distorting the real picture. 

Let’s break the whole energy debacle into three pieces. Inflow, storage and outflow. Putin is expected to turn the gas tab completely off, thus really putting the nail in the European coffin for this winter, right? But do you remember your first year microeconomics and the lessons on profit maximization in a monopoly/oligopoly? We were taught that MR = MC, not that the monopoly would completely stop selling.

Now, of course, there is a difference between talking about a company operating in a monopoly on a theoretical level and an (ir)rational dictator in the real world, but it is still justifiable to believe that Russia will deliver (some) gas to Europe during the winter. Remember that Russian flows are currently running at roughly 20% of normal and yet the total flow is not that bad. Germany has other suppliers and they have taken steps to safeguard the flow already. Just see the export development below.

Chart 1 - Ze Germanz turning their own gas tap off… 

So that is the inflow. What is the outlook for the storage? Well Germany will have their storages filled well before the first of November. Since Russia invaded Ukraine, Germany has saved its own natural gas and been filling their storages, which are now 1-2 months ahead of schedule. Storage wise they should easily reach 245 TWh by the first of November. That of course doesn't help a whole lot, if the inflow completely dissipates, but will Germany run out of gas? In most scenarios, they won’t. 

Now to the outflow part. Here I have tried to paint three different pictures where one of them indeed does look pretty grim.

Table 1 - Calculations on German Energy in various scenarios

So let’s look at the base-case first. Germany will be able to fully fill storages by 1st of November (245 TWh of Natural Gas) - the average consumption during the winter season is around 120 TWh per month and the monthly net inflow is currently around 90 TWh even as Russia has partly halted the flow. Even with a net/net minus of 30-40 TWh per month during the winter, Germany will easily make it to the other side without having to ration gas.

Secondly, what if Russia completely halts flows today and we get a severe cold winter? That will cut a further 30 TWh of Gas from the inflow every single month from now. That would probably leave storages less than 100% filled 1st of November and the net “burn” of Nat Gas will reach 60-70 TWh per month. Germany will not make it until 1st of April 2023 without rationing gas. This is a really bad scenario, BUT .. “There is a chance” to quote Jim Carrey.

If we get a mild or just a neutral winter season, Germany will make it through winter EVEN with 0 gas flows from Russia until April next year. The net “burn” of Nat Gas will be around 40-50 TWh per month, which will allow Germany to have 5-6 months of net reductions in the storage capacity of around 245 TWh before the spring-time returns.

The bottom-line is that Germany will likely make it through the winter, unless Russia 1) halts the gas-flow completely and 2) the winter is extremely severe. If just 1 or 2 is not true, Germany will get through the winter without any major supply issues.

Chart 2. German GDP will take a BIG hit no matter what

The German economy will take a hit no matter what. The cost of acquiring the gas is out of league with anything seen before and when we model the impact on GDP, we fear a 6-8% drawdown of the Gross Domestic Product based on already observed prices. The only way for politicians to mitigate such a recession, would be to swallow the entire “gas bill” via the public budget.

In such a case Germany will likely get through winter without a deep recession, but it will require a yuge public deficit in Germany. Not necessarily something that we see too often? But remember that the German administration bailed-out big banks to the extent of 100bn EURs in 2008/2009. Something similar is likely to happen this time around, just via energy bail-outs instead (Uniper, ahem…)

Chart 3 - The German energy component of CPI is only getting worse  

Politicians Europe-wide should be looking at the energy component of CPI with much fear… At least if they want to get reelected. In Germany, given current forward prices, we are looking at CPI numbers well above 10% y/y. In France and Spain that picture is even worse with numbers above 15% y/y. This should give them plenty of incentives to expand their programs for easing energy costs even further. Here in Denmark, we have literally been handing checks out almost randomly. Expect more subsidies to come, which could add further inflationary pressures down the road.  

For now, I stay long S&P 500 vs. DAX, but if we get signs of continued Russian gas flows at just 20-30% of normal levels, then it might be time to consider placing a few chips on the European table already during Q4.

For now markets tend to agree that risks are waning in European electricity markets, but volatility is bizarre.. From >1000 EURs per MWh a few days ago to 500 per MWh just a few hours ago. Buckle up! I will continue to monitor this closely, but no I sincerely don’t think that it is the base-case that Germany will run out of gas..

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Chart 4. Pricing of German baseload electricity 1yr ahead