Energy crunch will hurt like the 2009 crash if Europe gets it wrong

LONDON: The economic damage from the shutdown of Russian gas flows is piling up fast in Europe and risks eventually eclipsing the impact of the global financial crisis.

With a continent-wide recession now seemingly inevitable, a harsh winter is coming for chemical producers, steel plants and car manufacturers starved of essential raw materials who’ve joined households in sounding the alarm over rocketing energy bills.

Building on a model of the European energy market and economy, the Bloomberg Economics base case is now a 1% drop in gross domestic product, with the downturn starting in the fourth quarter.

If the coming months turn especially icy and the 27 members of the European Union (EU) fail to efficiently share scarce fuel supplies, the contraction could be as much as 5%.

That’s about as deep as the recession of 2009. And even if that fate is avoided, the eurozone economy is still on track to spend 2023 suffering its third biggest contraction since World War II – with Germany among those suffering the most.

“Europe is very clearly heading into what could be a fairly deep recession,” said Maurice Obstfeld, a former chief economist at the International Monetary Fund who’s now a senior fellow at the Peterson Institute for International Economics in Washington.

The bleak outlook already means that, seven months on from the outbreak of war in Ukraine, governments are shovelling hundreds of billions of euros to families at the same time as they bail out companies and talk of curbs on energy-usage.

And those rescue efforts may still fall short. Adding to the pressure on companies and consumers, the European Central Bank (ECB) is also squeezing the economy as its new laser-like focus on surging inflation drives the fastest hiking of interest rates in its history.

ECB president Christine Lagarde said Monday that she expects policy makers to lift borrowing costs at the next several meetings. Traders are already pricing in a jumbo 75 basis-point hike at the next monetary policy meeting on Oct 27.

“The outlook is darkening,” Lagarde told EU lawmakers in Brussels. “We expect activity to slow substantially in the coming quarters.”

Some energy-industry watchers warn of a lasting crisis that potentially proves bigger than the oil-supply crunches of the 1970s.

Indeed, the final impact of the shortages could be even worse than economic models can capture, Jamie Rush, Bloomberg’s chief European economist, said.

In an energy crunch, the industrial supply chain can break down in dramatic and unpredictable ways.

Individual businesses have a breaking point above which high energy costs simply mean they stop operating.

Whole sectors can face shortages of energy-intensive inputs such as fertiliser or steel. In the power system, once a blackout starts, it can quickly get out of control, cascading across the grid.

“Our analysis is a sensible starting point for thinking about the channels through which the European energy markets affect the economy,” Rush said.

“But it cannot tell us the impact of system failures.” As a witness to the pain, consider the experience of Evonik Industries AG, one of the world’s largest specialty chemical manufacturers, based in western Germany’s industrial Ruhr valley.

In a statement to Bloomberg, the company warned of the potential long-term harm from persistently high costs.