A breakup over natural gas?

Germany is one of the world’s great trading nations. In 2019, it imported $1.2 trillion worth of goods from all over the world. Only about 2% of that total came from Russia. In fact, the Russian Federation, with roughly

144 million people, was only slightly more important in German trade than Ireland, with around 5 million people. Ordinarily, then, you wouldn’t expect a disruption of economic relations with Russia to have a big effect on the German economy.

Unfortunately, Russia is a key supplier of one good Germany will find it hard to replace: natural gas. Nearly all of Germany’s natural gas consumption is imported via pipelines, and about 55% of its gas comes from Russia.

This situation should never have been allowed to happen; successive U.S. administrations going all the way back to Ronald Reagan have warned Germany not to let itself become so dependent on a despotic regime. (I witnessed some of those discussions during my own brief stint in government, in 1982-83.) But here we are. And while democratic nations have imposed a wide range of economic sanctions on the Putin regime, restrictions on Russian gas sales remain conspicuously absent from the list.

Yet Russian atrocities — and, to be honest, the surprising incompetence of Russia’s vaunted military, as the expected blitzkrieg continues its apparent stalemate — have been rapidly changing the political calculus of the West’s response. Not so long ago, it seemed inconceivable that German politicians would be willing to impose any significant pain on their voters in response to Vladimir Putin’s aggression.

Now there are serious discussions underway about whether and to what extent Germany can wean itself from Russian gas.

A small reduction in gas consumption shouldn’t be hard to achieve. Precisely because gas has been cheap, some of it is currently being burned in low-priority ways, easily discouraged with moderately higher prices and/or modest regulation. Large reductions, however, are another matter.

Put it this way: An important new study by a group of German economists (there are nine authors, so I’ll just refer to it as Bachmann et al.) estimates that eliminating gas imports from Russia would require cutting gas consumption by about 30%, to around 600 terawatt-hours from around 900 TWh. Why not 55%, the

Russian share of German gas? Because Germany can probably get somewhat more gas from other sources and limit the use of gas for electricity generation by relying more on coal and nuclear power. (Yes, coal must be phased out to save us from climate catastrophe — but not in the middle of a war. It’s the St. Augustine principle: “Make me chaste, but not yet.”)

Even a 30% fall in consumption will, however, be hard to achieve on short notice. Cutting consumption from 900 to 800 TWh might not be that costly; the reduction from, say, 700 to 600 TWh would be a lot more painful.

The German economists focus on a key economic concept called the elasticity of substitution — roughly speaking, how much demand for natural gas falls off for every 1% rise in its price. If that elasticity is low, the amount Germans would be willing to pay for an extra bit of gas once consumption has already been substantially reduced is large, implying that the economic cost of further reductions is also large.

Unfortunately, empirical estimates suggest that the elasticity of substitution for natural gas is low, at least in the short run. It’s not zero: Given high gas prices, households will turn down their thermostats, consumers will stop buying goods whose production requires burning a lot of natural gas, and so on.

Still, the best guess is that we’re talking about an elasticity of around 0.18, which in turn means (if I’m doing the arithmetic right) that the price of natural gas would have to rise by around 600% to cut demand by 30%.

That sounds like a lot, and Bachmann et al. deliberately use an even more pessimistic estimated elasticity of 0.1.

Yet even with those pessimistic assumptions, they find that Germany could, in fact, do without Russian natural gas, precisely because the country currently spends so little on Russian imports. The costs would be serious: German real income might fall by around 2%, the equivalent of a moderate recession. But it wouldn’t be the end of the world.

Such drastic action would have been inconceivable a month ago. But Putin seems to be in the process of achieving something remarkable: reminding the world’s democracies what they stand for. He has already ruined Russia’s reputation as a military superpower; he’s now in the process of reducing whatever economic power it had, too.