Dependence on Russian gas is hitting Germany hard and may be pushing the country into a deep recession

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Cheap Russian energy helped to turn Germany into Europe’s greatest industrial power, and one of the world’s top three exporters. Today, that same energy – or lack of it – threatens to unravel decades of German industrial progress and push the country into recession.

Germany’s energy-intensive industries are getting hit the hardest. Some companies are paying as much for electricity and natural gas in a single month, post-Russian-invasion, as they did for all of last year. The glass-making sector is but one example of a German industry in trouble.

Germany’s glass makers are energy gluttons since their furnaces have to be superheated to 1,600 C to make their products. Heinz-Glas, whose factory in Kleintettau, in central Germany, opened in 1661, considers the energy crisis an existential threat – its costs have soared 10-fold to 20-fold since 2019. It is paying premium prices for liquefied natural gas (LNG), delivered by truck, to help overcome the shortfall and has said it would require the equivalent of 3,000 soccer fields of solar panels to convert its operations to renewable energy.

The German glass industry is suffering so much that several prominent players, including Heinz-Glas and rival Wiegand-Glas, came together with local politicians and chambers of commerce to create a video, called Red Alert, to draw attention to their plight.

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“There is currently a serious market failure,” Hans Rebhan, vice-president of the German Chambers of Commerce, said in the video. “Our entire economy is breaking apart,” Heinz-Glas chief executive Carletta Heinz said. “Prices are no longer bearable. We can no longer produce economically.”

A smaller rival with a plant near Dresden, Glashutte Freital, whose products include maple syrup bottles shipped to Canada, has had to shut a production line to save costs.

The company’s managing director, Andreas Schnelle, told The Globe and Mail he believes Berlin had no backup scenario to support German industries when it was rolling out the sanctions that angered Russian President Vladimir Putin, who retaliated by cutting gas exports. “It is like a game of chicken,” he said. “We took away Putin’s food and he took away our water, then we wait and see who folds first,” he said. “If you propose such as sanctions, you should have a plan to see them through, but it seems there wasn’t one.”

Demand for German glass in the form of wine, juice and perfume bottles had soared after Russia invaded Ukraine in February. Europe was left with a shortfall because a big Ukrainian glass plant was bombed by Russia and exports of Russian glass ended. German producers were happy to fill the gap.

But the good times would never arrive because gas prices climbed immediately and crippled some of Germany’s Russian gas importers. Two of the biggest ones, Uniper SE and VNG AG, lost fortunes when Gazprom, the Kremlin-controlled gas export colossus, slowed, then virtually eliminated, deliveries to Germany. That has forced suppliers to buy gas on the spot market at much higher prices to fulfill their contractual delivery obligations. Uniper alone is losing up to €100-million (about $132.9-million) a day, its CEO has said.

In the summer, Berlin handed Uniper a bailout worth €19-billion to keep the company solvent for fear its collapse would wipe out dozens of regional utilities and even more businesses; Uniper was partly nationalized and this week revealed that a full nationalization is likely.

Germany total energy supply

Per cent, by source

Coal

Natural

gas

Nuclear

Hydro

Wind,

solar

Biofuels,

waste

Oil

100%

80

60

40

20

0

1990

1994

1998

2002

2006

2010

2014

2018

the globe and mail, Source: iea.org

Germany total energy supply

Per cent, by source

Coal

Natural

gas

Nuclear

Hydro

Wind,

solar

Biofuels,

waste

Oil

100%

80

60

40

20

0

1990

1994

1998

2002

2006

2010

2014

2018

the globe and mail, Source: iea.org

Germany total energy supply

Per cent, by source

Coal

Natural

gas

Nuclear

Hydro

Wind,

solar

Biofuels,

waste

Oil

100%

80

60

40

20

0

1990

1994

1998

2002

2006

2010

2014

2018

the globe and mail, Source: iea.org

Earlier this month, VNG pleaded for a bailout, too. “Until the start of the Russian war of aggression, VNG was a healthy corporate group,” the company said. “The impacts of the Russian war on the energy markets placed VNG in an increasingly critical financial situation through no fault of its own.”

The upshot is that Germany has been thrust into its biggest and most damaging energy crisis since the Second World War, one that is already slowing output and putting employees on the dole. If the crisis endures – Germany is preparing for possible energy rationing and rolling blackouts as winter approaches – the government might have to rethink the country’s entire economic model, which has centred for decades on delivering massive amounts of subsidized energy to heavy industries such as chemicals and steel.

“This crisis comes as a massive shock to Germany because we have very energy-intensive industries,” Georg Zachmann, senior fellow the Bruegel economics think tank in Berlin, told The Globe. “This could be the opportune time to reform this business model and go from the 19th century to the 21st century.”

German companies almost every day announce production cuts or bankruptcy filings as energy costs set new records. In recent weeks, several companies that make paper products, baked goods, metals and fertilizers have called in the insolvency administrators.

A survey published by DIHK, the Association of German Chambers of Commerce, in late July, revealed that one in six industrial companies feels forced to reduce production because of high energy prices. The highly energy-intensive companies are being clobbered, with one-third of them already starting to cut output levels or close entire production lines.

In early September, ArcelorMittal SA, the world’s second-biggest steel maker, announced it would shut one of its two blast furnaces at its massive site in Bremen, Germany, due to the “exorbitant rise in energy prices.”

Aluminum plants throughout Europe are under enormous pressure. Europe’s largest aluminum smelter, Aluminium Dunkerque Industries France SAS, will cut production by 22 per cent by October. Dutch aluminum maker Aldel is mothballing its plant in northern Netherlands. Norwegian rival Norsk Hydro ASA plans to close its Slovaco smelter in Slovakia by the end of September.

All these industrial closings are a gift to China. “Halting production means Europe will be forced to import aluminum from countries such as China,” Slovaco factory director Milan Vesely told the Euractiv media network.

The cutbacks are not limited to big companies. A poll published in September by DMB, the federation of Germany’s small and medium-sized companies, known as the mittelstand – collective employment of 500,000 – was sobering. Almost three-quarters of the companies reported being under “severe strain” from the energy crisis, with fully 10 per cent saying they were under “existential threat.” In an interview, DMB’s energy spokesman, Steffen Kawohl, said Russian gas went from being a German asset to a liability virtually overnight. “Yes, this is a real crisis,” he said. “The gas was easy and cheap and now we recognize that it was not such a great idea.”

Even Germany’s small mom-and-pop companies are feeling the pain.

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Last week, about 800 bakeries in Germany shut their lights for one day to draw attention to their plight. Customers had to sit in the dark to eat their pastries and sandwiches. “We are worried about our electricity costs,” said Sabrina Vossen, an employee at a shop owned by Schnell, one of Berlin’s oldest bakeries, said as she pointed to the outlet’s energy-sucking five fridges, two freezers and one oven. “We have no idea what will happen this winter.”

Sarah Schnell, the Schnell bakery office manager, who is a fifth-generation member of one of Germany’s oldest family-owned bakeries, said the company has not had to close stores or lay off employees – yet – but has worked hard to save energy. “The heat generated by the ovens is now recaptured to heat water to make dough, clean the factory and wash the dishes,” she said.

A year ago, German businesses were shocked when the one-year forward prices for electricity topped €100 per megawatt hour (MWh), then a record high. In 2019, power was half that price. On Wednesday, the same electricity contract traded at about €500 per MWh, though prices had been as high as almost €1,000 in August, when near-panic conditions hit energy markets as Russia reduced gas exports to Germany and much of the rest of Europe to virtually nothing in retaliation for the ever-expanding array of Western sanctions against Moscow.

Germany cannot blame Mr. Putin’s war for all of its energy woes. The roots of the crisis go back decades. Today, Germany’s energy policy is widely viewed as a failure. Only a year or so ago, it was considered the model for a wealthy country’s transformation from grubby to clean energy. “Germany’s energy policy didn’t start as a mistake but it became one,” said Pieter de Pous, the program head for the fossil fuels transition program at E3G, a climate-change think tank.

Germany has always been a fossil fuels pig and owes much of its initial industrial success to the coal mines in the Ruhr region in west-central Germany. By the mid-1800s, the region was home to about 300 coal mines, whose output was used to launch the iron and steel industries that would make Germany the heavy-industry champion of Europe.

Companies such as Krupp and Thyssen (now ThyssenKrupp AG), that used steel to make everything from locomotives to armaments, took off. In the Second World War, the Ruhr’s status as Nazi Germany’s premier industrial area, one filled with steelworks, weapons factories and synthetic oil plants, made it a prime target for the Allies’ 1,000-bomber raids.

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After the war, the Ruhr metal bashers came back to life and were instrumental in launching West Germany’s economic miracle – the Wirtschaftswunder. The Volkswagen Beetle, produced in the millions after the war, became a symbol of the war-ravaged country’s remarkable industrial recovery.

By the early 1970s, the West German wealth-generation model would undergo a transformation for economic and political reasons.

Shocks to the fossil fuel market were the economic reason. By then, the Ruhr coal mines, which employed half a million men in the mid-1950s, were getting tapped out (the last one would close in 2018). At the same time, the 1973-74 Arab oil embargo quadrupled the price of oil.

West Germany needed a new source of inexpensive fuel to keep its industrial machine rolling. The country’s Social Democratic chancellor, Willy Brandt, came up his Ostpolitik (Eastern Policy) idea that would ultimately open the door to vast quantities of cheap Soviet gas and oil.

His idea was to improve the relations between West Germany and its eastern neighbours, particularly East Germany, all then part of the Soviet bloc, even as the Cold War was still intact. Inevitably, the détente effort came with an energy component that would please both sides.

Soon, oil and gas pipelines, such as the Urengoy-Pomary-Uzhhorod gas pipeline, which was completed in 1984 and went from Siberia through Ukraine to Central and Western Europe, were sending hydrocarbons to feed Europe’s energy-craving factories. The sales earned the then-communist eastern countries fortunes in U.S. dollars.

At the time, then-U.S. president Ronald Reagan warned that Germany and other countries in Western Europe would become overly dependent on Soviet gas, giving the Kremlin political and economic leverage over the region. Other presidents, including both Bushes and Donald Trump, argued the same.

They were ignored and Europe, particularly Germany and Italy, became ever more reliant on Soviet (now Russian) gas. “We wanted to have cheaper energy than our competitors and there was the notion that Russia would always be a reliable supplier since we were sending them so much money,” Mr. Zachmann, of Bruegel, said.

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Two of Mr. Brandt’s successors, Gerhard Schroeder, the Social Democratic chancellor of Germany from 1998 to 2005, and Angela Merkel, the Christian Democratic chancellor from 2005 until last year, when she was replaced by Olaf Scholz, doubled up on Mr. Brandt’s Ostpolitik model – then doubled up again.

Mr. Schroeder approved the Nord Stream 1 gas pipeline that connected Russia directly to Germany, bypassing Ukraine. Ms. Merkel’s government approved the parallel Nord Stream 2 pipeline even amid warnings that its construction would make Germany ever more reliant – dangerously so – on Russian gas. Incredibly, Germany granted the pipeline’s construction permits in 2018, four years after Russia annexed Crimea from Ukraine and well after Kyiv began to fear, and prepare for, a full Russian invasion.

Nord Stream 2 was completed last year but never went into operation – Ms. Scholz halted its permitting process on Feb. 22, two days before Mr. Putin sent Russian troops into Ukraine. But by then, Germany and much of the rest of the European Union were utterly reliant on Russian energy. In the year before the war, Russian gas supplied about 40 per cent of EU’s gas demand and 50 per cent or more of Germany’s.

When Mr. Putin started to squeeze shut the taps, the energy pain came fast. Nord Stream 1, the biggest source of supply for Germany, is now delivering zero gas.

Germany’s energy plight was made worse by two crucial decisions made by the Merkel government a decade ago.

The first was Ms. Merkel’s decision to close all of Germany’s 17 nuclear power plants, even though she had been in favour of keeping the fleet going. She reversed course in 2011, after Japan’s Fukushima nuclear catastrophe, and pledged to close all of them by the end of this year, even though they had operated safely for decades, had supplied almost a third of the country’s electricity without spewing out greenhouse gases, and operated in a country that, unlike Japan, was not prone to massive earthquakes.

While the nuclear shutdown was ostensibly done for safety reasons, there is little doubt it was motivated by politics. Germany’s Greens, a strong force at the state and federal levels, have their roots in the anti-nuclear movement and oppose nuclear power to this day, even when Germany is starved for energy. “Merkel saw the Greens as a substantial threat to her power and flipped her position on nukes,” said Mr. Zachmann of Bruegel.

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Today, the Scholz government is searching for energy wherever it can find it and plans to keep at least two of the three still-operating nuclear plants open beyond their scheduled December closing date. But, under pressure from the Greens, which form one-third of Mr. Scholz’s three-party coalition government, Berlin is making no promises to extend the nukes’ lives beyond the winter.

The second decision by Merkel government that has come to haunt Germany was to slow the rollout of renewable energy power. Until about 2012, the construction of German solar and wind projects had been extremely rapid and renewables were taking up an ever-rising share of the power market.

But the heavy spending on the green projects was never popular with Ms. Merkel’s Christian Democrats and their coalition partner, the pro-business Free Democrats. The pace of approving and building renewable energy projects slowed substantially in the middle of the last decade, even as the government pledged to clean up Germany’s energy act to meet its ambitious net-zero emissions goal by 2045 – half a decade earlier than most Western countries.

“Germany dropped the ball on its own energy transition,” said Mr. De Pous of E3G. “Underinvesting in renewables and shutting the nuclear plants was wrong.”

At least it was in retrospect. The Merkel government evidently never suspected Russia could be anything but a reliable provider of cheap and endless gas, which was being billed as the “transition fuel” to the clean-energy future as nuclear, coal and oil were weeded out of the energy system. (The carbon footprint of gas is roughly half that of coal.)

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Berlin is now in a near panic to fix what Steffen Kotré, energy critic of the right-wing Alternative for Germany party (AfD), the fifth-biggest party in the Bundestag, calls “the world’s dumbest energy policy.” Indeed, the overwhelming reliance on Russian gas as other forms of energy were shunted aside left no room for error. Germany had ignored the golden rule that investors use to reduce risk – diversification (AfD is calling for the end of sanctions against Russia in the hope Moscow would restore gas flows).

Today, Germany, every other EU country and the European Commission (the EU’s executive arm) are frantically trying to devise plans – all of them expensive, some apparently unworkable – to take the sting out of energy bills and keep companies and families from going broke.

The EC this week proposed a windfall tax on power companies’ profits (except those that do not burn gas) in an effort to raise €140-billion that would “be shared and channelled to those who need most,” said EC President Ursula von der Leyen. The EC will also require companies to cut electricity consumption by 5 per cent during peak hours, and overall consumption by 10 per cent, through the winter.

Germany is putting in place a broad package of measures, including loan guarantees for struggling energy firms, a power price cap, nationalizing some gas importers, seizing Germany’s three Russian-owned oil refineries (which it did on Friday) and reforms to the electricity market. The latter effort is especially important because the highest-price electricity producer – now the gas plants – sets the price for the whole electricity sector, even for wind and solar companies, whose marginal cost of production is essentially zero.

The question is whether this mishmash of relief programs will come fast enough – and actually work. German companies are running out of time to sustain production as energy costs soar and their ability to keep raising product prices diminishes as consumers cut back. At the same time, Germany is reopening mothballed coal plants and rushing to build LNG terminals, neither of which bode well for its carbon-reduction plans.

As the German government tries to prevent mass deindustrialization, job losses and a potentially deep recession, there is a sense at street level that Berlin underestimated the damage that would be inflicted by the energy crisis. “Energy costs are not just our problem, they’re everyone’s problem in Germany,” said the Schnell bakery’s Ms. Schnell. “When workers are gone because of this crisis, who will pay taxes?”