Russian threat to cut off oil and gas brings recession closer for Europe

Europe is at risk of recession because of rising oil and gas prices amid concerns that Russia could turn off supplies completely, economists have said.

The threat is based on factors including falling demand in the US, Europe’s biggest export market; the continued fallout from Russia’s invasion of Ukraine; and related increases in food and energy prices, according to Nomura, a Japanese investment bank with significant operations in London.

Nomura said it expected the European economy to start contracting over the course of the second half of 2022 and for the recession to continue until the summer of 2023, with a total decline of 1.7% of GDP.

Energy prices had already surged in the second half of 2021 as leading economies lifted coronavirus pandemic lockdowns, but the invasion of Ukraine has added an extra layer of difficulty, as the European Union, the US and UK have sought to isolate Russia economically. Europe is still heavily reliant on Russia for its energy supply, and President Vladimir Putin has responded to sanctions by slowing gas supplies.

Russia has cut gas through the Nord Stream 1 pipeline to Germany and the TurkStream pipeline to Bulgaria, and has shut off supplies to Poland via the Yamal pipeline.

Europe is struggling with “conditions that are very much global in nature (surging energy prices and inflation, rising geopolitical risks and uncertainty), which leads us to believe that European economies will suffer the same fate – recession – as the US,” wrote George Buckley, a Nomura economist.

Inflation in the eurozone hit an annual rate of 8.6% in June, the highest since the bloc was created in 1999.

Analysts at JPMorgan Chase, the US investment bank, said last week that Russia could also cause “stratospheric” oil price increases if it used output cuts to retaliate against efforts to cap prices by the G7 group of large economies. Analysts including Natasha Kaneva wrote that prices could more than triple to $380 (£314) a barrel if Russia cut production by 5m barrels a day. One barrel of Brent crude oil for September delivery was worth $111 at the end of last week on futures markets.

“It is likely that the [Russian] government could retaliate by cutting output as a way to inflict pain on the west,” wrote JPMorgan’s analysts. “The tightness of the global oil market is on Russia’s side.”

Germany, Europe’s largest economy, is particularly vulnerable because of Russia’s control over the Nord Stream 1 pipeline. The pipeline is scheduled to close for 10 days starting on 11 July for planned annual maintenance. The economy minister, Robert Habeck, told German media last week that the government feared Russia would decline to reopen the pipeline.

Kay Neufeld and Jonas Keck, economists at the Centre for Economics and Business Research, wrote: “It seems clear that in the case of European gas shortages, a severe recession will be a near certainty. This is because European countries are linked to each other not only via energy interconnectors but also through highly integrated supply chains.

“A tight gas supply will lead to further increases in energy prices for consumers … claiming an even greater share of households’ disposable income, which is a recession risk in itself.”

Countries dependent on Russian gas are racing to find alternative supplies. The German government is hoping that two floating terminals that can accept liquid natural gas will be in operation this winter.

While the UK does not directly import gas from Russia, European shortages could still exacerbate the cost of living crisis by raising the price of gas on open markets. That would force the UK to pay more, a cost likely to be reflected in bills for consumers and businesses. Nomura has forecast a decline in UK GDP of 1.5% during an expected recession.

‘Conditions that are very much global in nature lead us to believe Europe will suffer the same fate – recession – as the US’

George Buckley Economist, Nomura