What impact will the termination of Russian gas supplies have on the European economy?

We recognize an accomplished fact - the supply of Russian gas to Europe has already been significantly reduced. The possibility of a complete termination is not even considered as a minimally probable scenario, but quite real. And it doesn't even matter for what reason — the refusal of the Russian Federation to supply or the unwillingness of the European Union to buy. Let's try to figure out what impact this will have on the economies of countries.

The survey published on the website of the International Monetary Fund examines several scenarios of possible consequences for the economic activity of the European Union (EU) in the event of a sudden termination of Russian gas imports.

The global market will smooth out EU shocks

Taking into account the global LNG market, the authors conclude that the shutdown would reduce EU Gross National Expenditure (GNE) by about -0.4% one year after the shock. If we assume that the shock will be absorbed only by the EU natural gas market, then the negative effect on economic activity will increase to -1.4-2.5 percentage points.

At the same time, an integrated global LNG market results in significant negative side effects from rising prices for non-EU countries, mainly in Asia. In fact, the impact on the economic activity of Asian LNG buyers such as Japan, Korea and Pakistan is broadly similar to the impact on the EU as a whole, as prices rise in tandem and demand in these countries adjusts accordingly.

Source: US Energy Information; IMF Primary Commodity Price System

Even with access to the global LNG market, gas prices in the EU would rise by about 100 percent. But growth without integration with the global market would be much larger, ranging from 370 to 1000 percent compared to the first quarter of 2022.

In other words, the global LNG market acts as a shock absorber and helps share the economic pain of shutting down Russian gas.

Global gas market in numbers

Natural gas markets on a global scale are quite segmented due to the requirements for transport infrastructure such as pipelines and terminals for importing and exporting LNG.

The volume of the EU gas market is about 400 billion cubic meters of annual gas consumption. Domestic production is approximately 45 billion cubic meters, net LNG imports are approximately 70 billion cubic meters, and the rest (approximately 285 billion cubic meters - net imports) is imported through pipelines. About 145 billion cubic meters of pipeline gas comes from Russia.

The European market is increasingly integrated with the global LNG market and is now well-connected to it. LNG trade has significantly increased since the United States lifted its export ban and companies built more and more gas import and export facilities around the world.

LNG consumption outside the EU is around 436 bcm. The main economies are the UK, China, India, Japan, Pakistan, South Korea and Taiwan Province of China.

Gas prices around the world have risen sharply over the past six months. The consequences of higher gas prices are tightening demand not only in the EU but also in other importing countries, and LNG cargoes are diverted to Europe.

The North American natural gas market is only partially integrated with the world market. US natural gas prices have not risen in comparison with European, Asian and other benchmark prices.

Capacities of export terminals limit the amount of gas that can be exported. LNG terminals in the US are at full capacity due to high global demand. Capacities continue to expand, but the construction of terminals requires two to four years.

Source: IMF

What substitution possibilities does the European Union have?

Europe can use non-Russian LNG imports, the throughput capacity of EU cross-border pipelines and storage facilities. However, the infrastructure will require partial reconfiguration.

Non-Russian import opportunities in the European Union are significant. It is 257 billion m3 through the pipeline and 232 billion m3 through LNG per year, with the current annual consumption of approximately 400 billion m3. Of the total LNG imports of 232 bcm in 2021, only 31% was used. Recently, this usage has increased significantly, but the throughput is still only 53% year-on-year in April 2022. Countries have also begun installing floating LNG import terminals to increase throughput.

Source: IMF

The European pipeline network is fairly integrated in most regions, and most countries in the European Union have a significant capacity of cross-border EU pipelines not connected to Russia. For example, the total capacity of Germany is 114 billion m3 from Norway, Austria, Belgium, Switzerland, Denmark and the Netherlands, and the total annual consumption is 94 billion m3.

However, if Russian gas is cut off, potential regional bottlenecks could arise. Because the European pipeline infrastructure for natural gas is still partly focused on imports from Russia.

The actual extent and timing of potential bottlenecks is difficult to predict, as higher prices also reduce demand, and consumption also depends on winter weather conditions.

There may be physical shortages and the market may collapse in individual countries, or governments may intervene with quantity regulation.

Hungary, Slovakia and the Czech Republic are most at risk, while most EU countries are unlikely to experience physical gas shortages.

Overall, a total shutdown of natural gas from Russia would deal an unprecedented blow to Europe's gas infrastructure. While storage will give households, firms, and governments some time to adjust, there is high uncertainty about potential infrastructure bottlenecks, the extent of policy responses, and the impact of prices.