Analysis: Can Germany free itself from Russian gas?

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Analysis: Can Germany free itself from Russian gas?

Germany is one of the largest trading nations in the world. In 2019, it imported $1.2 trillion worth of goods from across the globe. Only about 2% of that total came from Russia. In fact, the Russian Federation, with around 144 million people, was only slightly more important in German trade than Ireland, with around 5 million people. Normally, then, you wouldn’t expect a break in economic relations with Russia to have a big effect on the German economy.

Unfortunately, Russia is a major supplier of a good that Germany will struggle to replace: natural gas. Almost all of Germany’s natural gas consumption is imported through pipelines, and about 55% of it comes from Russia.

They should never have let this situation happen. Successive US administrations since Ronald Reagan have warned Germany not to become too dependent on a despotic regime.

(I witnessed some of these discussions during my brief tenure 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 noticeably off the list.

However, Russian atrocities — and, to be honest, the surprising incompetence of the Russian military as the long-awaited “blitzkrieg” enters its twentieth day of apparent stalemate — are rapidly changing the political calculus of the West’s response. Three weeks ago, it seemed inconceivable that German politicians would be willing to inflict any significant affliction on their constituents in response to Vladimir Putin’s aggression. There are now serious discussions about whether and to what extent Germany can free itself from Russian gas.

A small reduction in gas consumption should not be difficult to achieve. Precisely because gas has been cheap, some of it is currently being flared in low-priority ways, easily discouraged with moderately higher prices and/or lax regulation. Large reductions, however, are another matter.

Put it this way: a major new study by a group of German economists (there are nine authors, so I’ll refer to them as Bachmann et al.) estimates that eliminating gas imports from Russia would require a cut in gas consumption of approximately 30 %, from about 900 terawatt hours (TWh) to about 600 TWh. Why not 55%, the Russian share of German gas? Because Germany can probably get a little more gas from other sources and limit the use of gas for electricity generation, relying more on coal and nuclear power. (Yes, coal must be phased out to save us from climate catastrophe — but not in the midst of a war. It is St. Augustine’s principle: “Make me chaste, but not yet.”)

Even a 30% drop in consumption, however, will be difficult to achieve in the short term. Cutting consumption from 900 to 800 TWh might not be that expensive; the reduction from, say, 700 to 600 TWh would be much more painful.

German economists focus on a key economic concept called elasticity of substitution – roughly speaking, how much demand for natural gas declines for every 1% increase in its price. If this elasticity is low, then the amount that Germans would be willing to pay for a little more gas when consumption has already been substantially reduced is large, which implies that the economic cost of further reductions is also large.

Unfortunately, empirical estimates suggest that the elasticity of substitution for natural gas is small, at least in the short term. It’s not zero: due to high gas prices, households turn down thermostats, consumers 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 about 0.18, which in turn means (if I’m doing the math right) that the price of natural gas would have to go up by about 600% to reduce demand. by 30%.

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

However, even with these pessimistic assumptions, they conclude that Germany could indeed dispense with Russian natural gas, precisely because the country now spends so little on Russian imports. The costs would be severe: German real income could fall by around 2%, the equivalent of a mild recession. But it wouldn’t be the end of the world.

Such drastic action would have been inconceivable a month ago. But Putin appears to be in the process of accomplishing a remarkable thing: reminding the world’s democracies what they stand for. It has already ruined Russia’s reputation as a military superpower; now he is also in the process of reducing whatever economic power she had.

Translated by Luiz Roberto M. Gonçalves

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