In the first six months of the year, the euro has fallen nearly 11.37% against the United States dollar, at one point getting to parity with the dollar for the first time since 2002. The euro’s precipitous fall is grounded in several macro factors, but the most important is the widespread fear that Europe is on the verge of a massive energy crunch. Those fears are unlikely to go away for the rest of the year. 

Source: Google Finance

Europe’s Deepening Energy Crisis

When Ursula von der Leyden announced the European Union’s sanctions on Russia in response to Russia’s invasion of Ukraine, she said, “These sanctions are designed to take a heavy toll on the Kremlin’s interests and ability to finance the war.” Over time, the logic of sanctions took hold. Russia was kicked out of the SWIFT system, and the European Union declared that it would seek ways to shift from its reliance on Russian energy. Von der Leyden explained that the EU was “too dependent on Russian fossil fuels and, in particular, gas.” The EU set an ambitious target of being completely free of Russian energy by 2027. That, however, was eventually sharpened. The EU then said it would ban 90% of Russian oil by the end of the year. 

The game, however, has two players. Russian president, Vladimir Putin, has responded by progressively reducing exports of Russian gas to about a dozen EU states while shifting exports to India, China, and other friendly countries. Russia’s tactics have particularly hit Germany. According to Statista, Germany, Europe’s largest economy, gets 49% of its gas from Russia, Italy gets 36% of its gas from Russia, and France, which has a robust nuclear power program, gets just 15% of its gas from Russia. The energy crisis isn’t about the whole of Europe because, for example, Spain imports a very small amount of energy from Russia. It’s about Germany and other countries that are heavily dependent on Russia. 

Germany’s situation has weakened so much that the country is one stage away from gas rationing. If Germany is to escape gas rationing, it has to avoid gas rationing this winter, it has to cut gas consumption by 20%. The German gas regulator said, “The situation is tense, and a further worsening of the situation cannot be ruled out.” Since Russia restored gas supplies after repairs to the crucial Nord Stream 1 pipeline, which supplies 58% of Germany’s gas needs at its height, gas flows have been left at just 20% of maximum capacity. According to the EU, gas storage has to get to 90% before gas imports from Russia can be banned. Gas supplies in Germany remain below that threshold, at just 77.79%, with the crucial Rehden facility at 57.23%. 

As gas supplies to Europe weaken, the benchmark European TTF gas price has risen over 200% since the crisis began on February 24. 

Europe faces a winter where gas supplies will be stretched to their limit, with the possibility of blackouts in Germany, and industry shutdowns, which would lead to a recession in Europe’s largest economy, which of course, would affect Germany’s trade partners.

No Good Options

Germany has responded to this by trying to find new supply sources, and the country has even reverted to coal to keep its economy going. Unfortunately, the European Union seems to have underestimated the difficulties of finding new supplies. 

When in late July, the European Union agreed to reduce gas demand by 15% between August 2022 and March 2023, they warned that these measures, though voluntary, could be enforced. Although small steps have been taken to reduce demand, the obstacles are very high. Germany, for instance, has a very energy-dependent industry. Reducing demand from households is only part of the problem. Businesses cannot reduce demand without reducing output and, therefore, Germany’s economic activity.

Furthermore, suppose there is any gas rationing. In that case, German law prioritizes households over businesses, and many businesses have already indicated that they could be forced to shut down entirely if there is any gas rationing. Although the government has said it will support companies affected by the energy crisis, fiscal support would weaken the euro further. 

A gas crisis in Germany will cripple the European Union. Uniper, for instance, is the country’s largest gas supplier, but the company is a subsidiary of the Finnish parastatal, Fortum. The region lacks a gas-sharing agreement, with countries having bilateral agreements. Those most energy-secure countries, France, Spain, Belgium, and the Netherlands, are not part of any of these agreements. 

The impact of the energy crisis will drag down the euro’s value over the next few months. Getting a new supply is not as easy as the European Union imagined. Gas suppliers would be self-harming if they ramped up supply because this would reduce prices when fossil fuel producers are experiencing record profits. As Europe struggles to resolve its gas crisis, the euro will likely hit parity again and perhaps even dip below that.