Are the lights about to go out across Europe?

Today’s snap decision by German Chancellor Olaf Scholz to halt Nord Stream 2 — the new pipeline intended to export vast amounts of Russian gas into the EU — will make precisely no difference to European energy security, at least in the short to medium term. It could force a rethink of Berlin’s longer-term energy strategy, but the bigger question facing energy markets is whether Russia will curtail existing gas flows into Europe.

Scholz on Tuesday instructed Germany’s Federal Ministry for Economic Affairs and Climate Action not to allow the Baltic Sea pipeline to start pumping gas 'for now'. Halting the certification process puts the project on hold but doesn’t cancel it altogether, leaving the door ajar to future certification. This might give Berlin some leverage in any future talks with Russia, but that will be for another day; events are moving fast on the ground in eastern Ukraine, where Russian troops are reportedly closing in on the Donbas region after the Kremlin recognised the 'independence' of Ukraine’s Donetsk and Luhansk breakaway territories.

Shelving Nord Stream 2 is politically significant for Scholz, who only this month declined to cancel it when pressed during a joint meeting with Joe Biden. The US President pledged to 'bring an end' to the project, but Scholz became coy, saying only that Germany is 'ready with the necessary sanctions if there is a military aggression against Ukraine'. That time has come and the European Commission is reportedly preparing retaliatory sanctions against Moscow.

The fate of Nord Stream 2 is, for now at least, irrelevant. Energy markets had already priced in the non-availability of the extra Russian gas after Germany delayed the project in November. That delay is now indeterminate, drawing a line under the endless handwringing over the project.

The irony is that European capitals have been tearing themselves apart over Nord Stream 2 for years — all the while keeping the lights on using Russian gas flowing through Nord Stream 1. The first pipeline,  which follows an almost identical route to the now-shelved expansion, is running at almost full capacity to fulfil Gazprom’s contracts with its European customers. So the argument that Germany should halt Nord Stream 2 to avoid relying on Russian gas is moot; the country, and its prized manufacturing sector, cannot function today without it.

The big question facing Germany is whether Moscow’s bellicose escalation will lead to a disruption in gas flows along Russia’s existing gas export pipeline routes rather than future ones. Gazprom roiled EU wholesale energy markets by declining to send extra ‘top-up’ supplies last autumn, causing prices to skyrocket and gyrate wildly. Gazprom is not obliged to send extra gas, but EU gas markets have grown accustomed to receiving it when prices rise.

This is highly unusual behaviour when there are obscene profits to be made from capitalising on red-hot markets. As a result, gas futures contracts are still trading on EU hubs at wildly inflated prices.

Record-high gas prices prompted an almighty tug-of-war between Europe and Asia for spare cargoes of liquefied natural gas (LNG), which are delivered to the highest bidder. Asia always wins this battle and gets first dibs on spot LNG — bought at the current market rate — until its storage capacity is full. Only when European gas hub prices rise above the Asian LNG spot price do tankers switch course and head for the UK and European terminals.

That switch happened briefly in December 2021 and an armada of LNG cargoes arrived at European ports a few weeks later. EU terminals are now unloading and regasifying LNG at a record pace, meaning there is not much spare capacity to accommodate more LNG if it is needed. Moreover, Germany doesn’t even have any LNG import terminals of its own and must pipe the gas in from other European ports.

This is what makes Russian gas flows along the Nord Stream 1 pipeline so critical: if these are cut off, infrastructure constraints mean shipped in gas cannot fill the gap. There is also not much spare LNG floating around the global market, and EU efforts to cajole international allies to send more volumes have not been all that successful.

Besides, LNG tankers take several weeks to complete their trans-oceanic voyages — so if Russia turns off the gas taps, the lights could literally go out across much of Germany and eastern and southern Europe. The ensuing price spikes in EU energy markets would make December’s record volatility look positively tame by comparison.

All of this is taking place as Germany progressively cuts off its own access to other forms of energy, such as nuclear. The country closed three reactors at the end of 2021 and will shut down its last atomic power plants this year. The new government in Berlin also wants to accelerate the closure of Germany’s coal-fired power stations to 2030, which many observers see as impossibly ambitious.

With nuclear and coal on their way out and big question marks now hanging over the reliability of Russian gas, Germany is facing serious problems when it comes to balancing the grid and keeping homes warm. Kicking Nord Stream 2 into the long grass only makes those questions more pressing.

The EU climate agenda envisages a rapid fall in Europ gas consumption, be it from Russia or anywhere else. But renewable alternatives will take time to scale up. Quite what happens in the interim will have a huge bearing on European industrial competitiveness, jobs, inflation and the ballooning cost of living for many millions of hard-pressed consumers.