How Will Gas Supply Reduce Affect Eurozone?

What is happening?

The Russian president's announcement that countries "unfriendly" to Moscow must pay for gas deliveries with rubles shows that he's willing to use energy as a weapon in the Ukraine war. It puts the West in a tight spot.

With his demand for payments in the Russian currency, Vladimir Putin has dealt a surprise blow to Western countries still using large volumes of Russian gas for their energy needs.

The Russian president stated the measure would apply to 48 countries deemed "hostile" and include the United States, the UK, and all members of the European Union.

Combined with an extremely growing inflation in Europe, this fact might press the euro to the lowest numbers since 2015.

What are the outcomes?

Europe is the number one continent depending on the Russian gas supply. Data from the European Union Agency for the Cooperation of Energy Regulators shows which countries' energy supply would be most in jeopardy in the case of a Russian gas freeze. 

Among the continent's major economies Germany imports around half of its gas from Russia, while France only obtains a quarter of its overall supply. Italy would also be one of the most impacted major economies at a 46% reliance.

Some smaller countries in Europe rely exclusively on Russian gas, namely North Macedonia, Bosnia and Herzegovina, and Moldova. Dependence also exceeded 90% of the gas supply in Finland and Latvia.

As we can see, Russian holds the most significant part of the European gas market. That's why the European Union needs to find the right decision in this situation.

There are three possible outcomes: 

1. The Union accepts Vladimir's Putin offer and makes future gas payments in Russian rubles. In this case, the EUR will struggle due to falling demand. Moreover, payments for Russian gas purchases are usually so large that the amount of rubles needed cannot currently be secured on foreign exchange markets. Western buyers will most likely need to go via the Bank of Russia to make their payments, essentially undercutting sanctions against the Russian central bank.
2. The second option for the European Union is to ease sanctions against Russia and find a compromise about natural resources payments. In this case, the energy crisis in Europe might come to an end. However, it is hard to imagine the Union taking such a step in the conditions of the military conflict on the territory of Ukraine. 
3. The worst possible case in this situation is to decline the offer. In this case, the energy crisis might cost a lot for the European nation. Inflation, which reached its highest levels, will increase rapidly further. Moreover, some important factories might stop producing goods, and as a result, food deficits might occur. 

What about the US LNG?

US president Joe Biden called the European Union to refuse the Russian gas and replace it with US LNG (liquid natural gas). However, there are some issues with it. 

• The most important thing is the gas receiving terminals. They are completely different for natural gas and LNG. LNG terminals are less productive. Unfortunately, Europe was not very concerned about constructing new LNG terminals, but at the end of 2021, it scheduled some projects for 2027-2030.
• American companies will undoubtedly sell their LNG to Europe (and now in much larger volumes), but at a spot price. The spot market determines the cost of LNG. In the case of Gazprom (natural gas), Europe buys gas under long-term contracts, which at the end of 2021 were 3-4 times cheaper than local spot prices. For this reason, Europe refused to make new agreements in January 2022. Based on this, we might conclude that the United States is going to sell LNG to Europe at high prices. That's why, the American tankers turned around four times and changed direction either to Europe or Asia, as prices were rapidly changing within two weeks. However, if, at the same time, China, Japan, or Korea offer more for an LNG cube, then Europe may be left without energy.

Conclusion

Based on all of the above, unfortunately, Europe has little chance to avoid an energy crisis so far. Rising inflation adds oil to flames. It’s necessary to tighten the monetary policy and reduce the balance sheet in the future. Nowadays, people are going on strike with the topic of rising prices for raw materials, fuel, and fertilizers. However, Gazprom is 100% fulfilling all its obligations under the contracts. What will happen if Gazprom turns off the pipeline for at least a month? A shutdown of factories, unemployment, the introduction of food cards may happen. Alternatively, the European Central Bank will have to print money and increase inflation to 20%-40%.

Technical analysts

EURUSD, monthly chart

Why do we love technical analysis? Because at moments of total uncertainty, it may tell us the only right way.

 EURUSD is moving in the symmetrical triangle. At the moment, the price is consolidating above the lower border. The most important support level right now is 1.0800. If buyers manage to hold the pair above it, the price might reverse and increase to 1.1150 and even 1.1450.

On the other hand, a breakout of this support will signal a long bear market for EURUSD, and the pair will decline to 1.0500.

FBS Analyst Team