Unpredictable energy crisis hangs over the economic outlook

We have reached a crucial point in the economic war between Russia and the West, triggered by the Ukraine invasion. The row between Vladimir Putin and European Union countries over how gas supplies will be paid for has led to nervousness about an interruption of supply, with Germany and Austria – among the most exposed – triggering emergency planning mechanisms.

What exactly is going on here is not clear. The EU is puzzled by what Putin is trying to achieve. It may be mainly about trying to keep gas prices high to fill Russia’s coffers and avoiding the widening of sanctions on the Russian financial sector.

But nerves are jangling in EU capitals on this. It had seemed a way forward to keep gas flowing had been found in midweek. But subsequently doubts emerged over this and about how the West could comply with the latest demands. Letters were sent from Gazprom – the Russian state gas company – to customers on Friday, outlining the new payment demands, but this may take some time to play out.

Cutting off Russian gas would cost cash-starved Russia, particularly as oil revenues are already hit. Bloomberg estimated it will, on current supply volumes, earn more than €300 billion from energy exports this year. But logic – or at least longer-term consideration – does not appear to be guiding much of Putin’s actions. And he knows the economic and political damage he would create – particularly in Germany, Austria and the Eastern European countries most reliant on Russian gas, if he turns off the taps. In the meantime the speculation keeps prices high and adds to the Kremlin’s coffers.

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Cliff Taylor: Energy security now central to economic planning

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Ireland’s exposure to energy price rises is already clear. The latest EU inflation figures – which differ only marginally from our own consumer price index – show inflation here just under 7 per cent in March. And the round of energy price increases mean it is heading higher in the months ahead. The most obvious danger to the economic outlook is prices rising further and staying higher, for longer than current forecasts assume.

VAT cut

This makes further moves by the Government to try to soften the blow inevitable. A VAT cut, once clearance is given from the EU, is likely to be part of this. As it is, the exchequer is getting a short-term windfall from higher VAT receipts and any reduction in VAT on fuel – probably from 13.5 per cent to 9 per cent – would roughly give this back to consumers. Sooner-rather-than-later measures to help poorer households deal with the price shock will also be needed.

In the short term the exchequer has resources to pay for this. But looking out to next year, there are rising concerns in Government. A cool-headed approach is needed, but this will not be easy with inflation soaring and the Opposition – led by Sinn Féin – calling for more and more to be done. They will gain from this cost-of-living crisis just as they have done from the cost of the housing one.

Meanwhile, the supply situation from Russia, responsible for about a third of the EU’s gas, remains unpredictable. Countries supplied directly by Russia for the bulk of their gas would be immediately exposed in the event of the taps being switched off.

Ireland would be hit through the resulting higher prices on the wholesale market. What would happen to supply here is unclear. The Government seems confident of the short-term outlook, at least, but if the issue persisted there would be concerns heading into next winter. Ireland is not directly exposed to Russian gas – we get close to 30 per cent of our supply from the Corrib field and the rest from the UK. In turn the UK gets just 4 per cent of its supply from Russia, with the bulk coming from the North Sea and Norway.

With the UK having left the EU, there is some fuzziness over how EU measures to share out supply in times of shortage would affect Ireland. Some Norwegian gas now going to the UK might be diverted to make up for shortfalls in countries such as Germany. But it appears that some Norwegian fields are directly connected in to the UK network – and so supply from these might not easily be redirected. And tehnically piping more Norwegian gas to the EU could be difficult, given constraints on the current infrastrucure.

Protocols

There are some protocols between Ireland and the UK on dealing with shortages, intended to lead to an equitable share-out – and a mention of this in the Brexit agreement. But how these would work is not clear. These protocols were designed for short-term problems, not a long-term supply shock.

Ireland is protected to some extent by not having a direct link to Russia, but exposed by a reliance on the UK and a lack of storage capability. Any interruption to supply would hugely increase the economic damage from the war. Industry would be the first to face rationing – and a Department of Enterprise survey shows the output from the sector of €380 million a day.

So any need to halt production would rack up serious economic damage very quickly, to an extent much greater than the cost of higher energy bills to businesses. Though if prices did sky-rocket, then some production could become uneconomic and closures or cutting back production could not be ruled out.

The longer-term response to this is obvious – accelerate the move to renewables and away from fossil fuels. And the importance of energy security to economic competitiveness is clear. But that doesn’t solve the immediate problem. We can expect a range of measures from Government to try to cut demand and an acceptance – while it will not be stated – that higher prices will do some of the work here.

In terms of the economic impact of the war, we are entering a crucial few weeks. Whatever Putin does in the next week or two in the rouble row, what is the viability – politically – of keeping buying Russian energy as the price of the war on Ukraine and its people keeps on climbing?