Europe’s energy crunch threatens to nix nascent economic revival

Summary: 

• Factories pause operations as power prices hit record highs
• Draghi calls for urgent action to help business and households

European economies are facing a potentially crippling setback to their nascent recoveries if the worsening energy crunch forces many more factories to halt or curb operations.

Power and gas prices have hit record highs across the continent as unscheduled nuclear shutdowns in France, reduced supplies of Russian natural gas and winter demand push producers to their limits.

The situation risks stoking stagflationary forces as consumer-price growth -- already the quickest in three decades in Germany and Spain -- is pulled higher and economic expansion is curbed.

With the omicron variant of the coronavirus already looming over the continent's economic revival, analysts and politicians like Italian Prime Minister Mario Draghi say governments must act beyond the money they've set aside to shield consumers from surging costs.

"Higher gas prices, both for households and for businesses, are going to be headwinds to activity," Sarah Hewin, Standard Chartered Bank's head of Europe and Americas research, told Bloomberg TV. "If profits and wages are just not keeping pace, then ultimately real spending power is squeezed and the capability for businesses to invest is damaged."

The jump in costs has already prompted some plants to cut or stop output. Increases in domestic heating and electricity bills, meanwhile, will squeeze shoppers. Low-income households are most at risk.

The crunch may shave as much as 0.3% off euro-area gross domestic product in the first quarter of 2022, though some of that will be offset by government action and a recent drop in fuel prices at the pump, according to Berenberg Bank's chief economist, Holger Schmieding.

In a worst-case-scenario, the impact on economic growth would be far more severe if energy shortages force widespread production-line closures -- an improbable outcome whose overall effect would be "not unlike a lockdown," he said.

Kathryn Porter, an independent energy consultant at Watt-Logic, said that with European gas storage at their lowest level for years this early in the winter, an unscheduled power plant outage in the UK or Germany may be all it takes to force system operators to order factories "to curtail industrial production."

"The resilience of the market is getting very low," she said.

In France, Aluminium Dunkerque Industries has curbed production in the past two weeks because of high power prices, while Trafigura's Nyrstar will pause production at its French zinc smelter in the first week of January.

Eastern Europe is faring no better. Romanian fertilizer producer Azomures has temporarily halted output and Montenegro's Kombinat Aluminijuma AD Podgorica is shutting down production altogether.

There's likely to be more state action to ease the crisis, according to Dan Bucsa, UniCredit SpA's chief economist for central and eastern Europe. "It chimes with the larger footprint of the government in the economy -- especially in Hungary and Poland."

In the UK, steelmakers are pausing output at those times of day when prices spike and restarting when they drop back, according to industry group UK Steel.

"The most efficient way of operating is to run continuously," a spokeswoman said. "But it's got to the point where it's worth switching production off when prices are at their peak."

The squeeze on incomes will be significant, though the extent of the impact on consumption is an open question given the amount of savings amassed during lockdowns and expected government support.

Uneven Impact
Poorer households in the UK will be hit hardest by rising energy prices

The loss to euro-zone households' purchasing power will be about 170 billion euros ($192 billion) in 2022, Bantleon Bank AG economist Joerg Angele predicts.  

In the UK, utility bills are expected to jump by 56% when a regulated price cap is lifted in April, Investec analysts Nathan Piper, Sandra Horsfield and Martin Young said in a report to clients. 

Limiting that increase to 10% would cost the government about 9 billion pounds ($12 billion), according to Simon French, chief economist at Panmure Gordon. A cap on domestic bills would also bring down inflation, giving the Bank of England a little more breathing space to support flagging growth.

Other governments have already taken initial steps to protect the most vulnerable. 

In Spain, where wholesale energy costs feed quickly through to households, the government has announced 2 billion euros of tax breaks for the first four months of 2022. Its central bank last week cut growth forecasts substantially for this year and next, citing soaring energy costs as a factor.

Because faster inflation has yet to seep through to wages, workers and pensioners are still likely to spend less in the coming months, according to Jose Luis Calvo, a professor of mathematical economics at Madrid's UNED University.

Italy has spent more than 4 billion euros this year and allocated an extra 3.8 billion euros in its 2022 budget. Even so, Draghi says more may be needed.

"The increase in energy prices requires urgent action, we can't wait," he told a news conference Wednesday. "There are big producers and sellers of energy that are having fantastic profits. They will need to participate to support the economy, they too need to help families."

Disclaimer:This article first appeared on Bloomberg, and is published by special syndication arrangement.