Economics Minister Habeck announced the gas early warning on March 30th. This stage is the first step of a three-stage contingency plan. While level 2, the alert level, allows the gas to be allocated via the market, in level 3, the emergency level, the gas is allocated by the Federal Network Agency. That could severely weaken the economy.
We will have to live with less gas from Russia. In fact, we are already doing this because gas prices have risen so massively. companies are shutting down production; they move production abroad, where energy is cheaper; they buy products from third countries that they would otherwise have bought from suppliers in Europe.
An end to the high prices is not in sight, on the contrary. Even if the federal government has ruled out a gas embargo, it can still happen. The international pressure on Germany to reduce payments to Russia, which are mainly for Russian energy, is enormous.
Putin’s announcement that he would only accept rubles made it clear once again that we Europeans are not the only ones in charge of the economic dispute with Russia. It is unclear whether this conflict over the method of payment will lead to a possible temporary suspension of gas deliveries. In any case, you have to plan with the possibility and take appropriate precautions.
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What an embargo or a further shortage of gas with the associated price increase means for the German economy depends largely on how the government deals with it. A much-noticed model by economists (with the participation of one of the authors of this article) comes to the conclusion that if the public sector acts optimally, an embargo can be expected to result in an economic slump of one to three percent.
Where does gas work best?
In particular, this model presupposes that the price mechanism works: Then the gas is used where it makes the greatest contribution. It is used in places where, firstly, as an energy source it is difficult to replace in production; second, where it is difficult to replace the products themselves with less gas-intensive alternatives; and thirdly, where it is difficult to buy products from non-European countries.
Everywhere else there are substitution possibilities – at least with a sufficiently long planning horizon. And there are still six months until it gets cold again and we heat more with gas and thus consume more than twice as much gas in winter as in the summer months.
Substitution, where possible, would take many forms. In some places, such as in the electricity market, gas is being replaced by other energy sources; some gas-intensive products, i.e. products whose production requires a lot of gas, are replaced by less gas-intensive ones; and trade flows are also adjusting. Some of these substitutions are already taking place, albeit tentatively.
Even in the USA, where there is no gas shortage, forward prices for steel are rising because additional European demand is already being expected. As painful as the adjustments involved in the substitution processes are for individual companies or even sectors, they are important for the economy as a whole in order to keep the costs of a gas shortage low.
This insight is also reflected in the corresponding model calculations. Indeed, in the same economic model, if gas is allocated in a way that fully favors households and the service sector, the same overall gas reduction causes significantly higher damages. Industrial production would collapse. At ten percent, the decline in GDP would then be more than three times the decline in the baseline scenario without rationing, and that with an unchanged reduction in gas consumption.
The same scarce gas would only be distributed differently without taking into account willingness to pay and without taking market signals into account.
A warning sign
Now, the model is not specifically designed to analyze rationing. But the scale of the economic slump is a warning sign – if the political response is wrong, the economic damage can be many times greater. And this consideration is not purely hypothetical – the emergency level of the “gas emergency plan” currently provides for such a form of rationing.
Even the expectation of rationing creates false incentives. Companies will lobby for a high allocation instead of reacting adequately now to the high prices and the risk of gas shortages by adjusting production and switching supply chains. This too can already be observed. Most recently, the food manufacturers and the chemical industry asked that they be given priority in the emergency plan. It would make more sense to use free market means to reduce consumption as a precaution and encourage industry to import energy-intensive products.
The government can and should therefore set the right course now to avoid running into planned economy rationing. The principle is clear – if you let the price mechanism work, the greatest savings are made where the benefit of gas is ultimately lowest. State-administered price cuts, such as those announced for petrol and diesel, should be avoided. To protect households from being overburdened by high prices, the government can pay subsidies based on past gas consumption.
For example, one could already encourage additional savings in a distribution-neutral manner by pushing ahead with the plans discussed in Brussels and Berlin for a punitive tariff on Russian gas, which should be designed in such a way that the utility companies can pass it on to consumers, but with a tariff-financed credit based on consumption in the previous year – at a comparable level per kWh. Those who manage to save on Russian gas are better off than those who can’t, but they aren’t additionally burdened either.
The price mechanism must work
Such a procedure, communicated with savings tips to households, would largely absorb the undesirable distribution effects of high gas prices without undermining their desired incentive effects. Such a measure, already prepared today, also serves as a signal not to resort to rationing, even if gas prices are still higher. In a similar way, a gas tax and transfer mechanism that is detached from an EU tariff discussion could be designed to encourage gas savings in good time.
The gas emergency plan for the Federal Republic of Germany emphasizes: “Securing the supply of certain customers, such as household customers and customers who provide basic social services, is very important.”
The economic disadvantages of a gas shortage can be serious. However, they will be significantly higher if it is not possible to guarantee this security and at the same time allow the price mechanism in the gas market to take effect.
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