Breakingviews: Russia is giving German industry a slow puncture

LONDON, July 27 (Reuters Breakingviews) - Germany’s industrial sector has a problem. Russia’s latest threat to curtail gas supplies via its Nord Stream 1 pipeline means big hitters like $40 billion BASF (BASFn.DE) are frantically examining how to limit energy use. The chemical giant’s results on Wednesday show flexibility, but Berlin may dislike the longer-term implications.

In 2020, energy costs for BASF and fellow German groups $9 billion Evonik (EVKn.DE), $7 billion Wacker Chemie (WCHG.DE) and $6 billion Covestro (1COV.DE) were on average 5% of their costs of goods sold, according to UBS. This year, they’ll be over 40%. Had Nord Stream 1 flows stayed at 40% of normal output, German industry might only have had to cut its 2022 gas demand by 20% year-on-year, UBS says. Vladimir Putin’s decision to cut Nord Stream 1 flows to 20% creates a bigger problem. If Russian imports go to zero, German industrial gas usage at places like BASF’s giant Ludwigshafen plant may need to halve.

BASF has options. Boss Martin Brudermüller reckons Ludwigshafen could keep running even if he does halve last year’s 48 terawatt-hours of European gas needs, albeit in a reduced capacity. The company may be able to pass on some higher costs to customers, and its 73% stake in oil producer Wintershall Dea should be a lucrative hedge. Lastly, it can replace ammonia and syngas production in Germany with products made outside of Europe, using cheaper gas.

Still, if Russian gas disappeared, it could knock 1.5 billion euros off the group’s estimated 7 billion euros of operating profit this year, Berenberg reckons. The spillover effects, as a weaker European economy leads to lower demand for chemicals, could double the hit to 3 billion euros, according to one analyst. That would be in line with the 40% fall in BASF’s share price since February. The fact Wintershall has operations in Russia means its riches can’t be relied on.

Given it just earmarked 15 billion euros to bail out stricken gas importer Uniper (UN01.DE), the German government may see the chemical sector’s profitability as a lower priority. But less ammonia will mean less fertiliser for farming and inputs for food industries. And the cost of buying expensive liquefied natural gas to replace Putin’s flows means energy costs will stay high.

Longer term, the pride of German industry may want to shift production to somewhere with cheaper energy. That’s logical for BASF, which sells three-fifths of its wares to non-European clients. For Germany, where the industrial sector is a quarter of its $4 trillion GDP and drives exports, it’s a problem.

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CONTEXT NEWS

Germany’s BASF, the world’s largest chemical company, is cutting ammonia production further due to high natural gas prices, it said on July 27. The group said it would purchase some ammonia from external suppliers to fill gaps but warned farmers would face soaring fertiliser costs next year.

BASF’s natural gas demand in Europe in 2021 was around 48 terawatt-hours, of which its core Ludwigshafen plant alone accounted for 37 TWh. It said that the latter could continue to function with a reduced load so long as its natural gas supply does not fall below around 50% of the group’s maximum natural gas demand.

BASF said it expected operating profit of 6.8 billion euros to 7.2 billion euros in 2022, but that “risks could arise from production stoppages at major European sites as a result of further restrictions to European gas supplies from Russia”.

As of 0830 GMT, BASF shares were trading down 0.9% at 42 euros.

European Union member states agreed on July 26 to reduce their gas demand between 1 August 2022 and 31 March 2023 by 15% compared to their average consumption in that period in the past five years.

The target will be voluntary, and EU states will be able to hit it via measures of their own choice.

Russian energy giant Gazprom, citing instructions from an industry watchdog, said on July 25 that gas flows to Germany through the Nord Stream 1 pipeline would fall to 33 million cubic metres per day from Wednesday. That is half of the current flows, which are already only 40% of normal capacity.

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