Advertisement

Putin kickstarts de-industrialisation of Europe's factories

Putin
Putin

In Germany’s western industrial heartlands is BASF’s main Ludwigshafen facility, a sprawling complex that guzzles roughly as much gas as the whole of Switzerland.

Like many manufacturing giants, the chemicals maker has found that Vladimir Putin's war in Ukraine and the new normal of high gas prices is challenging the business model the country’s industrial hubs were built on.

“These challenging framework conditions in Europe endanger the international competitiveness of European producers,” its boss Martin Brudermueller admitted in October as it unveiled permanent cost-cutting measures.

As the war drags into the winter, Europe is facing up to a future without any Russian gas. That is a problem for industrial companies who have relied on plentiful supplies of cheap gas delivered through pipelines from Russia.

Experts warn that the likes of Germany and Italy will lose out to factories elsewhere as their competitiveness is hurt, not least by the US. The business model that has been the backbone of Europe’s industrial heartlands may have been broken by the Kremlin.

Carsten Brzeski, chief economist at ING Germany, says there is a “competitiveness issue” that could drive a de-industrialisation in Europe.

“It’s not going to happen overnight but it’s clear the trend is there,” he says.

“We assume energy prices remain high for at least the next year and actually also going into 2024. Then we have the entire energy transition going on, which I think in the first stage will also come at higher energy prices and only once there is the shift made towards more renewables, energy prices will drop again.”

But some are optimistic that substitutes and a massive efficiency drive can offer hope after a tough transition. In addition, companies are trying to shorten supply chains and move production away from regimes that risk being caught up in geopolitical tensions, though Brzeski says this is likely to be more than offset by the de-industralisation trend.

Holger Schmieding, chief economist at Berenberg, says: “For the longer term outlook, three-five years plus, Europe is now forced to become a world leader in energy efficiency and will, in a few years, be selling top notch technology to the world on energy efficiency.”

He adds that, given the climate push, “this could actually turn into a blessing in disguise”.

If de-industralisation does take hold in Europe, Germany and Italy would pose the biggest drags on the region. German factories made up 27pc of EU industrial production in 2021 while Italian firms accounted for 16pc, followed by France on 11pc.

A survey by Germany’s Ifo Institute in October suggests that the chemicals and metals industries were among the most likely to say that they have to cut back on production if they needed to save on gas costs over the next six months.

The clothing, data processing and paper sectors were most likely to say they could save on gas without reducing output, hinting at the sectors most and least vulnerable in any shift.

Claus Vistesen, eurozone economist at Pantheon Macro, says: “In a way, European industry is looking in a slightly better position than we might have feared when we looked at the very, very severe disruptions earlier this year when gas prices spiked.

“So far European industry has been quite good at adapting and I think that’s good news as far as the initial judgement of those long-term challenges.”

He adds that the companies that are most reliant on gas could become “non-viable” but cautions that they are “a fairly small part of European industry”.

Nonetheless, Goldman Sachs warns that the “sizeable” permanent hit to European industrial production will be between 2pc to 3pc.

Its economist Alexandre Stott says: “While lower gas supply implies a significant hit to potential output, economic models also suggest that an economy can lower this cost by substituting away from gas as an input into production. Moreover, academic studies suggest that the ability to substitute from an energy source tends to increase over time.”

The blow “can halve once one allows for substitution away from gas towards other energy sources”, she adds.

It is not just industrial powerhouses on the Continent that are exposed. The UK is one of the most services-oriented major economies in Europe but experts believe it is still vulnerable.

Persistently higher energy prices would cause a permanent impact on the economy’s potential output by reducing the amount firms find it profitable to produce, according to the Office for Budget Responsibility.

Despite oil and gas becoming less important to the UK economy, it warned in July that in the medium term it is difficult to speed up the building of new infrastructure to reduce the reliance on fossil fuels, such as renewable or nuclear energy.

It estimates that a 10pc increase in oil and gas prices cuts potential output by 0.13pc in the first year and 0.18pc after five years.

What’s clear is that any de-industrialisation would come at an economic cost for the likes of Germany. Already subdued trend growth – the long-run average rate of expansion – could be damaged by a shift of resources from the higher productivity industrial sectors.

Goldman says even with substitution away from gas the industrial sector in Europe is likely to shrink permanently, potentially weighing on growth rates.

“You could argue a positive scenario if this is then the driver to get a more services-orientated economy, to have more automation, more high quality production, more research and development back in Europe,” says Brzeski.

“The most pessimistic scenario would be a just continuing downward trend, in which Europe continues losing potential growth because high productivity growth sectors [and] companies are moving out of Europe.”

He says the US stands to gain the most given its lower energy prices and the recent introduction of the Inflation Reduction Act.

The package includes $369bn of subsidies for “Made in America” investments that hope to boost the US electric car industry among other green technologies, help that has angered leaders in Europe.

Both friends and foe are piling pressure on Europe’s industrial sector as a tough winter takes hold.