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August 10th, 2022
Courtesy of STRATFOR (subscription required), a look at the impact that Europe’s drought is having upon Europe’s economic and energy crises:
A severe drought is magnifying Europe’s economic risks by disrupting crop yields, energy production and trade flows at a time when the Continent is already facing soaring food and fuel prices, along with a possible energy crunch this winter. Several regions in Europe are facing severe droughts this summer, caused by the combination of a lack of precipitation and high temperatures since May. The European Commission estimated in July that nearly half of the European Union and large parts of the United Kingdom were experiencing ”warning” levels of drought, with unusually dry conditions set to persist through September across most of Europe. Water shortages are particularly severe in the northern Italian lowlands, central Germany, eastern Hungary and northern Spain, as well as the southern, central and western regions of France, Portugal and the Netherlands. Scarce rain is affecting river discharge and depleting stored water volumes, impacting the energy sector for both hydropower generation and cooling systems of power plants. Low water supplies and high heat are also reducing crop yields, while dangerously low levels in river channels are hurting trade flows by forcing cargo vessels to sail with reduced loads.
- Spain’s water reservoir levels are currently 31% lower than the 10-year average. In Portugal, water levels in reservoirs are at half the previous seven-year average. In Italy, water levels in many reservoirs have been below the minimum historical values since September 2021. In France, where the drought has prompted widespread limits on freshwater use, rainfall was 84% down seen in July on the 20-year average.
- Water levels in Italy’s Po River are at a record low. The lack of rainfall has also thrown off the salt-to-fresh water ratio at the river’s delta (which feeds into the Adriatic Sea near Venice), resulting in abnormally high salinity levels.
- Water levels in Germany’s Rhine River are dropping to dangerous levels for navigation as well. The reference waterline at Kaub — a key waypoint for the shipment of commodities — fell to a mere 49cm (19 inches) on Aug. 7. Below 40cm (16 inches), navigation is uneconomical.
- Water levels in the Danube River, which flows through several eastern and central European countries, have dropped sharply as well. Levels are now several meters lower than they were just a year ago, in August 2021.
The drought comes as Europe is grappling with rising inflation, a looming recession, and an energy crunch that will worsen in the winter. Europe’s economy is facing a combination of interconnected risks that is dissipating its post-COVID recovery and threatening to send the Continent into a recession as soon as this winter. Europe is currently grappling with its worst energy crisis in decades amid the fallout from the ongoing war in Ukraine, which has seen Russia reduce its natural gas supplies to European countries in retaliation against EU sanctions. Recent disruptions to natural gas flows via the Nord Stream 1 pipeline (which transports Russian gas under the Baltic Sea directly to Germany) have fueled fears that Russia could completely halt gas flows into Europe during the peak consumption season this winter. Such a cut-off in the winter — when Europeans use much more gas to heat buildings and homes — would cause inflation to soar even higher and would likely push several countries (including Germany, Italy and France) into economic recessions. This looming threat of additional gas supply disruptions and other Ukraine-related shocks is causing rising uncertainty and driving a surge in prices for goods and services. The record drought in Europe is now only adding to these inflationary pressures and the overall sense of unease, which will further weigh on economic growth, depress business activity and complicate plans to hedge against increased risks over the months ahead.
- In July, the European Commission downgraded its GDP growth outlook for the euro area from its last forecast released in May. The commission now expects the eurozone’s economy to expand by 2.6% in 2022 (down from its previous 2.7% forecast) before slowing further to just 1.4% in 2023 (down from its previous 2.3% forecast).
- In late July, the European Central Bank (ECB) raised its main interest rate by 50 basis points in response to rising inflation in the eurozone, which reached a record high of 8.9% last month. The ECB also hinted at more hikes in September and beyond, which will further dampen economic activity.
- The impact of the Ukraine crisis and associated EU sanctions has been felt most acutely in central and eastern European countries due to their economic ties with Moscow and greater reliance on Russian energy exports. Inflation in central and eastern Europe is the highest of any region on the Continent (at 15.4% in June), and could significantly worsen if Russia moves to fully cut off natural gas supplies.
- Outside of the European Union, the United Kingdom’s economy is also sliding into recession, according to the latest forecast from the Bank of England (BoE), which is accelerating monetary tightening to fight record-high inflation as well. According to the BoE, the U.K. economy is set to enter negative territory in the last quarter of 2022 and to contract by 2.1% through 2023. Inflation in the United Kingdom hit a 40-year high of 9.4% in June and is expected to rise beyond 13% in October.
The drought and extreme heat’s impact on crop yields in Europe risks further driving up food prices on the Continent and worsening global food shortages. The combination of record-high temperatures and record-low rainfall this summer is already taking a toll on several European countries’ agricultural sectors. In France, irrigation has been banned in large areas of the northwest and southeast due to water shortages. French farmers are also struggling to feed their livestock due to arid grasslands. In Italy, the decreasing quantity and quality of water from the Po River is threatening crop yields in the surrounding Po River Valley — the crucial agricultural zone that produces roughly 30% of the country’s food (including wheat, tomatoes and grapes). In Spain, where water reservoirs are at just above 40% capacity, olive oil output is expected to be a third lower than last year. Against this backdrop, the European Commission expects all summer crop yields will be ”substantially reduced” across the European Union in 2022 due to hot and dry weather. Poor harvests in Europe, which is home to some of the world’s largest wheat exporters, could further strain global grain supplies and increase already inflated food prices — adding to the disruptions brought on by the crisis in Ukraine, which is also a major exporter of wheat, corn and sunflower products. Reduced agricultural output in Europe may be felt most acutely in the Mediterranean region and nearby Middle Eastern countries, which are among the largest consumers of European wheat.
- In Italy, large agricultural producers along the Po River are struggling to keep their crops from drying out amid water shortages; smaller producers near the river’s delta are also struggling to keep their crops alive due to the water’s increasing salinity. Italian farmers’ association Coldiretti estimates that Italy’s production of wheat will decline by 15% this year due to an increase in production costs and the drought.
- France’s farm ministry forecasts the country’s 2022 soft wheat production will be down 7.2% this year compared with last year’s crop.
- In July, the European Commission said that EU yields of soybean, sunflowers and corn were between 8-9% below the five-year average, with cereal yields down about 2% overall.
The increasing temperature and scarcity of water in Europe’s rivers are reducing hydroelectric and thermoelectric power production, adding to the Continent’s energy woes. Higher water temperatures are making it more difficult for power plants that rely on rivers for cooling to operate. The European Commission revealed that output from run-of-river plants until July was lower than the 2015-2021 average for countries including France, Italy, Spain, Portugal, Romania, Norway, Montenegro and Bulgaria. Norway, one of Europe’s top exporters of electricity, is set to limit power exports to western Europe to preserve its low hydropower reservoirs. In Switzerland, restrictions on using warm water to cool reactors have forced the Swiss energy giant Axpo to reduce output at its Beznau nuclear power plant due to the rising temperatures of the Aar River. In France, the government recently granted a temporary waiver allowing the French electric utility company EDF to cool five of its nuclear plants into rivers despite high water temperatures. But while the waiver will help ease pressure on France’s power sector, it won’t fix the infrastructural issues that are also impeding the country’s nuclear production, meaning France will still need to import electricity from neighboring countries.
- Reduced output from France’s nuclear sector is forcing Germany — which previously imported French electricity to power its own grid — to burn more gas for power generation instead of preserving the fuel in storage for winter.
In addition, dangerously low water levels in rivers are making it more difficult to transport fuel supplies across Europe. Low water levels in the Rhine River — a key shipping route for commodities including coal and oil products through Germany and into neighboring countries — are forcing fuel barges to reduce their loads into inland Europe, with alternatives such as rail and road already running at full capacity. Countries that use the Rhine to import oil-based fuel, particularly Germany and Switzerland, are thus facing difficulties in building heating oil stockpiles before winter and in receiving petrochemical feedstocks from the Amsterdam-Rotterdam-Antwerp hub. This is also impacting coal supplies at a time when industries across Europe are compensating for gas shortages by readopting coal.
- The German utility firm Uniper warned that two of its coal-fired stations along the Rhine may need to curb output during summer.
These drought-related disruptions to both power production and fuel distribution are sending energy prices further up in Europe and frustrating efforts to increase storage levels before winter, which could result in severe economic impacts in the medium term. The added pressure on Europe’s gas and electricity markets comes at a time when high demand for cooling amid this summer’s record-high temperatures is already eating into supplies needed for the winter and disrupting efforts to stockpile fuel in case Russia halts natural gas supplies. But beyond the more immediate impacts, these developments could offer a preview of things to come in the long run, when the continent may have to adapt to rising temperatures and insufficient precipitation due to climate change.
- Germany’s and France’s year-ahead electricity prices hit new record highs on Aug. 8, as several utilities across Europe warned of lower power supply due to weather conditions affecting nuclear and coal power generation.
- In 2018, the last time water levels in the Rhine got as low as they are now, the resulting trade disruptions are estimated to have reduced Germany’s GDP growth by 0.4% in the fourth quarter of that year. This time around, the impact on Germany’s economic output may be much worse, given that the country already appears headed to enter an economic recession in the third quarter of this year.