: Inside Germany’s industrial-sized effort to wean itself off Putin and Russian natural gas

From its beginnings in 1916, making ammonia for Germany’s war effort via chemical giant BASF BAS, -7.86% BASFY, -7.23%, the complex now houses over 100 companies and 15,000 employees producing 12 million tons of everything from liquid gases to bulk chemicals. But times have grown increasingly tough for the country’s fourth-biggest industry as it navigates Europe’s most serious conflict since World War II, which has sent prices of essential commodities on a roller-coaster ride.

Natural gas is used in the production of hydrogen, a vital step in most chemical processes, explains Christof Günther, the CEO of InfraLeuna, which owns and operates the infrastructure on the Leuna Chemical Complex for companies such as Linde LIN, +4.75%, TotalEnergies TTE, -1.56%, Arkema AKE, -0.54% and Eastman Chemical EMN, -0.08%. “So there’s basically no way to produce chemical products without natural gas,” Günther told MarketWatch in an interview at his office on the industrial site.

“If you think about the German industry, with automotive and electric vehicles, electric industry and machine building, and manufacturing … they all need chemical products to produce. Around 90% of the industry depends on input from the chemical industry,” Günther said.

And a key component for Leuna-based companies, he explained, is steam, which comes from power plants that are gas-fired. “We are able to import electricity, but we are not able to import steam.”

For decades, Germany has been hooked on cheap and plentiful Russian natural gas, which ultimately fueled the manufacturing base of its export-driven economy — Europe’s largest — and bolted the two countries together with a steel network of multibillion-dollar pipelines. While other European countries had a similar reliance, Germany’s dependence was on a whole other level; on the eve of Russia’s invasion of Ukraine, more than half the natural gas it consumed was coming from that country.

But Vladimir Putin’s decision to make war in Ukraine has fundamentally changed Russia’s relationship with the European economic powerhouse. Now, Germany is determined to wean itself off Russian energy, putting its biggest industries, which include the natural-gas-guzzling chemicals and pharmaceuticals sectors, on the frontline of an emerging battle that is reshaping the global economy. That’s as it builds new liquefied-natural-gas terminals and biorefineries, while brewers use mixed gas to produce beer, among other efforts.

But even before Russian troops crossed the Ukraine border last February, the industry had already faced a price shock when Germany suspended the Russia-to-Europe Nord Stream 2 gas pipeline in late 2021, sending European natural gas to €146 per megawatt hour, or MWh, based on the bloc’s leading gas benchmark, the Dutch Title Transfer Facility. The spike followed a decade of prices hovering around the €20 mark.

By August 2022, with Russia having all but cut off supplies to Europe, natural gas surged to a record €342 MWh (about $ 342 at the time). Günther said InfraLeuna was eventually forced to increase prices for natural gas and some gas-dependent utilities by up to 10 times compared with 2021. By December, InfraLeuna had cut its own natural-gas usage by 50% — a result of reduced demand for steam, natural gas and electricity from on-site companies whose own customers were cutting back.

“So, for example, the automotive market is very weak, and other markets like machine building are very weak in demand. And that’s why production is down — costs are high and demand is weak and that’s why the facilities are operated in many cases on the lowest possible levels,” said Günther.

An example of this: Europe’s new-car market struggled in 2022, with just 9.3 million new automobiles registered, the lowest level since 1993, as analysts maintain caution about the year ahead. 

As Günther explained, chemical companies must optimize the usage of facilities due to high investment costs, so production cutbacks come at a price. “They are still running, but they are running the facilities at bad profitability. I’m afraid most of them are not profitable at the moment,” he said.

The start of 2023 has ushered in some hope and relief for Europe, thanks to warmer weather and a drop in natural-gas prices to prepandemic levels, resulting in full storage tanks that appear to have removed immediate threats of blackouts and shortages. Also helping: that Germany’s government agreed to measures late last year to cap electricity and energy prices for businesses and households, which will extend into 2024, along with the rapid building of its own liquefied-natural-gas terminals. And natural-gas prices now hover at levels not seen since December 2021 — at around €57 MWh. 

But Europe’s energy worries are not past, according to some. The International Energy Agency has warned that the continent faces a potential natural-gas shortfall of nearly 30 billion cubic meters next winter, as China emerges from its pandemic cocoon to possibly suck up more of the global energy supply. And, should the war in Ukraine drags on another year, next winter might not be so mild. 

Hanging on

One of the bigger companies at the Leuna site facing down the energy crisis is polyamide-based plastics maker DOMO Chemicals. It has on-site plants making phenol, which, for example, is used in coatings and release agents, and acetone, which can be found in laboratories, cleaning agents and rubber production.

The company’s operations sprawl over several blocks, an array of almost sculptural-looking buildings, with large, shiny pipes ringed by staircases that climb skyward. DOMO’S plants, like others at the Leuna complex, run continuously, 24 hours a day, seven days a week.

The production of polyamides is “energy-intensive, even compared with other plastics,” Yves Bonte, DOMO’s CEO, told MarketWatch.

According to Bonte, the entire value chain — from suppliers to customers — has been directly or indirectly impacted by the energy crisis. As a result, customers have become more cautious, leading to a slowdown of demand in anticipation of future stabilization in energy prices, though Bonte stressed that DOMO plans to keep investing in its innovation pipeline to prepare for a pickup in the market.

“The primary focus of the industry is to make sure that we all get through the ongoing energy crisis,” Bonte said. “We are currently facing a European-wide crisis, where the cost of energy remains substantially higher than in the U.S. or other regions. If this is not put to a halt, Europe will lose its competitiveness against other regions.”

Germany’s Association of the Chemical Industry, a trade group known in German as Der Verband der Chemischen Industrie, or VCI, in December estimated that one out of every four of the country’s chemical companies was loss-making as a consequence of the war-driven energy crisis. And those at the heart of the economy — the Mittelstand, or midsize companies — have particularly felt the pain. They employ 60% of all workers in the country, and 1,900 chemical companies are included in that count, according to the trade group.

“We are the sector which is suffering more than other sectors because we are the sector with the highest natural-gas demand and the highest electricity demand,” Jörg Rothermel, an energy expert at VCI, told MarketWatch in an interview. 

But Rothermel said it’s not just the smaller companies that suffer as bigger ones can face even larger problems. “For example, gas-intensive production is the ammonia production, which is only done in bigger companies. The ammonia production is dependent on natural gas as raw material, as feedstock.”

A byproduct of ammonia production is carbon dioxide, and CO₂ is crucial for several different technical applications and can no longer be produced at “an economically appropriate rate” in Germany, he said. 

“It goes to the breweries, it goes to the water sector, it goes to several different technical sectors, and this carbon dioxide is no longer produced when the ammonia is not produced,” Rothermel said. “Ammonia is also the basis for urea, a key nitrogenous fertilizer, which is also used in cars to reduce emissions.”

German law requires diesel-fueled vehicles, mainly in the transport and logistics sectors, to use a liquid made of urea and deionized water, known as AdBlue, that reduces emissions. Several reports emerged last year of AdBlue supplies running low, presenting problems for Germany’s hauling industry, for example.

Like others, Rothermel is cautious about the future. “It looks like the risk of forced gas rationing has gone away this winter. But prices will need to stay lower for much longer for most companies to see a real difference. The situation with the broader economy and rising interest rates mean 2023 will be a difficult year for the chemical sector,” he told MarketWatch 

Rolling out an expensive barrel

All but hidden away in the 140-year-old viaducts under Berlin’s railway is the Brauerei Lemke Berlin, a craft brewery that got its start in 1999 when founder Oli Lemke returned from travel and work abroad with a desire to introduce diverse beer styles to his home country.

His brewpub in the capital city’s popular Mitte district grew over the years to a business that now employs 110 people. It includes the railway brewery, four restaurants and an online shop that sells to Berlin supermarkets, bars and restaurants, and ships to several different countries, including the U.S., Japan and Sweden.

“All beer production requires a lot of heat. Our main energy source for this is natural gas. Higher natural-gas prices therefore affect our entire production and lead to significantly increased production costs. Our suppliers are also in a similar situation so higher gas prices lead to higher prices for almost all raw materials,” Lemke told MarketWatch.

Germany’s culturally important brewing sector has indeed been feeling the pain of the energy crisis. A tour of Brauerei Lemke’s operations offered a peek at just what the brewery and its rivals are up against in the production of that beloved German potable. 

Inside one cavernous room under the railway are three giant whirring metal tanks, closely monitored by two employees. That’s the brewhouse, where wort, made from malt and water and hops, is produced via a process of mashing, lautering and boiling. Brauerei Lemke uses natural gas to both heat the water and boil the wort. And it’s clearly no mean feat to keep the century-plus-old, damp, brick-walled room warm, when, as on this December day, outside temperatures hover below zero Celsius. 

Brewery owner Lemke said the company’s relatively smaller size has allowed it to react faster and more effectively than larger rivals with more rigid structures. “For example, we compensated for the CO₂ bottlenecks or irregular deliveries by switching to mixed gas,” he said. 

The company explains that CO₂ is needed to eliminate air from tanks, bottles, cans and kegs before filling, and to push wort and beer through the transfer hoses and move the beer on from kegs to taps. Industrially produced CO₂ is often bought by breweries, with plenty of supply until recently, according to the brewery. For this reason Lemke switched to a mix of 70% nitrogen and 30% carbon dioxide, though pure CO₂ is still also used.

“In the case of new bottles, we were in the fortunate position of being able to fall back on long-term contracts with agreed quantities, however new negotiations with suppliers are pending here, and significant price increases are already foreseeable,” said Lemke.

There are other energy-crisis repercussions. Lemke said the brewery was forced to raise beer prices for both wholesale and retail customers for the first time in years. “Prices for natural gas are extremely high. New rates are approximately 10 times higher than last year. That is more than we expected,” he said.

Holger Eichele, chief executive of the Berlin-based German Brewers Association, said many breweries responded to the energy crisis by switching from gas to oil as a main energy source. “But despite all the efforts, high investments and sophisticated sustainability concepts, replacing gas completely is currently impossible even in our industry,” he told MarketWatch.

While the COVID crisis caused supply bottlenecks and cost rises, Eichele described what happened in 2022 as “beyond all dimensions. We saw unprecedented price rises for raw materials, packaging, energy and logistics.”

Those included a 1,000% surge in the costs of electricity and gas, brewing malt and pallet costs that climbed 100%, a 70% rise in costs of crown corks for bottling, and a price of new glass that was 80% higher in 2022 than in the prior year.

“Basically, larger breweries often have fewer procurement difficulties due to the higher purchasing volume and longer-term planning. However, the cost increases have reached a level that threatens the existence of the entire brewing industry. This affects craft and medium-size businesses as well as the industry,” said Eichele.  

New floating terminals

In early January, a tanker called the Maria Energy arrived at the port town of Wilhelmshaven in northern Germany carrying a shipment of liquefied natural gas from the United States. The tanker docked at a floating terminal specially designed to take in LNG, and the Maria Energy’s shipment was its first. The terminal was not there when Putin sent his full-scale invading force into Ukraine a year ago. Neither were the two floating LNG terminals that have been constructed in the German ports at Lubmin and Brunsbüttel.

It took only months to build these temporary floating terminals as Germany pushed for industries to find different ways to source energy. They are not the only alternatives to Russian natural gas that German industry has been working on, and some have the added advantage of being cleaner. The IEA recently remarked that, while some blame climate policies for intensifying the run-up in energy prices, “a greater supply of clean energy sources and technologies would have protected consumers and mitigated some of the upward pressure on fuel prices.” 

Back in eastern Germany at the Leuna complex, site operator InfraLeuna has been expanding and modernizing its power plants, adding gas and steam turbines and a heat-recovery boiler to the existing gas and steam ones. “The new turbines are more fuel efficient and thereby help to reduce CO_2,” InfraLeuna’s CEO Günther said of the facility that’s now up and running after construction that began in 2020.

Leuna will also have bragging rights to the world’s first wood-based biorefinery, set to come online later this year after three years of construction, started in 2020 by UPM UPM, -1.39%, a Finland-based forestry-industry group that through its six companies works on delivering renewable solutions to replace fossil-based materials. 

The UPM Biochemicals plant will use locally sourced beechwood to produce so-called second-generation sugars, which will be transformed into renewable biochemicals for such products as PET bottles, textiles, fragrances and cosmetics.

“In Leuna, we will only be using certified beechwood, hardwood from regional forests, and we are transforming this sustainably sourced woody biomass into building blocks for the chemical industry, enabling the vital shift away from fossil-based to renewable materials across a range of industries, including automotive,” Gerd Unkelbach, director for molecular bioproducts research and development at UPM, told MarketWatch.

Delivering on this lofty talk has been difficult. UPM announced it would invest some €550 million in its 220,000-ton next-generation biochemicals refinery in Leuna in January 2020. It was originally scheduled to start operations by the end of 2022. Now, the startup schedule has been delayed to the end of 2023. 

“The pandemic has slowed down the completion of the detailed engineering in Leuna,” said Unkelbach. “Disruptions to global supply chains have affected both the availability and costs of critical construction materials. Hence the capital expenditure estimate has been increased to €750 million.” 

Unkelbach added that the investment is in line with Germany’s bioeconomy strategy and supports the goal of increasing responsible utilization of the commercial forests, aided by the availability of sustainably sourced hardwood in the region. “This responsible economic use of the hardwood is great for the forest, the economy and the planet,” he said.

As UPM pushes forward, so does the entire German chemicals industry, though, no doubt, with an overhang of uncertainty. Few saw the pandemic coming, followed by Putin’s surprise invasion of Ukraine, and Europe’s economy facing higher interest rates as the European Central Bank tries to get inflation under control.

The obvious solution to the energy uncertainty, according to InfraLeuna’s Günther, is more than 900 miles away, where the Russia-Ukraine war is marking its anniversary. “In the long run, I think the only feasible way is peace. If there is no peace in Europe, we are really in trouble. And the German industry and the European industry are in heavy trouble.”