The Energy Transition and Green Deal as a tool for economic recovery from the COVID-19 crisis

Coronavirus: a global phenomenon

Although the spread of the Corona virus is a clear result of globalization, the response to this pandemic seems to be individual and separate for every country. The lack of global cooperation to form a combined response to this global threat is very striking. I remember when the first Corona cases were reported in China about 3 months ago, most people thought this will be a re-run of the 2003 SARS epidemic and that this was China’s problem.

The fact that in an interconnected world, a global threat can arise in any country but cannot be contained there, was not recognized by most people and most governments. If there was either a global task force for cooperation in order to respond to a global pandemic threat and support the country where it started, then thousands of lives would have been spared and also trillions of dollars (which is the expected economic cost of the Corona pandemic).

The Coronavirus is part of a growing number of global problems that are hard to resolve by individual countries. These problems demand a global response and thus global cooperation between countries. Madeleine Albright, former U.S. Secretary of State, said it best:

“There is something childish about the belief that, in our era, one can be safe behind a wall, a moat or even an ocean. The principal threats we face, even beyond pandemic disease, do not respect boundaries. They include rogue governments, terrorists, cyber warriors, the uncontrolled spread of advanced weapons, multinational criminal networks and environmental catastrophe. These perils cannot be defeated by any country acting alone, and any country would be foolish to try.

It was for good reason, then, that world leaders strove in decades past to establish regional and global mechanisms to spur development, prevent war, promote health, regulate trade and prosecute crimes against humanity. The institutions created were often overly bureaucratic, plagued by politics and less efficient that one might hope. However, they have also helped us to resolve dangerous conflicts and to make unprecedented gains in, among other missions, alleviating poverty, expanding literacy and containing the ravages of communicable diseases from polio and yellow fever to HIV/AIDS and Ebola.”

How does a global pandemic affect the economy?

COVID-19 has already slowed down the world economy so much that a recession seems inevitable.

A nugget of wisdom passed along more than once by Warren Buffett to Berkshire Hathaway investors: “You only find out who is swimming naked when the tide goes out.“ What did the oracle from Omaha mean?

According to him, we cannot really know or appreciate the risks companies are taking until they are tested by adverse conditions. Most likely, strong companies will survive, becoming stronger. Weak companies (companies with too much leverage = companies that are swimming naked) will disappear.

Governments around the world have already taken measures to combat the oncoming economic decline. Overall, the measures will probably be divided into two:

• Monetary measures:  QE (Quantitative Easing) and low interest rates (or even negative rates).
• Fiscal measures:       Direct investment in the economy, mostly in infrastructure projects (Keynesian economics).

a.       How QE and low interest can cause inflation

Paul Volcker, Chairman of the FED in the Reagan years, is widely credited with having ended the high levels of inflation seen in the United States during the 1970s and early 1980s. This was achieved by raising the federal funds interest rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. These actions were not very popular, but they did reduce inflation from 14.8% in March 1980 to below 3% by 1983. Thus, since the time of Paul Volcker (who passed away in December 2019), increasing interest rates is the standard solution for fighting inflation.

This was the “blueprint for saving the economy” until the collapse of the Dot-Com bubble in 2000, to which the FED responded by lowering interest rates. Following the collapse of the Sub-Prime mortgage bubble, the FED (as well as the European central bank and the Bank of Japan) started Quantative Easing programs (which is more or less equivalent to printing money):

• The Federal Reserve printed close to 2 trillion dollar.
• The ECB (European central bank) printed 3 trillion dollars.
• BOJ (Bank Of Japan) – more than 3 trillion dollars.

Together, the QE of all these central banks is about 8% of the broad money supply to 21% of the nerrow money supply in the world. The big question is: despite the low interest rates and money printing, why was there no inflation over the last 20 years? In my opinion, it could be related to the 2 major unique reasons:

• The rise of a new technology for producing shale oil.
• The rise of China as the factory of the world and the resulting deflationary effects.

b.       Shale oil – how low interest rates and technology released millions of barrels of oil into the market and prevented inflation

The shale oil revolution changed the world’s energy supply map drastically, with far reaching effects. It made the US, which had to import a big part of its oil up until the beginning of the 21st century, the world’s biggest oil producer and even an oil and gas exporter.

Because of the abundant shale oil supply, OPEC (or more accurately – Saudi Arabia) stopped protecting the high oil price levels, causing oil prices drop drastically from 2014. The shale oil revolution is partly a technological revolution (hydraulic fracturing and horizontal drilling), but there are two more important causes: high oil prices (peaking in 2008) and low interest rates.

China’s energy needs

So, what caused these high oil prices? They are most likely the result of China’s economical rise. Between the year 2000 and 2019, China has grown at a rate of 6%-8% per year. It now amounts to about 17% of the world economy. At first, China had a hard time fueling this growth with the required energy supplies. Chinese power plants started to use oil (instead of cheaper and more abundant coal), which created an increased demand and pushed oil prices up (source: ‘The Prize’ by Daniel Yergin).

And what about the low interest rates? They result from a relatively new policy, introduced by Federal Reserve chairman (Alan Greenspan) in the wake of the Dot-Com bubble collapse. In order to avoid a recession, the FED started to lower the interest rates to support the economy and avoid the natural consequences of the business/market cycle. This policy did indeed mitigate some the negative economic effects after the Dot-Com bubble burst, but it also caused a lot of distortions in the market which eventually led to the collapse of the 2008 subprime bubble.

Mountain of debt

High oil prices made shale oil profitable (from a price of about 60$ per barrel) and cheap loans from wall street provided the capital. The shale oil revolution is built on a “mountain of debt”. Why did wall street supply this debt to such a risky industry? Very simple: they produce a valuable commodity (oil) that helps these companies maintain the debt. Harold Marks explained it well in his book ‘the market cycle”: most companies do not really pay off their debt, they just maintain it by paying the interest rates and recycle it after it matures. Wall street companies do not care because as long as the debt is serviced, it shows in their balance sheet as assets and increases their profit.

Oversupply

The shale revolution caused another side effect: it created an abundance of supply of oil in the world, which pushed oil prices down (after 2014) and reduced inflation. Oil is the most sold commodity in the world (source: ‘The Prize’ by Daniel Yergin), comprising 30% of all goods sold and about 50% of all goods transported by sea. An increase in oil prices (like after the oil embargo of OPEC in 1973) can lead to worldwide inflation, as did occur in the 70s and beginning of 80s (up until the oil fields in the North Sea were developed and subsequently balanced the oil supply). Therefore, the opposite is also true: the oversupply of oil due to the shale revolution led to deflationary effects.

And thus, the low interest rates since 2000 have led to the development of new shale oil resources which mitigated the inflationary effects usually caused by low interest rates and thus allowed these rates to continue going down. A sort of virtuous cycle was created, although I think nobody expected this phenomenon.

c.     The rise of China and its deflationary effects on the world

China’s meteoric rise over the past half century is one of the most striking examples of the impact of opening an economy up to global markets. In the past 50 years the country has undergone a shift from a largely agrarian society to an industrial powerhouse. In the process it has seen sharp increases in productivity and wages that have allowed China to become the world’s second-largest economy.

The rise of China caused an inflation in some commodities (Metals, oil etc..), and a deflation in the price of finished consumer goods. There is a similarity between the rise of China and the great deflation period of 1870-1890. This deflation was partly caused by productivity gains due to new technology (Bessemer steel, Telegraph communication, etc…) and partly due to the rise of the United States as an economic power in the world (similar to the rise of China today) after the end of the American Civil war.

At the same time, it is also an example for deflation which is not necessarily bad for the economy. Deflation which is accompanied by a recession or even depression (usually after a bursting of an economic bubble), is usually negative (bad deflation). An example is the deflation that followed the stock market crash of 1929 and the deflation in japan after the bursting of the stock market and real estate bubbles of 1989. However, a deflation that is caused by increased productivity (due to technological progress), is usually positive (good deflation) and is usually accompanied by a period of economic growth (like the gilded age).

d.    So, why is there no inflation?

Summing it up, the oversupply of shale oil was a major cause in preventing worldwide inflation as a result of the low interest rates and the enormous printing of money as part of the quantitative easing programs of the US, Japan and the European Union. Combined with the growing part of China in the world’s economy and its deflationary effects, the world’s economy was able to absorb the increase in the money supply without a major increase in the price of goods and products.

e.    The importance of economic growth

The most important thing for governments now is to promote economic growth. The importance of economic growth was first understood by Leon Keyserling, who was an economic aid of Harry Truman. Without growth, the economy is a zero-sum game (any new business must come at the expense of an existing business). The common analogy to explain this is with a piece of pie. If someone takes a bite of the pie, then someone else has less to eat. However, with economic growth, the pie keeps on growing so that there are enough pieces to go around. Economic growth is usually attributed to two basic factors:

• Population growth:               By natural birth rate or by immigration.
• Increased productivity:         Increase in the ratio of the value of output to input.

f.      Growth through productivity

Productivity increases are usually caused by technological advancement. For instance, in 1872 Andrew Carnegie visited a steel plant in England which was using Bessemer's method, and he realized the potential of producing the same quality of steel in America. Carnegie learned everything he could about steel production and began using the Bessemer Process at mills he owned in America. Due to the productivity gains of the Bessemer's method, steel in the US reduced to 1/7th of its former price. This led to an increased economic activity, mostly in the building of train tracks. The same principle that was true at the end of the 19th century (a period that Mark Twain has named: ‘the gilded age’) also applies today.

Increases in productivity lower the real cost of goods. Over the 20th century the real price of many goods fell by over 90%. How does productivity help growth? If goods and services become cheaper than either the costumer pay less and have more money to spend on other goods and services, or the makers of the goods have more money to spend on developing other businesses. In other words, money that was tied up into the production of a certain good or for the payment of that good, is now free to be used for other purposes. Productivity leads to an increase in real wages, inspiring consumers to open up their wallets and buy more, which means a higher material quality of life or standard of living.

g.    Growth by population increase

Economic growth is an increase in the production of economic goods and services (usually measured in GNP or GDP), compared from one period to another. It is always possible to artificially increase GDP or GNP since most countries have an over capacity in either manufacturing or services, but that is meaningless if there is no real demand for these services or goods. This is the reason that population growth is so important.

h.    Can zero interest rates promote growth?

The first reaction by national banks around the world to the economic slump which the Corona pandemic is expected to cause was to lower interest rates and start QE again. Can these measures promote economic growth?

Of course, they cannot increase the population, but they might allow investments in technology that can lead to increased economic productivity. However, there are a lot of negative sides to a world with zero or even negative interest rates:

• It causes an artificial price increase (inflation) in the house market (since it is easier to get a mortgage to buy a house).
• It causes an artificial increase (inflation) in the price of stocks. In the book ‘Makers and takers’, Rana Foroohar describes how companies borrowed money against low interest rates over the past 10 years in order to buy back their own shares, increasing their share price and so reward their shareholders. This is a major reason for the high share prices (before the Corona pandemic) which have recently lost all touch with reality (For instance Tesla went from 300$ per share to close to a 1000$ per share in 2019)

i.      So, what can promote growth?

A possible option for promoting growth is to invest money in an industrial program that can lead to productivity gains and reduced prices. Therefore, it is the opinion of the author, that investments in the Energy Transition and in specific programs like the Green-Deal in Europe or the Green-New-Deal in the US, can lead to productivity gains which are required for economic growth.

The Energy Transition

Daniel Yergin is one of the most respected energy experts in the world. In his book ‘The Prize’, he described the typical person of the 20th century as the ‘Hydrocarbon man’. This is due to the heavy use that humanity makes with energy sources from fossil (carbon based) fuels (coal, oil and natural gas). Although most of his expertise is in the oil&gas industry, Daniel Yergin wrote a follow up book (called ‘The Quest’) which is mostly devoted to renewable energy. Although renewable energy is still a small part of the world’s energy today, it is the fastest growing energy source, taking up about 72% of all new energy sources investments in 2019.

What happens now all over the world, is that almost all new energy capacity power plants are renewable and the replacement of old coal/gas/nuclear power plants is also renewable. This change is commonly referred to as the ‘energy transition’, a term taken from the German program with the same name. At the rate this is happening, the majority of electricity production in the world will be from renewable sources in several decades.

a.    Advantages of the energy transition

Several economic advantages result from the energy transition:

• Cheap electricity: wind energy and solar energy are currently the cheapest source of electricity in most of the world.
• Cheap transportation: Electric cars have energy costs (electricity vs. fuel) that are half those for ICE cars and they have also relatively cheap maintenance costs due to their relative simplicity. They do not require spark plugs, oil and fuel filters, exhausts, gearboxes, couplings, radiators and apply regenerative braking, using the electric motor to do much of the braking and reducing braking system expenses in the process).
• Less deaths due to pollution (enabling demographic growth): The WHO estimates that more than 4 million people die every year due to pollution. The annual economic cost of premature deaths from air pollution across the countries of the WHO European Region stood at US$ 1.431 trillion; and the overall annual economic cost of health impacts and mortality from air pollution, including estimates for morbidity costs, stood at US$ 1.575 trillion.
• More stable jobs: Employment of wind turbine service technicians is projected to grow 57% from 2018 to 2028 and 63% for solar panel installers. The job security for wind turbine technicians is especially high since wind farms are typically built for a period of 20 - 25 years and the O&M work needed to keep these farms running cannot be shipped overseas.
• Extra revenues for farmers: Farmers and farming communities in the American Midwest have been struggling for years to stay afloat as prices of farm goods decline. They have now found a new source of revenue: renting their land to developers of solar farms or wind parks. The revenue from these energy farms allows farmers to keep their way of life, while making a decent living. It also increases the tax base of small municipalities and allows them to invest more money back into the community. To put it in a more figurative manner, American farmers are now harvesting the sun and wind.

Thus, the economic benefits of the energy transition allow gains in productivity that are so much needed in order to grow the economy and mitigate the effects of the Corona Virus pandemic.

b.    The European Green deal and the American Green New Deal

An early adopter of the phrase "Green New Deal" is journalist Thomas Friedman. He argued in favor of the idea in The New York Times and The New York Times Magazine. In January 2007, Friedman wrote:

‘If you have put a windmill in your yard or some solar panels on your roof, bless your heart. But we will only green the world when we change the very nature of the electricity grid – moving it away from dirty coal or oil to clean coal and renewables. And that is a huge industrial project – much bigger than anyone has told you. Finally, like the New Deal, if we undertake the green version, it has the potential to create a whole new clean power industry to spur our economy into the 21st century.’

The green version

This approach was subsequently taken up in Great Britain by the Green New Deal Group, which published its eponymous report on July 21, 2008. Senator Edward Markey and Representative Alexandria Ocasio-Cortez released a fourteen-page resolution for their Green New Deal on February 7, 2019. The approach pushes for transitioning the United States to use 100% renewable, zero-emission energy sources, including investment in electric cars and high-speed rail systems as well as implementing "social cost of carbon" that was part of Obama administration's 10 year plan for addressing climate change.

The cost of COVID-19 is going to be very high. The world will most likely go into recession and governments all over the world will spend trillions of dollars/euros in order to revive economic activity and support the economy. The Green deal in Europe and Green New Deal in the US are perfect candidates to jump-start the economy and create real and lasting change.

Francesco Starace, CEO of the Italian utility Enel, made an interesting statement on this matter: “We think there will be a need for investment to restart after a period of low growth. This could be a perfect opportunity for renewables to pick up speed again,” “If you look at the fact that perhaps after this crisis is over there will be a need to kick-start the economy, the [Green Deal] is exactly the case.”

Thomas Friedman from the New York Times added another convincing argument: governments should do the same thing FDR did with the different actions taken as part of the New Deal. Roosevelt used the rural electrification act and other projects to invest money in things that he knew will increase the productivity of the American economy at the end of the big depression. The same principal applies now for investment in the energy transition (Thomas Friedman made a similar recommendation).

Summary – COVID-19 as a trial run for the climate change crisis

The amazing thing about the Coronavirus outbreak is the amount of health experts claiming the writing was on the wall. Every century, humanity is faced with several periods of deadly diseases. In the 20th century it was the Spanish influenza, polio, Hong Kong flue and AIDS. In the 21th century, we already had the SARS and Ebola (and the century has only started). Statistically it is only a matter of time until the next viral or bacterial disease will hit humanity again and will lead to loss of life and economic damage. Furthermore, due to globalization and the advanced level of transport of both people and goods between regions and continents, the danger of spreading of disease is larger than it was ever before in human history. For good or for bad, the world is interconnected. Everything that happens in one part of the world can have a serious effect of all other regions with the speed of air travel.

Global impact

The Coronavirus gives us a glimpse of the price we would have to pay, in economic damage and human life, if we continue to ignore or neglect global dangers with far reaching implications. The biggest danger of all is probably climate change. In both economic as well as human life terms, the price of climate change and global warming are expected to dwarf those of the current pandemic. Furthermore, it is a real global problem (the term ‘global warming’ is very accurate) and the solution can only be global. There is no way to stop global warming in an individual country. It is a problem that needs global attention and global cooperation.

Every dollar we do not spend now on this issue, will cost us 10 dollars in the coming decades. We can continue to bury our head in the sand, but the effects of climate change will be evident within our lifetime, not to mention in that of our children, which will most likely have to pay the price of our negligence. The manner in which we tackle COVID-19 might just be the dress rehearsal for the future fight against climate change.

Note: The author of the post is expressing his own opinion. The views in the post are the sole responsibility of the author and do not reflect the views of any past or current employer (or their parent company or affiliates). A reference is made to all external data mentioned in the post. All external data mentioned in the post comes from public sources and does not violate Copyright law. Comments on this post are the sole responsibility of their writers and the writers will take full responsibility and liability.

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