Climate change, inflation and de-carbonisation

Inflation is still in single digits, but there is more to come and Europe may well end up ratcheting the inflation phenomenon and usher in a mild recession

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We all recall the international problems associated with the 2007-08 financial crisis and the various bail-out schemes meted to countries in distress. We learned we needed to be frugal and set aside reserves for a rainy day. 

Nothing can compare to the disruption caused in the great depression of the 1930s which led to the collapse of global finance and trade, and resulted in a downturn far longer and more severe than the rescue packages paid to protect jobs and businesses during the two years of the pandemic. Granted, policy remedies were helpful, but the abovementioned crisis exposed the economic profession’s continued ignorance of the business cycle. 

Now inflation is still in single digits, but there is more to come and Europe may well end up ratcheting the inflation phenomenon and usher in a mild recession (more so as a result of sanctions on Russia and the problem of releasing millions of tons in cereals/sunflower oil locked up in Ukraine).  With such challenging factors, the primary task for any management team is to defend margins and cashflow, which investors favour over revenue growth when GDP growth is slowing. 

That will require fighting harder down in the trenches of the income statement. Even if management keep revenues and costs under control, CEOs are discovering what their predecessors knew all too well: inflation plays havoc with the balance-sheet. That requires even tighter control of working capital (the value of inventories and what is owed by customers minus what is owed to suppliers).  

Many firms have misjudged demand for their products in the light of the explosion in oil and gas prices apart from severe shortage of grains and fertilizer due to the bombardment of Ukraine ports by Russian destroyers. 

A recent surge in covid and supply-chain bottlenecks caused Germany’s economy to shrink by up to 1% in the fourth quarter of 2021 compared with the third, according to an initial official estimate. For the whole year, German GDP rose by 2.7%, though output was still 2% lower than in 2019, before the pandemic. 

Other Asian countries suffered similar challenges such as that the People’s Bank of China had to cut one of its main interest rates. The reduction was small, but a signal to markets that officials are prepared to act to stabilise the economy amid covid and severe lockouts in Shanghai and difficulties in the housing market. The main lending rate for mortgages was also cut.GDP grew by 4% in the fourth quarter, year on year, the slowest pace since the depths of the pandemic. Thankfully, the Chinese economy officially grew by 8.1% for the whole of 2021.  

Back to Europe, and we observe how Britain’s annual rate of inflation rose to 7.4%, its highest level in 30 years. Food prices are climbing at their fastest pace since 2008. Energy costs are also rocketing, and are expected to soar even higher should the regulator’s price cap is lifted (as is most likely). This jump in fuel prices has caused concerns to a number of households under “fuel stress”, spending at least 10% of their income on energy bills. 

Yet, some good news for the British economy, GDP rose above its pre-pandemic level for the first time in November.  Although that was before the new strain of Omicron struck. Consider Denmark and its measures to secure cheap energy from renewables. Over the years, it has installed enough wind turbines that, when at full capacity, no other source of electric power is required. 

When Mother Nature takes a break and wind energy subsides then Denmark has laid a subsea cable to Norway, which has ample hydroelectric potential. Obviously, when the wind blows, both places can use Danish wind power, keeping Norwegian water in reservoirs. Further energy links from Denmark to the Netherlands, Sweden, Germany and Britain (planned for 2023) provide yet more options. 

When energy costs are skyrocketing, it is wise to add new links, in Europe, and electricity becomes a tradable commodity. For a local grid manager, reducing carbon emissions becomes a case of buying and selling the right contract as Malta is doing by its inter-connector.  Germany, for example, was once a big exporter of power but is becoming an importer as it finishes shutting down its nuclear plants and phases out coal. 

Another immediate challenge is how best to reduce carbon dioxide from the atmosphere to arrest global warning. McKinsey, a management consultancy, pledged $925m over nine years to innovate technology how best to remove carbon dioxide from the atmosphere. A systematic approach to reduce the carbon emissions from high-efficiency natural gas–based power generation involves two fundamental choices: switching to zero or net-zero carbon fuels (eg. green hydrogen), or the use of post-combustion carbon capture.  

The former approach takes advantage of the fact that gas turbines are highly fuel flexible and can operate on a range of fuels including hydrogen. For a local grid manager, reducing carbon emissions becomes a case of buying and selling the right contract rather than building a solar or wind farm in the wrong place. 

Germany, for example, was once a big exporter of power but is becoming an importer as it finishes shutting down its nuclear plants and phases out coal. The gas turbine industry has been using fuels that contain hydrogen for more than 30 years. Gas turbines generating electricity have operated on fuels with hydrogen concentrations ranging from 5 percent (by volume) up to 100 percent. This includes the use of hydrogen/natural gas fuel blends as well as industrial fuels containing hydrogen. 

One example of an industrial fuel that contains hydrogen is syngas (synthesis gas), which is typically produced by gasifying coal or refinery residue. Syngas typically has about 30 to 40 percent hydrogen (by volume). 

The modern trend is for technological upgrades that may be needed to be applied to existing gas turbines as well as new gas turbines to support the use of hydrogen.  

In our case, for example, the Electrogas plant and BWSC system can both be upgraded to operate on blends of hydrogen and natural gas.  Exciting times lie ahead and Malta cannot afford not to catch up with advances in technology.

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