Inflationary periods will come and go, but greenflation is here to stay

Inflationary periods will come and go, but greenflation is here to stay

Inflationary periods will come and go, but greenflation is here to stay

Greenflation and its drivers

Let’s start with a bold statement: The ecological transition will have long-term inflationary effects. We might not like to hear it, but we better face the truth. Some mechanisms are well known, others less so. But the good news is that you can prepare yourself for this greenflation and that your business will not be impacted by it for eternity. In this blog, we will discuss the mechanisms you should take into account as well as their effects on your business.  

It is common knowledge that the ecological transition is going to be very expensive. The transition requires the investment of tens of thousands of billions of euros and dollars to develop new and less-polluting energy sources. The economic supply and demand law tells us high demand leads to price increases (especially if the supply does not catch up). Supply chain disruptions, such as the COVID-19 pandemic and the war in Ukraine, have created additional pressures on the demand side, which has led to additional price increases. 

Decreased investments in fossil fuels 

Experts from the IIB (International Investment Bank) and the research institute of American asset management giant BlackRock, believe that the transition to a net-zero emissions economy is comparable to a reset of the economy stretched out over several decades, bringing new constraints that will push up inflation both at the general level and through industry channels. 

The mechanisms of greenflation are as follows. 

Supply and demand imbalance

For energy prices, first, there’s an impact on the supply side as fossil fuel giants are reducing their investments in research and exploration. They fear not being able to amortize the exploitation of new developments, under the pressure of decreasing future demand for fossil fuels, and of environmental laws and standards. Additionally, activist investors and ESG (Environmental, social, and governance) funds continue pressing fossil fuel giants into ecological commitments. Under the law of supply and demand, it becomes clear that oil and gas risk becoming more expensive if their demand is not adjusted accordingly. This is without taking into account the depletion or blocking (in case of sanctions) of easily exploitable resources, which can create further pressure on energy prices. 

World energy investment

Figure 1: Global energy investments as % of GDP Global investments in energy as % of GDP 

Carbon tax 

Additionally, carbon taxes automatically push energy prices upwards. Credit Suisse experts have calculated that a tax of 75 dollars on each ton of CO2 emitted in the world would result in an additional levy of 3.600 billion dollars! Goldman Sachs experts have examined the hypothesis of a tax gradually rising to 100 dollars in 2030. They estimate the cumulative additional inflation at nearly 2% in the United States.

Given the strong opposition of public opinion to tax increases, states will push the public through either regulation, such as emission standards for cars or insulation norms for housing, or subsidies, such as tax credits for environmental cars or subsidies for energy-conscious renovations. It’s more acceptable… but also more expensive, because it would be more effective to reduce CO2 emissions by closing massively coal-fired power stations.  

Tax and underinvestment, however, are only a small part of the greenflation story. To make progress in the energy transition, we will have to invest massively in less polluting production processes to produce energy, steel, or cement.  

Metal greedy

The upscaling of green energy sources needs to fill up the gap of reduced investments in fossil fuels and additional energy requirements by the growth of the economy. However, due to the intermittency of green energy sources (when there is no wind or too much wind, wind turbines need to shut down and solar panels don’t generate electricity when there is no sun), it will be necessary to invest in additional storage capacities to compensate for the intermittency of solar and wind energy.  

The additional demand for green energy will generate additional demand for greener technologies and the materials necessary to produce them. Carlos Tavares, the CEO of the car manufacturer Stellantis, estimates that electric technologies are 50% more expensive than thermal. Furthermore, it takes a lot more metals to make a wind kilowatt-hour than a gas kilowatt-hour.  

The prices of “transition metals” necessary for green technologies (copper, nickel, lithium, cobalt, palladium, etc.) have already risen significantly over the previous years. That is probably only the beginning considering the energy transition will only increase the demand for these metals; this combined with geopolitical instability might lead to additional price pressures on those materials. 

Nickel, copper, aluminium, lithium and cobalt price performance

Figure 2: Nickel, copper, aluminium, lithium and cobalt

Some examples: 

World Cobalt Production

Figure 3: World cobalt production & reserves: 70% of production comes from Congo, 5% from Russia 

Transport cost and labor market tensions  

Beyond these clearly identified effects, the ecological transition will have other consequences on prices that are more difficult to assess. Long-distance transport, for example, will cost more because of the price rise of conventional fuels. However, the lowering of its tariffs has played an essential role in the reorganization of the supply chains of companies, which has enabled them to reduce their costs and therefore their prices again and again. Price increases will also push employees to demand wage increases, with the possibility of a second-round effect where wages in turn drive prices potentially leading to a wage-price spiral. 

Tensions will be all the greater on the labor market as many workers will have to change jobs. The McKinsey Global Institute estimates that the transition could create 200 million jobs and lead to the loss of 185 million direct and indirect jobs by 2050. 

Labor shifts needed for transition

Figure 4: Employment changes in the next 30 years – Source: BlackRock Investment Institute

Navigating to calmer waters 

Greenflation is unavoidable and we already see and feel its effects today in rising grid and metal costs. However, this is not a reason to delay the transition even further since IIB experts estimate that inaction on the climate would lead to a cumulative loss of nearly 25% of global production over the next twenty years.

Global average delivered cost of electricity

Figure 5: Overall cost of electricity in the net-zero emissions scenario in 2050 Global cost of electricity in the net-zero emissions scenario in 2050 – Source: McKinsey Global Institute

After a (huge) inflation bump, prices should calm down. MGI (Mc Kinsey Global Institute) experts predict, for example, that the total cost of electricity could increase by 25% by 2040 but that it could then level off.  

Supply shock compensated with demand stimulus 

The costs of the green transition as such imply a negative supply shock. Higher energy costs through EU ETS (Emission Trading System) and a range of regulations, at least in a transition phase, increase production costs and reduce the productive capacity of the economy. However, the current supply shock differs in one important respect from the oil supply shocks in the 1970s: since the proceeds from carbon taxes remain available for domestic usage in the form of (green) investments, transfers, or tax cuts, this leads to a positive demand impact that occurs simultaneously with the negative supply shock.   

A final note 

 At the moment of writing this article, the prices of fossil fuels and European electricity prices (due to the marginal cost principle) remain under pressure in view of the current geopolitical tensions and related sanctions with potential long-term structural impact. This leads on the one hand to an accelerated usage and production of alternatives such as shale gas combined with investments in LNG transport and terminals. On the other hand, one can expect an acceleration of the energy transition, especially in Europe reinforcing the greenflation mechanisms described above. 

This article is offered to you by Solventures’ LIFe team, a dynamic crew of macro-economic and data science experts. 

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2022-06-01T17:58:06+00:00

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