Green inflation: Energy transition cost worth the short-term pain?
Updated
“Green inflation” or “greenflation” is a term we are hearing a lot more at Capital.com. Why? Because there’s a global supply shortage of oil and natural gas and a push to replace these commodities with cleaner alternatives - a transition that will debatably come at a cost.
Brent Crude Oil Spot CFD
Russia’s invasion of Ukraine in February prompted crude to surge over the $130 per barrel (bbl) mark for the first time since 2008 - and gas prices to spike to all-time highs as supply fears set in.
What is your sentiment on Soybean?
US Crude Oil Spot CFD
That’s because Russia is a key global supplier of both oil and gas, but sanctions were implemented against the country by the European Union (EU), US, UK, Canada, Switzerland, Japan, Australia and Taiwan, for its actions.
The supply shift has left these countries, among others, looking to fill the commodities void - and accelerate renewable plans as a result. It’s also left traders wondering what the markets are going to do next.
US Natural Gas Spot CFD
In the meantime, the surging commodity prices have pushed inflation in many countries to the highest levels seen in over 40 years.
“The transition to this new steady state will not come for free,” warned Isabel Schnabel, member of the executive board of the European Central Bank (ECB).
Why is the transition to green energy likely to be inflationary?
Schnabel explained further. She said many companies are adapting their production processes to reduce carbon emissions - but added that most green technologies require significant amounts of metals and minerals, such as copper, lithium and cobalt.
“Electric vehicles, for example, use over six times more minerals than their conventional counterparts. An offshore wind plant requires over seven times the amount of copper compared with a gas-fired plant. No matter which path to decarbonisation we will ultimately follow, green technologies are set to account for the lion’s share of the growth in demand for most metals and minerals in the foreseeable future.”
And because such demand is rising quickly, supply is constrained in the short and medium-term.
“This imbalance between rising demand and constrained supply is why the prices of many critical commodities have increased measurably in recent months. The price of lithium, for example, has increased by more than 1000% since January 2020,” she said.
Schnabel noted that the developments illustrate an important paradox in the fight against climate change.
“The faster and more urgent the shift to a greener economy becomes, the more expensive it may get in the short run.”
The International Renewable Energy Agency (IRENA) said in 2019, the energy produced from renewable sources was comparable in price to that of fossil fuels. However, energy replacement costs are not so in sync.
According to the US Energy Information Administration (EIA), the lifespan of wind turbines is about 20 to 25 years, slightly less than natural gas power plants which have a lifespan of 25 to 30 years. While oil plants can last 30 to 50 years, not far off coal power plants, which can operate for an estimated 50 to 60 years.
The green inflation debate
So how inflationary is the green transition and is it worth the short-term pain to reap longer-term benefits? Which assets might benefit traders in a high inflation environment? Is there anything in this for them?
Chief market strategist at Capital.com, David Jones, hosted a debate with David Woo, economist and CEO of David Woo Unbound - and Özlem Onaran, a professor of economics at the University of Greenwich.
Impact of Ukraine war on inflation?
He started by asking the panellists about the war in Ukraine and how big of an impact they think it is having on inflation.
David Woo believes the impact is large: “Oil prices are 120 bucks. Russia is still getting $90. It's true that they are not exporting to Europe anymore. But guess what? You know, India, China, and other countries are willing to basically pay, especially given the deep discount. But Russia is still getting them more.”
Food poverty due to surging prices
He also noted that because Europeans are trying to reduce their dependence on Russian energy, burning more coal to make up for it could be more likely. He also highlighted the issue of food poverty due to the surging prices.
“Again, these sanctions are going to be killing more people in the world than the Russians are ever going to kill in Ukraine. Because think about this, 50 million people are going to be going hungry tonight everywhere in the world. And there is no question and by the way, this is going to get Europe, because right now food inflation is at the highest level since 2011. And you all remember what happened 2011/12. We had the Arab Spring. Three years later, we had the refugee crisis in Europe and a year later we had Brexit,” Woo highlighted.
Soybean Spot CFD
Onaran was of the view that it would have been impossible to navigate the situation without the sanctions against Russia but also shared her concern over how they are hurting those on a lower income.
“A good part of the food price inflation is because Ukraine can't use its ports now to export the wheat that is stuck in their stocks.”
Wheat Spot CFD
Faster green transition needed?
She also noted how more thought should be going into investing in a wartime emergency in renewable energy, as a result of the current supply woes.
“The more resources pooled to achieve that transition, the quicker we would be able to overcome the energy crisis as an outcome of sanctions against Russia. I am optimistic that this is going to open the door to more radical thinking in terms of transitioning away from fossil fuels towards renewable energy,” Onaran added.
How can inflation be tackled?
“Today's inflation is pushed by rising imported input costs due to the supply chain disruptions. In the context of Britain, first after Brexit and then globally after the pandemic. And on top of it came Russia's invasion of Ukraine. All these are hitting food and energy prices.
“So, today's inflation is not due to wage price spiral. It is also not the main driver. Therefore, the current actions of the central banks here at the Bank of England and elsewhere, the Fed or ECB, to increase interest rates to fight against inflation, won't cure this type of imported, costs driven inflation. It won't help with the rising cost of gas and oil or wheat due to the Russian invasion of Ukraine,” Onaran argued.
To help tackle inflation, Onaran noted price controls need to be put in place - on energy rent and on essential foods, for example.
The economist also noted that monetary policy should accommodate an expansionary fiscal policy, particularly to fund public investment, including in the green and care economies.
“I'm talking about investment in renewable energy, energy efficiency, public transport, green social housing, as well as organic, sustainable plant based agriculture,” she added.
Corn Spot CFD
Push for renewables worth the green inflation challenge?
However, David Woo argued that it would be much faster to drop the sanctions against Russia than to spend the next few years trying to find a replacement for Russian energy.
“I can understand the whole argument about positive supply response to a negative supply shock.
“You want to invest, but that's unfortunately not how things work. It takes years and years and years. And last year, most of the wind turbine makers in the world were unprofitable because of the rising prices of raw materials that make a wind turbine. It requires half a ton of copper to make one turbine.
“So from that point of view, it's not clear that this whole emphasis on renewable is even the solution, certainly not a solution for the next two or three years and maybe not even beyond. In fact, if anything, the whole renewable business has only exacerbated the inflationary tendency right now,” Woo said.
Copper Spot CFD
Which assets might benefit traders in a high inflation environment?
Woo further highlighted that the best kept secret on Wall Street is the idea that inflation hedges do well when inflation is high.
“Whenever central banks think inflation is a good thing, they call it reflation. And reflation, generally speaking, is very bullish for inflation like assets: whether it's gold, whether it is inflation indexed bonds, or even Bitcoin for that matter.”
Gold Spot CFD
“Now, however, what happens is that when central banks decide inflation is not a good thing anymore, that's when inflation assets become worthless,” Woo added.
Onaran warned the effect will be deeper and more troublesome in the emerging markets and said there will be a flight to safety to the US and gold.
“So assets and currencies of emerging markets are likely to perform worse than those in the safe haven of the US and gold in general. Now there might be some temptation to think oil obviously is a good hedge against inflation and in general utilities. I would caution against that and urge people to think carefully about the former Bank of England's governor, Mark Carney, as warnings about the climate risk,” she said.
Carbon Emissions Futures ECFZ22 CFD
“On the other hand, obviously, utilities, commodities are good hedges. Then I would say, why not consider renewable energy? Why not consider plant based foods as opposed to other forms of agribusiness? And obviously, if some form of fiscal stimulus is to continue,” Onaran added.
Edf - EDF CFD
E.ON SE - EOAN CFD
Upward pressure on prices
Isabel Schnabel, member of the Executive Board of the ECB, made comments that summarised the green inflation debate well - she said that so far, green inflation has had much less of an impact on final consumer prices than fossilflation (the legacy cost of the dependency on fossil energy sources) - and it would therefore be misleading to claim just yet that the greening of our economies is to blame for the painful rise in energy prices.
“But as more and more industries switch to low-emission technologies, greenflation can be expected to exert upward pressure on prices of a broad range of products during the transition period,” she said.
Markets in this article
Related topics