What is Green Inflation, Causes and Solutions for the Economy and Environment
Once again, the use of foreign language terms occurred again in the broadcast of the 2024 vice presidential debate on Sunday 21 January 2024 which took place at the Jakarta Convention Center (JCC) Convention Hall building. The statement on the use of foreign languages made by candidate pair number 2, namely Gibran Rakabuming Raka, when asking Prof. Ma’ruf MD, who is currently hotly discussed regarding Green Inflation.
The topic of environmentally friendly inflation (Green Inflation) is a hot and interesting topic, because rising energy prices have caused social unrest and economic problems. Green inflation often refers to inflation associated with public and private policies implemented as part of the green transition. What is Green Inflation?
Green Inflation does mean green inflation. This word is taken from the words green (green) and inflation (inflation). Then quoting from the Cambridge Dictionary, greenflation can be interpreted as “an increase in prices due to the transition to a green economy”. Green Inflation then refers to the increase in prices and labor crisis that occurred because the government began to make an environmentally friendly transition.
This causes price increases that originate from companies, because they spend more budget to carry out the energy transition. This is because the energy transition does require more costs. This can be seen from the use of green energy which is still considered more expensive than fossil fuels.
For example, we can report from the European Central Bank (ECB), where a country wants to make a transition to reduce carbon emissions, new problems arise. Namely because most environmentally friendly technologies require large amounts of metals and minerals, such as copper, lithium and cobalt, especially during the transition period.
So what causes this green inflation to occur?
- Carbon taxes increase
Many factors that trigger inflation occur during the green energy transition. First, the increase in carbon tax costs. The price of one ton of CO2 is currently ten times higher than when the new Paris Agreement was signed, December 12 2015. The International Trade Agency (IMF) stated in June 2021 that the global carbon tax needs to rise to 75 US dollars per ton by 2030. That figure will continued to increase in the following years. The reason is that carbon dioxide (CO2) and greenhouse gas (GHG) emissions must be reduced by a quarter to half by 2030 so that the climate can return to stability. Global CO2 emissions are projected to increase from 30 billion tonnes in 2020 to 37 billion in 2030. “We must hold warming to well below 2 degrees Celsius and ideally towards 1.5 degrees Celsius above pre-industrial levels. “Global CO2 emissions in 2030 must be limited to around 15 to 25 billion tons,” wrote the IMF Staff Proposal. Another study mentioned by ESGclarity suggests the carbon price needs to reach US $ 160 per ton by the end of this decade to reach net zero emissions by the middle 2050. - Reducing fossil fuels
To encourage a green transition, governments must reduce fossil fuel subsidies and introduce policies that reduce incentives for companies to add new production. As those companies reduce investment in exploration and extraction, it is likely that the supply of new oil and gas will decline faster than demand. This condition puts upward pressure on prices. This impact will occur because currently large oil and gas companies are starting to shift their focus to renewable energy. - Surge in demand for green energy raw materials
Market demand will be higher for commodities needed for the green transition. However, some minerals are available in limited quantities. A surge in demand for lithium and nickel, for example, will occur due to an increase in the need for electric vehicles. Likewise with the copper needed for electric vehicle cables. The International Energy Agency (IEA) estimates that demand for lithium could jump 40-fold over the next two decades as battery use increases. In addition, investment in wind power plants will also increase demand for zinc and rare earths. Large amounts of rare earths are required for the construction of photovoltaic panels, along with silicon and silver. Not all aspects of the green transition will be inflationary. Government policies can help reduce the buildup of inflationary pressures, for example by allocating revenue from carbon taxes to provide subsidies to more vulnerable communities. This step is important to take considering that the impact of inflation tends to be difficult for people with lower middle class economies because prices will be much higher for important goods.
So what is the solution for Green Inflation in the future?
In the near future, some solutions may be inflationary. Electric vehicles, for example, are more expensive than internal combustion engine vehicles. However, electric vehicles have experienced the largest decline and this also applies to various renewable technologies, such as solar photovoltaics. But forces that appear inflationary today could become disinflationary in the future. There will come a time when commodity prices fall, and as a large commodity importer, Asia will be the biggest beneficiary.
What asset managers have an obligation to do when promoting sustainable investment is to communicate that the energy transition is a long-term decision. Businesses that use a lot of commodities and fossil fuels are doing well because production costs increase more slowly than price increases, thus having a positive impact on income and valuation.
In contrast, the valuation of the renewable energy sector became expensive last year because most of these businesses are growing companies. As the interest rate structure improves, the discount rate applied to their earnings also increases leading to significant underperformance.
The bottom line is that investors will likely experience a lot of variation in the process. Even if market participants believe that central banks will eventually address these issues, strategies that seek to manage inflation and volatility will be attractive from a portfolio perspective in the short term.
