There is a debate around the potential cost of a green transition. “Greenflation” would be caused by higher demand for greener solutions, and the consequences of new public policies (e.g. green taxes). How can we deal with the social tensions that could possibly arise with greenflation? Salil Shahane, ESSEC Business School MiM student and competition finalist, explores.
Greenflation: The dirty cost of building a clean and green economy by Salhil Shahane.
Greenflation – The cause and the effect
The need for green energy is more than ever today and this has ironically put a lot of strain on conventional energy sources. The more the push towards this greener transition, the more expensive the whole campaign. Government policies have positively influenced the demand for green energy resources but tightening regulations for the conventional resources required to produce green energy have affected supply – making these resources expensive.
The unintended result is “Greenflation”, caused by rising prices for raw materials like copper, aluminum, and lithium that are essential for harnessing energy from non-conventional energy sources like Solar and Wind. Copper and Aluminum – two of the most important minerals used in the electrification processes required to create greener resources – end up doing more damage than good to the environment due to their procurement processes.
As such, public policies tighten the regulations surrounding their procurement thereby discouraging investments in mines, smelters or any other source that belches carbon. This kind of growing demand and decreasing supply, both due to public policies and regulations, is leading the world into Greenflation.
Is Necessity birthing inventions?
Historically, transitions to a new energy source have pushed for innovation in the old one. With the introduction of the steam engine, the makers of sailing ships innovated more in the 50 years than they had in the previous 300 years. Electricity proved to be the mother of innovations in gas lighting.
Extending this analogy and given the current scenario, the transition to green energy would require increased consumption of oil in the transition period. But we do not see investments picking up in the oil sector as the stringent regulations and dis-incentivising policies against this polluting ingredient make this sector less and less attractive for investors.
Even when we see oil prices rising (Brent crude has already breached the $100/barrel mark), the big hydrocarbon companies and countries are reluctant to join the party. As mentioned earlier, the two vital minerals in green electrification, Copper and Aluminum, also are subject to scathing ESG scrutiny thereby making them less lucrative for investment. It is a paradox that the world needs more copper than ever to go green eventually and this has inevitably hurt the environmentalists who recently helped block a new Alaska mine over concerns for the negative impact on the local community around the mines and the threat to aquatic life like the salmon.
Increasing awareness around Environment, Sustainability and Governance (ESG)
ESG concerns have now taken the entire world by storm and are no longer the prerogative of rich nations. Due to the new-found ESG awareness, supplies are restrained even from Latin American countries – once considered as the wild west of global mining. One big copper project in Peru, one of the largest global exporters of copper, scheduled to open in 2011, remains unfinished due to resistance from the local community. A similar trend can be seen in China, one of the world’s largest commodity exporters, that has cut production of raw materials like iron ore and steel as it aims to achieve carbon neutrality.
The “Green” Conundrum
Green technologies need more wiring than the prevalent fossil fuel-based technologies. Electric vehicles, for example, use up to 6 times more minerals than a normal car. Over the past couple of years, governments around the world have announced new green spending plans and pledges thereby leading analysts to revise their demand estimates for copper and aluminum.
So, we have on one side public policies and government pledges that create a demand for green technologies; but on the other hand, we also have tight regulations constraining the supply of the essential raw materials required to build green energy thereby leading to Greenflation.
The effects of this greenflation can be felt across different sectors of the economy and eventually in the entire society. No one including businesses, governments and central banks is spared by this greenflation. The spurring demand for green energy and the consequent rise in commodity prices required to create green energy would definitely increase the complexity of monetary policies for the central banks of the world.
Governments around the world with their labour and technological constraints would need to look out for plausible implications on other priorities like equity and public finances. For businesses, the balance among different stakeholders like employers, customers and society will become more complex and difficult.
Greenflation – Transitionary or here to stay?
Perhaps greenflation is transitionary and economies of scale can be applied to eventually rationalise commodity prices and decrease overhead costs like permit fees, customer acquisition costs and installation costs. Better access to funds can probably reduce the threats to the economic viability of clean energy. Having said that, there is still a possibility that inflation will appear further up the green technology supply chain. We can already see some evidence in the case of electric vehicles.
But inflation sources do not tend to distinguish between conventional and electric vehicles. For instance, on average, the price of Tesla vehicles increased by 6.3% as compared to 5% seen in regular cars during the same period. Isabel Schnabel, a German economist, while speaking at an ECB virtual panel, stated that “While in the past energy prices often fell as quickly as they rose, the need to step up the fight against climate change may imply that fossil fuel prices will now not only have to stay elevated, but even have to keep rising if we are to meet the goals of the Paris climate agreement.”. With the rising demand and decreasing supply, the prices for non-renewable energy sources can only go up. As Schnabel likes to put it – “At present, renewable energy has not yet proven sufficiently scalable to meet rapidly rising demand… The combination of insufficient production capacity of renewable energies in the short run, subdued investments in fossil fuels and rising carbon prices means that we risk facing a possibly protracted transition period during which the energy bill will be rising. Gas prices are a case in point.”
Now, the onus is on the governments to acknowledge that this noble transition to a greener future is going to cost dearly in the shorter run. It is not a matter of “if” anymore but rather a matter of “when” this price needs to be paid. Perhaps, the sooner the better.
The Balancing Act
Governments around the world need to rethink their expenditure and income redistribution policies. The challenges posed by this transition to a green economy will need to be faced head-on, to a large extent, by Governments. They need to mobilise their public capital by employing it in the essential infrastructure required to facilitate the green energy transition. Public accounts need to show huge investments towards green electricity and storage. Carbon taxes or the green premium are highly unlikely to cover all these expenditures and hence the public debt has to bear the brunt in the shorter run for the sake of future generations not having to live in adverse climatic conditions.
This transition could also have regressive income impacts and carbon taxation could affect the various strata of the society differently. In the shorter run, this regressive carbon pricing impact needs to be compensated for by the different urban groups affected by it and this compensation again needs to be borne by the government’s exchequer. Income transfer mechanisms need to be in place within the country and between countries to mitigate these regressive impacts.
Reskilling of labour is another priority for the government as we move towards this greener future. Workers need to be skilled for procuring, manufacturing and maintaining greener substitutes, and job creation in these sectors becomes a priority. Obsolescence of physical assets like machinery and equipment as we move towards green technology is something that needs to be compensated for with investments in their greener counterparts.
Still, a long way to go
We are confronted with a conundrum. The cost of doing nothing is surely more in the longer run. We need to supply enough dirty material to build new, clean and green technology. But to achieve this we need to strike a balance. Having stringent regulations in place that reduce the supply of essential raw materials will not help realize the goal. Governments need to understand that this transition needs to be given time – and shutting the old economy too fast could lead to exorbitantly high prices in the newer and the cleaner ones of the future.
Useful links:
- Link up with Salhil Shahane on LinkedIn
- Read a related article: Greenflation: The Achilles heel of the green economy?
- Discover ESSEC Business School, France-Singapore-Morocco
- Apply for the ESSEC GMBA or ESSEC & Mannheim EMBA.
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