Will Concerns Over "Greenflation" Derail the Energy Transition?
No. The inflation attributed to green initiatives (known as “greenflation”) is part of the current inflation narrative, but we doubt concerns related to it will derail the global energy transition. Net zero pledges and related policy frameworks have been rolled out in nearly 200 countries, underpinning a transition already underway due to climate change and technological advancement. And, an extended period of high fossil fuel prices (and related output costs) might expedite the transition by making them less economically competitive with renewables.
Inflation rose in 2021 due to various forces such as ongoing stimulus measures, supply chain issues, and pent-up consumer demand as COVID-related lockdowns eased. Oil & gas prices rose globally, but to a larger extent in Europe as utilities transitioned away from coal, while Russia restricted exports. In addition, metals—such as lithium for batteries and copper for electrification—also saw prices skyrocket as the energy transition accelerated. The impact of this greenflation on consumers has generated concern that some countries might backtrack on transitions underway to cleaner energy production.
We don’t think this is likely for a few reasons. First, policy commitments to the energy transition are increasingly enshrined in law, making them difficult to reverse. As examples, the European Union’s “Fit for 55” package commits the region to generating 40% of energy from renewables by 2030, and both the 2021 US Infrastructure Investment and Jobs Act and recently updated fuel efficiency standards will boost the US market for electric vehicles (EVs) going forward. Policy support reflects growing voter concern over climate change. A recent Pew Research poll across 17 advanced economies found a median 72% of adults think climate change will harm them personally during their lifetimes.
Second, clean energy is increasingly cost competitive with power generated by hydrocarbons, both in terms of supply and in terms of usage. Levelized costs of energy from sources like wind and solar are below those of coal in many regions. Battery prices for EVs have fallen around 90% over the decade, pushing all-in costs of driving EVs close to, and in some cases below, those of comparable internal combustion engine automobiles.
Admittedly, global energy prices could continue to rise in the near term. Producers have been slow to ramp back up production cut during the pandemic, and declining energy industry cap ex in recent years may weigh on supply. However, mechanically the contribution of high energy prices to inflation indexes will drop, at least unless oil rises another 50% in 2022. Further, the cure for high energy prices has historically been high prices. OPEC+ members are gradually bringing supplies back online, and US drillers are likely to continue to increase rig counts, which are up 50% over the past year.
Other forces are regulating the speed of the energy transition. Renewables like wind and solar face intermittency and storage issues, and the electricity they generate is not yet an efficient power source for some types of industry and transport. Technology currently limits both the range and charging time for EVs. Subsidies for renewables could be curtailed in some regions, slowing adoption. Rising prices for metals like copper and lithium may affect cost curves and relative economics, as would political dynamics that disrupt mining output.
However, there are countervailing forces. Battery efficiency is increasing, and storage costs are plummeting. Rising investment and technological advances could further flatten curves for sources like green hydrogen and (perhaps) someday nuclear fusion. Recycling of some raw materials could reduce long-term demand.
In other words, it seems early to worry that political pushback over greenflation is going to derail the energy transition. If anything, short-term squeezes on consumers may increase investment in renewables, further lowering cost curves, which are already competitive with fossil fuels in some cases. Investors should respond by exploring opportunities in clean power and related industries, being mindful of potential corporate winners and losers as consumers and companies adapt. All of this said, valuations should remain a guiding light, and stretched prices for some clean energy plays suggest investors be selective in their approach.
Wade O’Brien, Managing Director, Capital Markets Research
Sehr Dsani, Investment Director, Capital Markets Research