Greenflation – The Cost Of Energy Transition

Put simply, the term “greenflation” is used to characterize the increase in energy and raw material costs brought on by the green transition. When there is a greater demand for raw resources, the price of those raw materials tends to rise, which can be brought on by a number of causes like improved efficiency, a rise in the demand for goods and services, stricter environmental rules, etc,… Due to the growing demand for electricity and other sources of energy, energy costs often increase along with those of raw materials.

Greenflation – the rise in energy and raw material expenses during the green transition.

Where does greenflation first come from?

It may not be as temporary as we once believed that the inflation that accompanied post-pandemic recovery plans was. The phrase “greenflation” expresses the idea that price rises might be long-lasting as countries work to fulfill their environmental obligations. Strategic materials for these infrastructures are becoming more expensive as spending on carbon-free technology increases.

In the meantime, stricter environmental regulations that prohibit investment in extremely polluting mining operations are also reducing the supply of raw materials, which further drives up prices. As a result, the cost of the green transition rises as it is adopted more extensively.

What causes an increase?

Gas prices rise as a result of carbon taxes, which are sensible from an environmental standpoint. Lithium, a crucial element that is required to produce the batteries for electric automobiles, saw a 400% price spike in 2021. While the demand for Lithium is anticipated to increase by 40 times by the year 2040, this trend is predicted to continue.

The same is true for aluminum, which cost quadrupled between 2021 and 2022 before reaching an all-time high and being utilized to manufacture solar and wind energy. Since China, which produces 60% of the world’s aluminum, has chosen to restrict the building of new, highly polluting factories in order to attain carbon neutrality, this trend is also anticipated to continue.

Carbon taxes, while environmentally sound, lead to increased gas prices.

Furthermore, the cost of transition is increasing as nations throughout the world set ambitious goals for decarbonization, tightening laws, and even prohibiting specific fuels and raw materials. Due to the additional environmental and social impact assessments needed, mining projects in Chile and Peru, which provide 40% of the world’s copper, now take 10 years to complete instead of the usual five.

As a result, producers of commodities are making less investments than they otherwise would and giving cash back to shareholders. Thus, there is a shortage of fresh supply, which raises prices. This is an example of greenflation and shows how well-intentioned actions, like the top-down enforcement of ESG requirements, may have unforeseen results.

What policymakers and governments should do to limit a rise in prices which is hurting households and companies?

To restore price stability, monetary policy will need to tighten if greenflation proves to be permanent, as appears likely, and starts to impact inputs across the economy, such as the level of wages. Notably, the US Federal Reserve recently moved to signal at least six interest rate increases for 2022, with the first one of a quarter-point increase announced on March 16 and the market anticipating even more.

However, raising interest rates could lead to tensions between central banks and governments, which are already under pressure to boost spending in order to aid in the pandemic’s recovery, compensate households, particularly poorer ones, for rising prices, and finance the energy transition. This will lead to disorganized decision-making and rising societal unrest.

Since combating climate change and preserving people’s living standards are both crucial, there is no simple solution and giving one more priority would seem to harm the other. We might be able to overcome this by concentrating not only on decarbonizing supply (transport, industry, and electricity grids), but also on decarbonizing demand. To put it another way, to lessen the amount of carbon that we produce by altering the way that we live, eat, and travel.

Governments should take action to limit the price increases that are affecting both households and companies.

This also has significant social and ethical repercussions, although some of these may be lessened by social expenditure paid for, for instance, by a higher carbon tax. In the end, there is no free lunch when it comes to the energy transition; today’s greenflation is only the first illustration.

However, there are certain methods to reduce the expense of the switch to green energy. Low-income French individuals received an “energy check” in 2021. By the conclusion of their first “life cycle,” or about 2030, the globe should begin recycling electric vehicle batteries in large quantities, which will supply some of the metals required to create clean technology.

Finally, the EU hopes to ensure a “socially equitable transition” through its Green Deal by establishing a social fund for climate change that would fight poverty brought on by high energy costs and poor transportation options. Thus, from 2025 to 2032, more than 70 billion euros will be released in order to encourage individuals and organizations to spend money on renewable energy sources, building insulation, and environmentally friendly transportation.