What is Greenflation?

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    Stockholm (NordSIP) – Having previously considered the meaning, drivers and effects of climateflation and fossilflation, this series on the inflationary effects of climate change concludes with a review of the last of the inflationary mechanisms tied to climate change and global warming: “greenflation”.

    According to “A new age of energy inflation: climateflation, fossilflation and greenflation”, a 2022 speech given by Isabel Schnabel, a Member of the Executive Board of the ECB, greenflation is that part of inflation that can be attributed to shifts in the economy towards increased used of green technologies.

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    According to the International Energy Agency’s (IEA) 2050 Net-Zero Roadmap, renewables are expected to rise from representing 10% of our current energy mix to 60% in the next 27 years. Although not an exhaustive list of the tools that will characterise the green transition, batteries, solar panels and wind turbines, are perhaps the most salient technologies that dominate our collective idea of what a climate-friendly future might look like. Other technologies that come under this rubric include LEDs, smart grids and heat pumps. Achieving this goal will require increased investment in renewable energies and exposure to the whims of their associated commodities.

    As Schnabel puts it, “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. Yet, as demand rises, supply is constrained in the short and medium term. It typically takes five to ten years to develop new mines.” The result of this increased demand in the face of a slow adjusting supply is what Schnabel and others have come to refer to as “greenflation”.

    Metals and Minerals of the Green Transition

    Focusing on the most prominent mineral components necessary to build solar panels, wind turbines and electric batteries can provide a practical template of the relevant commodities to consider. The list can vary, but we can identify at least 17 elements that appear to be crucial for the energy transition.

    The United States Geological Survey (USGS) points to 11 miscellaneous commodities as “vital to renewable energy infrastructure like solar panels, wind turbines and batteries.” Solar panels are highly dependent on arsenic, gallium, germanium, indium and tellurium. Cobalt, graphite, lithium and manganese are some of the most prominent components of modern batteries. Lastly, wind turbines are highly dependent on Aluminium and rare-earth elements.

    According to the EU’s Joint Research Centre (EU JRC), the key rare-earth elements for clean energy technologies are neodymium, praseodymium, dysprosium and terbium, which are used to manufacture neodymium–iron–boron (NdFeB) permanent magnets, used to build smaller and lighter electricity generators of wind turbines. Moreover, the Chicago Mercantile Exchange (CME), adds that Copper, Silver and Platinum are also crucial elements for electricity transmission and as catalysts in batteries.

    Given these facts, the green transition cannot but expose the world to increased influence from the shifts in the prices of these commodities on the general level of consumer and producer prices.

    The Economics of the Green Transition

    According to the IMF, the increased demand from the renewable energy industry for minerals and metals could be problematic given potential shortfalls in the supply needed to satisfy 2050 Net-Zero-consistent demand. “Given the projected increase in metals consumption through 2050 under a net zero scenario, current production rates of graphite, cobalt, vanadium, and nickel appear inadequate, showing a more than two-thirds gap versus the demand. Current copper, lithium and platinum supplies also are inadequate to satisfy future needs, with a 30% to 40% gap versus demand,” the IMF argues.

    The IEA concurs, noting that “mineral demand for clean energy technologies is set to quadruple by 2050 in both the Announced Pledges and Net Zero Scenarios, with annual revenues reaching USD 400 billion.”

    The picture painted by these estimates is clear: As efforts to transition to a less fossil fuel energy economy proceed at a fast pace, demand will exceed supply, which facing physical constraints to its capacity and delays to its upgrade, will struggle to catch up. At this stage, the immutable economic truth that demand in excess of supply causes prices to rise will materialise and cause commodity prices to rise.

    As the inputs of renewable energy technologies increase in price, the costs of solar panels, wind turbines and batteries will increase. Faced with decreased profits, renewable energy companies will be forced to pass the cost of these price increases to consumers as they build new renewable energy capacity, or else struggle to stay afloat.

    Climate Change, Supply Changes and Geopolitics

    Following Russia’s paradigmatic invasion of the Ukraine and the ongoing instability with Taiwan, it is not surprising to find that cleantech and greenflation also interact with geopolitical risk.

    As the IMF highlights, one of the issues facing the green transition is the concentration of these commodities in third countries. “The Democratic Republic of the Congo, for example, accounts for about 70% of cobalt output and half of reserves. The role is so dominant that the energy transition could become more difficult if the country can’t expand mining operations. Similar risks apply to China, Chile, and South Africa, which are all top producers for some of the metals most crucial to the energy transition. Breakdowns or disruptions in their institutions, regulations, or policies could complicate supply growth.”

    According to the Fragile Countries Index, the DRC and Mozambique are the 4th, and the 21st most fragile countries in the world, while Freedom House ranks China, Russia and Kazakhstan as the 9th, 16th and 23rd least free countries in the world, respectively.

    The result of this concentration, especially in countries that are perceived to be potentially unstable and politically unaccountable, is that the supply chain of the energy transition is heavily exposed to geopolitical risk. “A few producers will benefit disproportionately from growing demand. Conversely, this lays bare energy transition risks from supply bottlenecks should investments in production capacity not meet demand, or in case of potential geopolitical risk inside or between producer nations,” the IMF adds.

    Although geopolitical risk is a separate issue from climate change, it is nevertheless a consideration that factors into the effects of climate change and the energy transition, without which cleantech investments and dependence on unstandble regimes, might not have materialised to the same extent. The issue is particularly pertinent in light of the ongoing Ukrainian conflict, which caused the price of lithium, nickel and zink to soar in 2022.

    Is Investment Picking Up?

    It is difficult to quantify precisely the global level of investment in renewable energy.  Nevertheless, there seem to be some greenshoots. The 2022 inflation reduction act (IRA) unlocked US$369 billion in cleantech investment in the USA. In response, the EU announced its €225 billion Green Deal Industrial Plan, the latest part of its Green Deal. Meanwhile, China invested US$80 billion in 2019 alone.

    Perhaps more importantly, renewable energy markets appear to have reached maturity. “In the early days of the sector, governments provided direct subsidies to support the development of renewable energy infrastructure. Energy generators would get a fixed and generous price and that would support low-cost financing of these early projects. As the cost of the technology has fallen with time, renewables can now increasingly compete directly with fossil fuels in fully unsubsidized market settings, and the necessity of subsidies has faded away,” Barney Coles, Managing Director and Co-head of Capital Dynamics’ Clean Energy team, told NordSIP in 2022.

    Dario Bertagna, Managing Director and Co-Head of the Clean Energy Infrastructure team at Capital Dynamics, noted in 2021 that the stability provided by long-term purchase power agreement (PPAs) led to a boom in this market, with PPA contracts more than doubling between 2017 and 2020. “2020 was a record-breaking year in terms of new contracts signed worth almost 4 Gigawatts (GW) in PPAs, up from the previous record of 2.5 GW announced in 2019,” Bertagna told NordSIP.

    These values still fall substantially short of  the US$4 trillion annual investments required by 2030 to meet the Paris Agreement targets, but suggest an increased momentum. Should such a trend proceed apace, we may meet those goals without too much price disruption.

    Note: This article is part of a series on the effects of climate change on inflation. Click here to read an introduction to the series and find its accompanying articles.

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