‘Greenflation’: will a more sustainable society come at the cost of rising inflation?

06 October 2021

Alvaro VivancoHead of Emerging Markets Strategy and Head of ESG Macro Desk Strategy.

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The argument that more sustainable outcomes will carry higher costs and thus lead to rising inflation could have huge implications for businesses, central banks, and global governments. But are we really likely to see sustained price rises as a result of going green? Alvaro Vivanco takes a closer look.

Key takeaways:

  • Rising demand for green technologies may drive sustained price increases across global supply chains, from raw materials & commodities through to end products
  • Inflation resulting from the transition to a green economy – or ‘greenflation’ – could have significant implications for businesses, governments, and central banks

As regular readers will know, the interaction between environmental, social and governance (ESG) factors and financial asset performance is something that fascinates us, as well as corporate decision-makers and investors – not least because, whether looking at female board participation or emissions intensity, sustainability has a clear and tangible link with the bottom line.

With sustainability rising up the agenda across businesses, sectors, and regions, we wanted to take a closer look at a rarely considered though potentially crucial macroeconomic consequence of rising green investment: inflation.

Why ‘greenflation’ is an important consideration for businesses, governments, and central banks

The argument that more sustainable outcomes will carry higher costs across large swaths of the economy seems straightforward, at least for the initial phase of the transition to a more sustainable, net-zero future.

Indeed, in recent months, industry commentators have argued that surging clean energy demand is fuelling a commodities boom for minerals used in renewable energy generation and storage. But will higher demand lead to sustained price rises? Intuitively, this seems possible. Green technologies like wind turbines and electric vehicle batteries, for instance, require higher concentrations of certain materials (copper, aluminium, lithium), increasing demand when investments in traditional mining could be limited (due partly to the globalisation of ESG policy).

Any inflationary impact of the shift to a more sustainable society could have critical implications for central banks, themselves key drivers of the sustainability agenda, and the complexity of monetary policy. As government policy is geared increasingly towards promoting sustainability, some of their constraints (labour, technological) and potential implications for other priorities (equity, public finances) will become more prevalent. Balancing these considerations against the broader impact of higher emissions will pose yet more challenges for public policy. For businesses, it could make balancing the needs of employers, customers, and society more difficult, too.

Is there a ‘greenium’ for commodities strongly linked with green technologies?

One way to better understand the impact of ESG on prices in a sustained way is to look at how minerals needed for green technologies perform against a broader basket of commodities. After all, as businesses, governments, and markets double-down on ESG, one would expect the price of minerals needed for green technologies – everything from wind turbines & solar panels to electric vehicles – to come under pressure and command a premium (or ‘greenium’), both because of higher (relative) demand for them and because mining extraction generally carries higher environmental costs.

To investigate, we created estimates of expected long-term demand for various minerals driven by six renewable energy generation technologies, based on the average of different energy mix scenarios geared towards carbon reduction by 2050 (see chart below).

Change in mineral demand from energy technologies through 2050 (compared to October 2021, %)

Sources: Bloomberg, NatWest Markets. The energy mix used for the estimated mineral demand in this chart is based on the average of scenarios with different carbon intensities and climate ambitions, ranging from the status quo to an ambitious scenario limiting global temperature rises to below 2 degrees Celsius by 2050.

We then compared these demand intensities to the change in their prices, looking at the period between May 2020 and September 2021 – which saw a broad commodities rally as the post-pandemic recovery set in. Interestingly, we found that the correlation between expected additional demand and price changes was relatively weak; in fact, minerals used in high concentrations in green technologies, such as silver and aluminium, underperformed, while some of the sharpest price increases have been in minerals scarcely found in them, such as nickel.

Another way to check whether there is a ‘greenium’ for minerals used heavily in green tech is to see whether there is a correlation with global growth assets. Like commodities, global equities rallied aggressively from the middle of last year as pandemic fears receded. A lower correlation for clean energy minerals would suggest that they are being driven an independent factor. We used the MSCI Global Index, which includes stocks from across developed and emerging markets as a proxy.

But when we reviewed the same period as above, we found that correlations were generally between 0.8 and 1 in most cases and had no clear link with their intensity in greener technologies. For example, both nickel and aluminium have correlations above 93% even though they play very different roles in the energy transition.

High commodity prices may start to push up the price of green tech

This doesn’t necessarily imply higher demand for cleaner energy will not become a commodity driver over the long-term. Indeed, for specific minerals such as graphite, lithium and cobalt, rising demand from emerging technologies present a challenge to current production levels, which – absent more efficient extraction methods – could have price implications.

Nor does it mean that inflation won’t appear further up the green technology supply chain as a result of rising commodity prices. In fact, we may be seeing some evidence that this is the case in electric vehicles, which use about 6 times as many minerals as regular cars (see chart below).

Electric cars use far more minerals than conventional cars (kg per car)

Sources: International Energy Agency (IEA), NatWest Markets

Official inflation sources don’t tend to distinguish between conventional and electric vehicles (EV), but given Tesla’s dominance in the US market, it offers a decent proxy for the electric vehicles sector in the country. On average the price of Tesla vehicles has increased by 6.3% this year through July (and more since), greater than the 5% seen for new cars during the same period. Higher mineral prices and perhaps stronger demand may have resulted in higher inflation for EVs, though the differential doesn’t seem that significant in the context of much higher mineral prices.

For more insights on managing the transition to a net-zero economy, check out our Road to COP26 series, get in touch with your NatWest Corporates & Institutions representative, or contact us here.

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