In 2022, inflation is cited as the most concerning issue worldwide. From the Russian-Ukraine war and its trickle-down effects on food and energy security to the unequal recovery from the COVID-19 pandemic across nations, inflation is necessarily caused by the complexity of interconnected global economic conditions.
However, another important facet of this circumstance is a heightened awareness of climate issues, Energy Transition and net-zero goals. While all of these socio-political issues are occurring, climate change also proclaimed prominence in the global consciousness, turning greenflation into a growing pain that is increasingly non-negligible.
Essentially, this present economic phenomenon called greenflation happens when the costs of transitioning from traditional to renewable energy sources become so high that it causes prices of other goods and services to increase significantly.
As sustainability and environmental, social and governance (ESG) factors become hot global topics, greenflation continues to occur through both direct subsidies for renewable energy production and indirect costs. In order to phase out coal, oil and gas to reach net-zero goals, the demand and costs of essential materials required for renewable energy, such as nickel, copper, aluminium, lithium, and cobalt, increase along with the prices of other commodities. Indirect costs happen in instances such as job losses in the fossil fuel, coal or gas industry. Ultimately, the cumulative effect of these economic interlinkages causes greenflation to become a global challenge, urging countries to push out policies and subsidies to invest in renewable energy sources.
According to experts, this transition to a cleaner and greener economy is inherently inflationary, as industries across the globe have to relook at outdated infrastructure to rebuild more sustainable alternatives. Although economists are still undecided on the extent of the impacts of greenflation, it is ideal for savvy business owners and investors to remain prepared and ready for a change in their business or investment strategies.
For business owners, this transition is likely to drive up electricity prices as other forms of generation, such as nuclear or coal, are eased off the market. With higher costs associated with renewable energy and inflated energy prices due to limited supply, greenflation thus presents a risk to businesses that are highly vulnerable to electricity cost volatility.
To minimise these risks, businesses need to identify and understand the potential implications of greenflation on their bottom line and develop strategies for managing exposure accordingly.
One strategy for mitigating business risk is through hedging electricity prices. This approach uses derivatives such as futures contracts or forwards in order to lock in energy prices over a certain period of time. This effectively protects businesses against price fluctuations caused by greenflation but can be risky depending on the forecasted direction of pricing levels.
Another critical strategy is to make energy efficiency a business priority and long-term goal. This tactic is often the most cost-effective way to improve competitiveness in the long run. Investing in energy-efficient technologies and processes can not only help reduce electricity costs but also reduce emissions associated with energy production.
Additionally, businesses should consider sourcing from renewable projects or directly investing in renewable infrastructure, as opposed to relying solely on their current energy suppliers. This diversification of sources will further protect against volatile prices resulting from greenflation.
Beyond the intermittent and direct concerns for business owners, what does greenflation mean for investors and the future of the markets? As stock prices and the trends of the market are increasingly driven by ethical reasons, investors need to look beyond economic circumstances in their investing considerations.
However, when everyone is overly incentivised to pour money into the limited supply of green companies, greenflation is exacerbated due to the lack of investment in other necessary economies.
Due to unfavourable natural conditions across the globe, the performance of renewable energy generation was impeded, increasing global energy insecurity with no suitable alternatives made available. Whether it be hydro generation, wind generation or nuclear generation, the underperformance of these renewable and nuclear energy generations in 2022 occurred concurrently with the world’s inability to access Russia’s natural gas supplies.
This increases the need for oil and gas companies to generate more supplies; however, they are continually faced with stricter green-tinted regulations and a lack of investments due to the demands of a net-zero economy. Thus, in this current situation, we see skyrocketing prices for fossil fuels, insufficient supplies of renewable and nuclear-generated energy and a distinct limit to ESG investment options.
Evidently, there is a need for more conservative assumptions of renewable energy capacity even as a continued focus on renewable energy capacity is embraced. Time, investment, resources and more research are required in the advancement of possible solutions like hard tech to ensure that the supply of renewable energy can meet the demands of the global population.
Hence, in the meantime, investors can consider mixing selected ESG leaders into a pool of other inflation-sensitive investments. As fossil-fuel-generated energy will continue to see demand in developing countries in the midst of transitioning to clean energy, oil and gas stocks should not be demonised altogether.
After all, while it may be ideal for all nations to embrace the demands of a zero-carbon future, it is simply impossible to expect the same level of progress, and a more balanced approach is required. Thus, amid the Energy Transition, investors have to make ethical and economically viable decisions that will support market growth to push for a better, more profitable and sustainable future
Ultimately, businesses and investors must stay informed about the trends that are driving up electricity prices or market shifts and develop strategies for mitigating risk accordingly. Timely investments into renewables infrastructure or derivatives trading could be beneficial for those seeking to minimise exposure to greenflation risks. In addition, companies should remain open to exploring new opportunities related to clean energy, such as energy storage or off-site renewables generation, in order to maximise cost savings and maintain competitive advantages. Investors can also take proactive steps to prepare for greenflation by balancing out investing options to ensure their assets remain competitive and secure in the long run.