Greenflation: When inflation meets energy transition


The battle to cool down the planet appears, ironically, to be heating up the economy. This is the essence of ‘greenflation’: the extra boost given to prices when conventional cost-push inflation – which we are currently experiencing as the world recovers from the pandemic thanks to massive fiscal/monetary stimulus and large excess savings – is supercharged by the costs of the green transition.

Energy transition comes at a substantial cost 

Not only is greenflation a non negligeable part of the higher wholesale and consumer prices that, since spring 2021, have been rapidly spreading from commodity and energy costs to electricity bills, food and even rent. It is also proving to be sticky, meaning that inflation as a whole is turning out to be less transitory than first hoped, leading to volatility across bond and equity markets and the need for a decisive tightening of monetary policy. 

In hindsight, it was unrealistic to expect a task as enormous and enormously complicated and costly as the energy transition to cause no dislocation. Consider the vast amount of commodities required to scale up clean energy production. 

“Building a single 100-Megawatt wind farm requires 30,000 tons of iron ore, 50,000 tons of concrete and 900 tons of non-recyclable plastics1.” 

Meanwhile, the lithium-ion battery in most electric vehicles (EVs) requires around 25 pounds of lithium and 30 pounds of cobalt as well as quantities of nickel, copper, graphite, steel and aluminium2. According to the International Energy Agency, the number of EVs is set to rise to 200M by 2030, from 18M today. Even that is only a fraction of the roughly 1.2 billion combustion engine vehicles currently on the road – so the demand for batteries will remain huge for years to come3

This is, unsurprisingly, fuelling a commodity boom. Yet despite mindboggling increases in prices lately, minerals such as copper, nickel, lithium and cobalt are in short supply. Partly this is due to geopolitical reasons: some rare earth metals, for example, are highly concentrated in just one or two countries. A second factor, however, is that the supply response one would expect from profit-maximising mining and energy companies is not forthcoming, or only very slowly. This can be partly explained by slower investments as their costs of capital increase and pressures from shareholders to reduce emissions mount. 

Moreover, the war in Ukraine is disrupting supply chains and having a significant impact on the price of commodities. Take the recent unprecedented increase in the price of nickel, a key metal for batteries and wind turbines, for example. This crisis is also causing European countries to seriously rethink their energy security strategies. Accelerating the transition to renewables is on the table in most capitals and will likely add to the upward price pressure key energy transition related commodities are seeing. 

As countries around the world are setting bold targets for decarbonisation, they are tightening regulations and even outlawing certain raw materials and fuels altogether – raising the costs of transition. In Chile and Peru, which supply 40% of the world’s copper, mining projects that used to take five years now take ten because of the extra environmental and social impact studies required4

As a result, commodity manufacturers are investing less than they otherwise would and are instead handing cash back to shareholders. The consequent lack of new supply is driving up prices. This is greenflation in action and demonstrates that good intentions, such as the top-down imposition of ESG standards, can have unintended consequences. 

How should policymakers react to greenflation? 

If it remains largely confined to energy and commodity prices, they may be able to look through it, as European Central Bank executive board member Isabel Schnabel suggested in a recent speech5 – in the same way that they exclude volatile food prices from their underlying inflation measures. 

However, if greenflation turns out to be persistent, as seems likely, and begins to affect inputs across the economy, such as the level of wages, then monetary policy will have to tighten in order to reimpose price stability. Notably, the US Federal Reserve recently switched to signalling at least six interest rate hikes during 2022, the first one of a quarter of a percentage point having been announced on 16 March, while the market expects even more.  

The problem is that raising interest rates could create some tensions between central banks and governments that are under pressure to increase spending to boost recovery from the pandemic, to compensate households, especially poorer ones, for rising prices – and, indeed, to finance the energy transition. This is a recipe for uncoordinated decision making and growing social tensions. 

There is no easy solution, since fighting climate change and protecting people’s living standards are both essential but prioritising one would appear to set back the other. A potential way through could be to not only focus our attention on decarbonising supply (electricity grids, transport and industries) but to also focus on decarbonizing demand. In other words, to reduce the amount of carbon we produce by changing how we travel, eat and live.  

This too has enormous social and ethical implications, though some of these might be mitigated through social spending financed via, for example, a (higher) carbon tax. Ultimately, when it comes to the energy transition there is no free lunch – and today’s greenflation is just the first example. 

Kokou Agbo-Bloua, Global Head of Economics, Cross-Asset and Quant Research - UK Head of Research, Societe Generale Corporate and Investment Banking

1Mines, Minerals, and “Green” Energy: A Reality Check, the Manhattan Institute, July 2020.
3Global EV Outlook 2022, Securing supplies for an electric future, International Energy Agency, May 2022.
5“Looking through higher energy prices? Monetary policy and the green transition” - American Finance Association 2022 Virtual Annual Meeting.

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