Can global inflation be tamed to 2% despite greenflation?
Can global inflation be tamed to 2% or is this wishful thinking, as new pressures from ESG (environmental, social and governance) factors result in ‘Greenflation’ that is not priced into predictions?
Alec Cutler, portfolio manager at Allan Gray’s offshore investment partner Orbis, says it is indeed wishful thinking or a naïve belief that central bankers have the issue under control and will deliver on their promise to get global inflation back to 2%.
“The ESG wave is driving a new inflationary impulse that is gaining steam and does not seem reversible. This is ‘greenflation’ and while it is completely new, we expect it to have a significant impact on inflation going forward.”
The War on Carbon is forcing economies to decarbonise and most frequently, this translates into electrifying.
“Economy wide, this will require a gargantuan amount of capital spending on capacity over the coming decades that may for the first time in history drive lower productivity for the investment outlay.”
Cutler points out that alternative energy and its electricity output are not getting cheaper, given that all the input prices for what is needed to make solar panels and windmills have skyrocketed, owing to the drive for electrification.
“Leading wind turbine maker, Vestas, for example, has seen a 65% drop in its share price from the start of 2021, because input prices have skyrocketed.”
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Adding green energy will add to prices
Shifting from the most efficient energy source to the greenest energy source adds to the cost of the products produced, because not only will the producer have to repay the cost of capital it took to build the required new plant or process across all units produced, but also the higher production cost of each unit at all levels of the supply chain.
“Think about the added expense of building roads from an alternative material to tar that is a cheap residual from the oil refining process, or about the massive investment required to reorient and re-cable electricity transmission systems. Electrification and elimination of carbon-based inputs are greenflationary.”
Alternatively, and increasingly where we are heading now, Cutler says we should admit that we need to continue to burn fossil fuels, but operators must be forced to capture the carbon from the process and store it away forever, a process called Carbon Capture and Sequestration (CCS).
“This makes a lot more sense than trying to electrify. Examples would be natural gas or biomass power generators, refineries and chemical plants where carbon collection processes and takeaway infrastructure can be added to existing plants. However, this is again the definition of inflationary.”
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Even carbon capture and storage require electricity
Orbis estimates that biomass power generator Drax which is taking the lead in installing CCS, will need to use 15% of its current electricity generation capacity to power the decarbonisation process.
“This may be a net win for society, but we cannot get around the inflationary impact it will have. Carbon capture is greenflationary.”
According to Cutler there are several levers that all represent clear swings of the pendulum that helped reduce inflation for the past 10 to 40 years, but all seem to be reversing direction at the same time.
“If 2% is supposedly the inflation a normal healthy economy produces, should we not consider laying on the inflationary impulses coming from reshoring a big chunk of the productive parts of our economy and the impact of the reversal of a 40-year pendulum swing away from labour power?”
Cutler says we do not really need exact answers to have a decent conviction that expectations for 2% global inflation are likely to be disappointed, while some massive new deflationary impulse counterweight is absent.
