What is Green Inflation?

In today’s post, we will discuss green inflation, a concept we have been frequently hearing lately. Green inflation refers to high demand for eco-friendly products and technologies and their rising prices due to inadequate supply. And adoption of energy transformation and low-carbon production methods also contribute to this impact. So, what are the reasons that lie behind this situation? Let us explore together.

Definition of Green Inflation

Green inflation refers to increasingly rising prices of eco-friendly products due to high demand but inadequate supply. Green inflation, in general, expresses price increase due to the costs of transitioning to green energy. Energy transformation, especially adoption of low-carbon production methods may also create this impact.

While discussing green transformation’s inflationist impact, it is also necessary to assess critical metals and increasing pricing of these. Because critical metals play a significant role in terms of infrastructure and electric vehicle batteries necessary for the development of green technologies. For example, nickel is a mineral source used as a raw material in the production of electric vehicle batteries. If increasingly more nickel is needed for technology due to intense production of electric vehicles, the price of nickel will inevitably rise.

However, let us remember that the only reason for green inflation is not transitioning to green energy or intense production of electric vehicles. Many factors may cause green inflation such as geopolitical events, growth in global economy, setbacks in production activities, exchange rates, change in product quality and alternative products.

Green inflation - such as in general inflation rate formula - cannot be seen as a black-and-white percentage that can be calculated by dividing the difference between the current month’s “consumer price index - CPI” and previous month’s CPI by previous month’s CPI and by multiplying the result by 100%. The calculation results of green inflation consist of estimates because factors causing green inflation are much more extensive. These incoherent estimates originate from the utilization of econometrics approach which combines economy theory, mathematics, and statistics in a single analysis system.

What are the Impacts of Green Inflation?

When the transitioning from fossil fuel utilization to renewable energy is considered, many factors come into play such as the relevant technologies, supply chains that need to be assessed, economic considerations, timing - process factor and both direct and indirect impacts emerge.

Transitioning from fossil fuels to renewable energy, in short “green transition,” basically involves changes in production methods, and it is necessarily associated with the responsibility of high greenhouse gas (GHG) emissions. “Green” production as capital replaces everything with equipment, materials and techniques that produce lower greenhouse gas emissions. This important change can be inflationist.

Despite its long-term benefits, these transitions require significant investments, and they can create an upward pressure on the prices. Energy transformation may also create a macroeconomic impact on inflation, especially in the short-term.

What is Industrial Decarbonization?

Industrial decarbonization involves changing production methods to reduce greenhouse gas emissions. Industrial decarbonization may cause inflation due to limited mineral supply. Green inflation risk increases especially considering matters such as significant increase in the demand for certain valuable chemical elements such as lithium, and supply of minerals which with questionable current reserves.

For example, dependency on limited supply from few countries, as seen in the natural gas monopoly of Russia over Europe, may increase the risk of inflation. Conditions such as supply limitations, geopolitical phenomena, environmental restrictions, demand for metals and minerals create an inflationist configuration in the international markets.

Examples of Green Inflation

To explain green inflation completely, we have to follow the increase in the prices of copper, aluminum, lithium necessary for transitioning from fossil fuels to green energy. For example; “Green aluminum" is more expensive than normal aluminum and while Apple can afford this cost other competing companies cannot.

Renewable technologies require more cable utilization compared to fossil fuels. Solar and wind power plants use 6 times more copper compared to conventional energy generation. As the governments announce their green expenditure plans and commitments, financial analysts continuously increased their growth estimations in copper demand. Therefore, green adjustments increase demand while shrinking supply and fuel green inflation.

Green inflation complicates energy transformation from fossil fuels because the cost of green energy does not fall as rapidly as expected due to the volatility in the supply-demand balance.

Why is Green Inflation Important?

The term “green inflation” was being used in academic communities for some time but not to describe the increase in costs of climate change, only to describe the increase in costs to deal with climate change. Green inflation is now accepted as the cost of energy transformation which will be much less than the cost of climate change.

The heading of an article published in The Atlantic magazine was “Rise of Greenflation” and its subheading was “Extreme weather and energy uncertainty are already sending prices soaring.” The reporter Robinson Meyer opened to discussion how lumber prices soared due to climate change and how extreme weather events caused rise in prices of almost everything by creating problems in supply chains of food, fuel, water, and other goods.

For example, in his book “How to Avoid a Climate Disaster”, Bill Gates argues that pricing over carbon is necessary to encourage innovation;
“We can reduce it by making zero-carbon life cheaper - which requires technical innovation - by making a carbon-emitting product more expensive - which requires political resolve - or by doing both. The idea here is not to punish people for greenhouse gases; it is to encourage scientists to create competitive zero-carbon alternatives. Governments can steer producers and consumers to take more rational decisions by gradually increasing the prices generated during carbon usage in order to reflect the actual cost. Thus, they can promote a zero-carbon life, zero-carbon innovations. The possibility of you inventing a new kind of electro fuel is much higher if you know it cannot be beaten down by artificially cheapened oil.”

So, what benefits do we gain from keeping fossil prices up? Probably more green inflation! As Bill Gates also states, this strategy will create its own problems even though keeping prices up to make alternatives more attractive seems like a solution.

For example, German economist Isabel Schnabel from European Central Bank made the following statement during a panel on Bloomberg;
“While in the past energy prices often fell as quickly as they rose, today what is done to reach the goals of Paris Climate Agreement with the need to accelerate the fight against climate change may mean not only fossil fuel prices are required to remain high, but also even to continue to rise... Insufficient production capacity of renewable energies in short-term and reduction in the investments made in fossil fuels show that energy bill will soar. It is possible that we have a risk of facing a long green transition period. The increasing gas prices are proof of that.”

Why Should We Talk about Green Inflation?

Green inflation emerges as an inevitable consequence of transitioning from fossil fuels to renewable energy. In our post, we tried to look at green inflation from every aspect; in the long-term, although transitioning to renewable energy is inevitable to find a solution for climate change, it seems that this process will bring with it its own troubles.

This transition process causes rising prices due to increasing demand for eco-friendly technologies and insufficient supply of these products. In this post, we talked about what green inflation is, its causes and impacts. Although the benefits of energy transformation are undisputed in the long run, economic challenges and price increases faced during this process cannot be ignored. Innovative solutions and policies will be required to be developed to minimize the impacts of green inflation in the future. Thanks for reading!