From the prolific (not kidding, I don't think he ever stops thinking about this stuff) Peter Sainsbury's Substack, Carbon Risk, May 10:
The lumpy, unpredictable nature of climate change and the transition towards zero carbon is likely to mean that inflation will be higher, and more volatile in the future.
Much of this inflationary pressure relates to the impact that climate shocks have on the supply of essential commodities, especially agricultural and energy. However, the transition to a zero carbon economy (and the costs that implies) is likely to become an increasingly important contributor to high and volatile inflation.
Up until relatively recently, carbon prices were low and the impact on carbon abatement behaviour was limited. Over the longer term though, higher carbon prices provide the incentive to decarbonise power generation and industrial assets. However, these assets take time to come to fruition, which means that in the short-term capital is diverted away from high carbon sectors such as fossil fuels.
Higher carbon prices also represent a cost that business must either pass onto their consumers, or alternatively absorb it and see their margins cut. Uncertainty over short and long term carbon prices will become more and more important in determining inflationary expectations.
Volatile inflation is particularly pernicious due to the significant cost it imposes on economic activity resulting from the the uncertainty it introduces into decision making (see 'Greenflation' fears are a twin threat to the EUs monetary and climate credibility.
Central bankers should play a pivotal role in communicating the economic trade-offs involved in decarbonisation. They have the power to provide a stable foundation for the investment and behaviour change required. Without that foundation then carbon prices are likely to be higher, and for much longer.
‘Greenflationary’ expectations
The degree to which inflation will result from carbon pricing ultimately depends on where we are today.
Compliance carbon markets covered ~17% of global emissions in 2021 and posted a carbon market-weighted average price of ~$28 per tonne (~€26.50). The low average price reflects the large share of emissions covered by China’s nascent carbon market and it’s relatively low carbon price; launched in July 2021 the scheme closed the year below $10 per tonne. Taking account of other countries where carbon taxes exist and carbon pricing of some sort (either taxes or carbon markets) covers around 22% of global emissions. The other 78% are starting from zero.
On a global basis this means the price of carbon is low, really low.
~$2.50 per tonne.
We are so very early. Global carbon prices need to be well north of $75 per tonne if the world is to decarbonise in the timescales its leaders have committed to. The inflationary implications of higher carbon prices has barely begun.
Impact of higher cost of carbon on energy prices
Credit Suisse estimates that every $10 per tonne increase in the carbon price (equivalent to €9.50), will add ~$4 per barrel (bbl) to the oil price. At an oil price of $100 per bbl, this would imply a 21% and 42% increase in prices if carbon rose to $50 per tonne and $100 per tonne respectively.
When it comes to natural gas the bank estimates that every $10 per tonne increase in the carbon price would add ~$0.5 per MMBtu. At $8 per MMBtu, a $50 per tonne carbon price would raise natural gas prices by 34%, and 68% at a carbon price of $100 per tonne.
Crucially, the estimates here only account for Scope 3 emissions, i.e. those involved with the combustion of the fossil fuels. If Scope 1 and Scope 2 emissions are included then the impact on energy prices for every $10 increase in the carbon price could be some 25% higher.1
Remember that higher carbon prices could be introduced through the compliance markets (e.g. via steeper floor price or expanding the coverage, etc.), or through direct carbon taxes, or some combination of the two (e.g. several countries in Europe have a separate carbon tax and are also part of the EU ETS).
Impact on inflation across economies....
....MUCH MORE
