Greenflation: How the energy transition is affecting capital markets

Do capital markets face a risk of "greenflation"?

As the ongoing energy transition fuels rising electricity prices, "greenflation" is giving capital markets plenty to talk about. The implications, and tips for investors.

Capital markets unsettled by rising electricity prices

The recent jump in electricity prices has sparked a socio-political discussion about inflation, climate policy, and the consequences for capital markets. Experts warn of an ongoing wave of price increases due to the energy transition. In a bid to calm matters in view of the steady rise in energy prices, the European Commission has recently been looking at awarding a sustainability label for electricity produced from nuclear power or natural gas. The EU's stated goal is to increase the share of renewable energy sources from the current 39% to 85% by 2050.

Greenflation: Capital markets concerned about rising electricity prices

Capital markets concerned by rising electricity prices

Indexed electricity prices (100 = January 1, 2021)
Last data point: December 23, 2021
Source: Bloomberg, Credit Suisse

Should capital markets be expecting greenflation?

Capital markets are in fear of greenflation. This is the term used to describe inflation caused by higher prices for commodities increasingly in demand due to the green transformation.

It is a matter of concern to investors given that the cost of the energy transition is still unknown. One thing is certain: The rise in global bond yields has triggered considerable inflationary fears and caused equity prices around the world to gyrate.

Capital markets: Clean energy vs. nuclear energy indices

Capital markets: Clean energy vs. nuclear energy indices

Indexed (100 = January 1, 2015)
Last data point: January 10, 2022
Source: Bloomberg, Credit Suisse

Significant mismatch in carbon prices contributing to greenflation

The International Monetary Fund (IMF) estimates that a minimum global carbon price of approximately USD 75 per ton is needed in order to achieve the Paris climate agreement targets, which include a reduction in EU carbon emissions to net zero by 2050. Yet the world is still a long way off this level of carbon pricing – both politically and in de facto terms, with a current price of less than USD 4 per ton.

Although renewable energy is now cheaper than all fossil fuels and even cheaper than nuclear power, the problem is scalability. Fact is, the construction of new power stations takes time and capital. The cost of building renewable infrastructure is rising. At the same time, the production capacity of fossil fuels is shrinking and making them more expensive.

This is resulting in fluctuations in relative prices, generally higher inflation volatility, as well as knock-on effects on politics, business, and society.

Greenflation: Renewables are not very scalable

Greenflation: Renewables are not very scalable

Source: Our World in Data, Lazard, BP, Credit Suisse

What does this mean in concrete terms? Three tips for investors.

The Credit Suisse Investment Committee continues to see solid support for its view of renewed, strong growth in economic activity, earnings, and productivity. Equally, it believes there is justification for the cautious positioning of investors as well as the persistently high level of liquidity within the economy as a whole. It therefore iterates its current investment strategy and does not see any compelling reason to alter anything in one direction or the other.

Future of nuclear power?

The new EU Green Deal taxonomy and proposed inclusion of nuclear power and natural gas in ESG themes will likely lead to growth in the corresponding infrastructure.

Tailwind for defensive stocks

Monetary policy – led by the US Federal Reserve – is striving for a new "normal" amid rising prices. Rate moves and a normalization of bond purchases will probably be part and parcel of this, as will greater financial market volatility.

Through infrastructure programs, fiscal policy in the US and Europe will aim to stimulate the energy transition at the same time. The transition from pandemic to endemic is also likely to lead to the end of supply-chain issues and a peaking of inflation. The transition phase could be a turbulent time on markets, with defensive stocks likely to enjoy a tailwind.

Thematic investing

The energy transition Supertrend is still at an early stage in its development. If you had bought a share in Apple in 1980, you would now be a millionaire. This example illustrates the importance of selecting the right topic when investing, as well as the fact that patience is a timeless virtue.

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