Carbon pricing is coming, but watch out for “greenflation”
By Terry Raven, Director, European Equities, Fidelity International; Gita Bal, Global Head of Research, Fixed Income, Fidelity International; and Amber Stevenson, Investment Writer, Fidelity International
Carbon pricing is an inescapable tool in the race to net zero, according to Fidelity’s latest Analyst Survey . But a higher carbon price could fuel inflationary pressures, especially when combined with the capital expenditure (capex) required to go green.
Companies expect carbon pricing.
Over a third of companies will adapt their business models in anticipation of a future carbon price over the next three years, according to a survey of Fidelity analysts. In high-emitting industries such as energy and materials, the analysts believe the proportion is closer to two-thirds (see Chart 1). This suggests many companies are acting to get ahead of the financial and regulatory effects of carbon pricing, especially in those sectors where a carbon price will make new technologies more viable.
Chart 1: Some companies anticipate a future carbon price and are seeking to adapt.
Question: “Over the next three years, what proportion of your companies do you expect will adapt their businesses in anticipation of a future carbon price?” Chart shows the average response. Source: Fidelity International, September 2021.
Some form of carbon pricing is likely to be on the table at the U.N. climate conference in Glasgow. A global regime would push companies to adapt, but could be inflationary if implemented too aggressively. Keeping the carbon price too low, however, would slow the transition and make companies more vulnerable to sharper price hikes in the future.
Analysts have put hard numbers on the effect a carbon price could have. “A carbon tax or carbon cost above $100 a ton [up from $3 today] would have a dramatic impact. Capex plans would be adjusted quickly,” argues an analyst covering North American and European chemicals companies.
Companies are beginning to adapt
The good news is that the analysts believe over half of companies globally have begun to adapt their business models for a pathway to net zero by 2030 – far sooner than the Paris Agreement deadline of 2050. However, only 7% are taking far-reaching action, fewer than may need to in order to achieve that target (see Chart 2). Government policy may be required to fill the gap. Fidelity analysts have identified incentives and regulation as the most effective measures to help firms get to net zero, with carbon pricing being the top policy choice for the energy sector.
Chart 2: Companies are starting to adapt their business models.
Question: “What proportion of your companies are acting today to change their business models for a pathway to net zero by 2030?” Chart shows the average response. Source: Fidelity International, September 2021.
The transition will fuel “greenflation.”
Policy interventions will, however, have consequences. Fidelity analysts expect that around a quarter of their companies will incur higher costs due to carbon pricing over the next three years, with the energy, materials and industrials sectors most exposed. “European airlines are required to purchase carbon credits under the E.U. cap and trade system. Prices are rising as allowances reduce,” reports one analyst covering European industrials.
Many companies will face other types of costs from going green. Just over half the analysts expect the low-carbon transition to increase operating costs for their companies over the next three years, while 60% believe it will push up capital expenditure (see Chart 3).
Chart 3: The transition will drive up costs for many
Questions: “How, if at all, do you expect the low-carbon transition to impact your companies’ operating costs?” and “How, if at all, do you expect the low-carbon transition to impact your companies’ capex?” Source: Fidelity International, September 2021.
But that investment could pay off. Firms that increase transition-related capex today could lower their operating costs sooner. The utilities industry is one example. “Utility companies are moving toward renewable generation,” reports one analyst covering utilities in emerging Europe, the Middle East and Latin America. “This requires significant upfront capex, but the marginal cost of production then falls to zero. This is compared with traditional generation methods that require a commodity input.”
Paying for it all
Nonetheless, the transition is likely to increase upfront costs for most companies. The analysts expect companies will fund these costs predominantly from internal resources such as cash (see Chart 4). But a growing proportion of analysts expect companies to raise prices for consumers, which could further fuel greenflation.
Not all companies have the pricing power to do this, however. Some will need government subsidies, while others will rely on debt. “As my companies are price takers, they can’t pass prices onto consumers, so they will need fiscal incentives to continue investment,” says an analyst covering European materials companies.
Chart 4: Companies will need to fund the transition.
Question: “How do you expect your companies to fund the low-carbon transition over the following periods? Tick all that apply.” Source: Fidelity International, September 2021.
We are carbon-based organisms in a carbon-fuelled economy. Making the transition to a lower-carbon world will require new policies to break energy-usage habits that have become entrenched over centuries. Even if new technologies ultimately lower costs, the policies needed to get there could pour greenflation fuel on the post-pandemic price fire already underway. But Fidelity’s analysts suggest that, for some companies, the costs of delaying policy action, even by a few years, will be many times higher.
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