More inflation thanks to IPCC report
The IPCC report is widely seen as disturbing and alarming. The urgency is clear. The most important consequence for investors is that it will lead to more inflation. After all, the report’s obvious aim is that more needs to be done to combat global warming.
Higher commodity prices
The way to combat global warming is to switch from fossil fuels to alternative forms of energy. An important part of this energy transition now consists of electrification. Electricity requires a lot of copper. An electric vehicle consumes five times as much copper as a fossil vehicle. A 3-megawatt wind turbine uses a total of 4.7 tonnes of copper. The electricity network must be adapted to the higher consumption, which again requires a lot of copper and also steel. Copper prices are already at their highest level in ten years and strangely enough, this hardly seems to encourage copper producers to increase production. More metals are required for the transition. Electric vehicles also consume more cobalt, nickel, lanthanum, and lithium. Fuel cells need platinum, palladium and rhodium. Wind turbines also use neodymium, dysprosium and terbium. Solar cells consist of cadmium, indium and gallium in addition to silicon. Copper is used in almost all applications. For those who see nuclear power as a solution, it requires more uranium.
Higher oil prices
Alternative energy is heavily subsidised and is, therefore, a competitor to fossil fuels. This causes oil producers to invest less. They are already under great social pressure to invest less. A year ago, everyone stopped investing in new oil production because of the low oil price. Despite the steep rise in oil prices since then, new investments have been delayed. The IPCC report also makes OPEC realise that not all oil will be pumped anymore. OPEC’s strategy now is to get everything out of it financially. The oil price must go up, and this is also possible thanks to the investment discipline resulting from the energy transition. This energy transition is still not visible in the statistics; this year we are going to 100 million barrels a day again. The demand for oil will continue to rise in the coming years. Oil is also used for many applications, from glasses to tires, and is also needed to build the new electrical infrastructure. The first effect of the energy transition is that the demand for oil rises because of the many investments. Less supply, more demand, and therefore higher oil prices.
Higher food prices
To emphasize the urgency of combating climate change, this IPCC report is full of examples of more extreme weather. Further warming will lead to even greater changes in the climate: more intense and frequent heat waves, more heatwaves in the oceans, more and more frequent rainfall, more frequent droughts, more severe tropical cyclones, less and less ice at the North Pole, and a decrease in permafrost. Almost all of them are detrimental to food production. The past forty years have been exceptionally good for food production, perhaps even assisted by global warming. There has been the occasional bad year, but it was always followed by a new record harvest year. We have to go back to the Dust Bowl of the 1930s to see that weather can also have a negative impact on food production for longer periods of time. As the weather becomes more extreme, it does affect food production. The inevitable result: higher food prices.
Higher CO2 prices
Global warming is a negative external effect that is not (yet) incorporated in the price of products. One way to incorporate the negative effect is to price CO2. There are now some important regions where this is happening: Europe, in parts of the United States and Canada and, since June this year, also in China. This year, CO2 prices in Europe have risen sharply to over EUR 55 per tonne. The global Karbon ETF is even up 50% this year. Higher CO2 prices will be passed on in product prices. Like higher prices for metals and oil, this will increase the prices of many products.
Higher energy costs
The energy transition does not mean that energy will become cheaper. In Germany, renewable energy is already a large part of total energy production, and this has led to higher prices there. Moreover, alternative energy cannot always deliver, as we have recently seen in Texas and in California. If alternative energy were cheaper than energy from existing fossil fuels, no new coal-fired power plants would be built today. The most recent gas plants (CCGT) are still 75 percent cheaper than sun and wind. Such power plants will continue to be needed as backups, also because extreme weather is more common. We must be prepared to pay a lot more for energy if we want to switch completely to alternative energy.
Higher interest rates
The energy transition will cost a lot of money. Much of that infrastructure will be financed with more debt. The demand for finance may cause interest rates to rise. It is more likely that interest rates will rise because of rising inflation. The risk of higher inflation is that it gets between people’s heads and that they would rather buy something today than tomorrow. Take the housing market, for example the rise in house prices is partly due to the fact that buyers assume that house prices will continue to rise. The same can happen with cars, products with lots of chips or even shoes. Inflation then has a self-reinforcing effect, and rising prices eventually lead to rising wages. The Fed is now buying 56 percent of the newly issued US government debt since the start of the pandemic. They are also buying mortgage bonds, while the American housing market could really do without this help. The three criteria that the Fed used in the past to raise interest rates have been met: unemployment is low, inflation has reached 2 percent, and is expected to stay above 2 percent for some time.
In recent decades, the development of inflation has been moderate. It was also an ideal environment for the switch to alternative energy. Stable prices, more than enough raw materials at extremely low prices, low-interest rates, and plenty of investments to further improve the processes in the field of alternative energy. For the future, only those investments are guaranteed thanks to the IPCC report. Investors would do well to count on a higher level of inflation in the future.