Climate change, central banking and inflation: the energy conundrum

Global - Dec 07 2018

Recently the European Central Bank, through Members of its Executive Board, first Benoît Cœuré [1] on November 8th then Yves Mersch [2] on November 27th, outlined some views on how the monetary authorities of the world’s richest bloc approach the question of climate disruption. Obviously, climate is but a number of factors being taken into consideration by the European central bankers while conducting their monetary policy, but it is interesting to see how that particular factor has now been woven into their overall thought canvas.

 

In their respective speeches, both officials talked about the ECB’s role in the Green Bond market, climate disruption’s impact on the strategy and conduct of monetary policy (still open for debate apparently), but it is noteworthy too that, in the fight against climate disruption, they also mentioned renewable energy: Mr. Cœuré to warn about the potential deflationary effects of a scaling-up in renewables, Mr. Mersch -with regards to that threat- to dismiss any doubt about the ECB delivering on its price stability mandate. According to the former, whereas changes in the effective supply of oil are at present a recurrent source of disruption, too quick a switch towards renewables could push headline inflation towards negative territory and make the task harder for central banks to reach inflation just shy of 2%, because companies, consumers and markets would expect medium-term inflation to stay subdued due to the changing energy landscape. The latter ECB official is more sanguine: regardless of what happens to energy prices, “credible monetary policy, conducted by an independent central bank, anchors overall inflation expectations”…

 

To put things into perspective and ponder the ECB’s concerns, one can consider how the price of oil (and with it Big Oil’s cashflows) has evolved over the last four years, going from $100 to $40 and back to nearly $80, with corresponding effects on levels of inflation.

This happened against the background of still increasing production and consumption of petrol, which in 2018 crossed the 100 million bpd (barrel per day)! Evidently a cat-and-mouse game is being played between consuming and producing countries (Russia, the US and Saudi Arabia jockeying for the top slot on the podium of producers), with the US and China now firmly the leading tandem for consumers.

However, as the largest share of this oil is currently burnt in transportation (cars, trucks, trains, ships, planes etc.), oil producers are undoubtedly aware of the following striking graph which could sound like a death knell for that segment in the next five years, as more and cheaper electric cars start to gain market share (Tesla is currently the best-selling car manufacturer in the premium segment in California, but is rapidly increasing its production capacity and other brands are now trying to catch up).

 

Finally, it is also worth noting that last month ExxonMobil signed a 250MW renewables Power Purchase Agreement in Texas, whereas it implicitly acknowledges that wind and solar power are cheaper than fossil fuels... which begs the question: why would anyone still buy a new car with a petrol tank?

So, is the ECB right to identify renewable energy as a potential 800-pound gorilla in the inflation-modelling room? Undoubtedly! However, it still seems quite timid in its approach of the question, and one wonders whether the EU (never mind the US) is prepared for the onslaught that renewable energy + electric vehicles & storage will bring to worldwide inflation maybe, but also industrial sectors and impacts on workers’ and consumers’ lives.

Contrast that to the latest available People’s Bank of China’s Monetary Policy Reports (Q1 & Q2 2018) which, while appearing quite conservative and traditional in many respects, mention in the Monetary Policy Operations: “transformation of the energy mix”, “[the PBC] established and improved the green financial system while vigorously developing green lending” or “guide financial institutions to increase their support to […] the green economy”. But then, China is now both main producer and main client of clean technologies, with solar power and electric vehicles being emblematic of this 4th industrial revolution, so it is perhaps less surprising that its central bankers could be more partial to renewable energy and less worried about its medium-term inflationary effects…

 

All of those perspectives will reasonably generate more questions than answers, of which:

-            Could central bankers worry so much more about price stability than climate stability (as some would seem to) that they might be willing to trade a few/a lot more climatic extreme events for the sake of a hoped-for predictable inflation? And could they be wishing for a consumers-producers “oil truce” which would keep inflation tamed but alive?

-            What about industrial policies and suppliers’ dependence: as China currently produces for instance more than 75% of solar panels, but Germany is still the dominant supplier of machine-tools to manufacture those panels, could the world be held hostage if either decided to stop deliveries? Or can robot-intensive new manufacturers emerge in other countries to rebalance that industrial landscape?

-            Are central bankers really anticipating the tsunamis brewing in sectors such as utilities or car manufacturing, where millions of jobs have started to radically change? And as China (today the largest car market) is pivoting to electric transportation where everybody starts afresh, what economic shocks are potentially in store for legacy car industry champions and their national bases?

-            In today’s less unionized workforce, is “second-round” inflation (salaries rising to compensate higher cost of living) a serious risk, that is, until social networks displace trade unions (e.g. Yellow Vests in France)? And as economies overall become more energy and resource-efficient, should we not expect a lower level of inflation driven by input productivity (less commodities per unit of GDP)?

-            Fuel taxes representing substantial amounts for many countries, how are national budgets going to compensate for the loss of income on fossil fuels, whilst also rebalancing some of stagnant salaries’ effects for many workers, maybe through more redistribution or guaranteed living standards?

-            What are those questions’ implications on the creditworthiness of countries or industrial sectors at the heart of the difficult strategic choices through which captains of industries and political authorities will have to steer over the next two or three decades? And how will stakeholders be convinced to buy in those changes, sometimes impacting their way of life?

 

To map some answers to such questions, the ability to combine economic/financial analysis with ESG quantitative and qualitative evaluation is key. Whatever its currency, like you, it will be worth it! Stay tuned…

 

Special Contributor

 

Sources:

https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp181108.en.html

https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp181127.en.html

Thomson Reuters / Refinity

https://cleantechnica.com/2018/06/09/100-kwh-tesla-battery-cells-this-year-100-kwh-tesla-battery-packs-in-2020/

https://www.pv-tech.org/news/exxonmobil-signs-250mw-texan-solar-ppa

China Monetary Policy Report Quarter Two, 2018          (released 2018-08-10)

China Monetary Policy Report, Quarter One, 2018          (released 2018-06-25)




[1] Benoît Cœuré, Member of the Executive Board of the ECB, at a conference on “Scaling up Green Finance: The Role of Central Banks”, Berlin, 8 November 2018

[2] Yves Mersch, Member of the Executive Board of the ECB, Workshop discussion: Sustainability is becoming mainstream, Frankfurt, 27 November 2018

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