Greenflation: Will It Derail Move Towards ESG Business Management?

With the transition to renewable energy at the top of the global agenda, the global market is bearing the brunt of an energy crisis. From the widespread power outages in China and the subsequent disruption in the global supply chain to the intensifying competition for natural gas in Europe and the diesel exhaust fluid shortage in Korea, countries around the world, in one way or another, are grappling with the ramifications of the energy crisis. Some point to “greenflation” as one of the major causes. What is greenflation, and what has caused this global chaos? Let us explore together how to overcome the crisis and put ESG business management to practice.

 

 

 

 

 

A series of recent media reports have been describing China’s severe power shortage. What caused this sudden electricity shortage in China? The main culprit is the spike in coal prices due to the shortage of coal supply. The disruption in coal supply to China is the result of the combination of reduced imports of Australian coal and the decrease in the domestic production of coal in China, brought on by its move towards decarbonization. This is what is often dubbed “greenflation.” A term coined by combining the word green and inflation, it refers to sharp inflation caused by implementing policies for a greener economy in the transition to a carbon-neutral society.

 

 

 

 

With the Paris Climate Accords, adopted by 195 countries in 2015, the global community reached an agreement to achieve “net zero” by 2050. Assuming that carbon reduction continues as planned, the demand for fossil fuel such as coal and petroleum—which are responsible for a large amount of carbon emissions—is bound to fall sharply. Reduced demand for fossil fuel will eliminate the need for companies in related industries to make large investments in developing coal mines and oil fields. Decrease in investment will reduce production, which in turn, will cause more frequent price fluctuations.

 

 

This is not an issue limited to fossil fuel. Industries that emit a large amount of carbon in the production process will be regulated by governments. The raw materials produced in these industries will attract less investments, resulting in reduced supply of the raw materials, which in turn, can cause price hikes. A case in point is the surge in steel prices that occurred this spring. As the Chinese government began implementing its policies to transition to a greener society, many small- to medium-sized steelmakers either closed down or reduced their production capacity. The decrease in the production of steel in China caused price hikes in steel products, having a ripple effect in Korea, where construction works came to a halt in certain sites due to the shortage of steel H-beams.

 

 

As illustrated thus far, the transition to a net-zero society entails not only efforts to reduce fossil fuel, but also tighter regulations on various industries to limit their carbon emissions, which subsequently causes investment cuts in these industries, limited supply of raw materials, and price surges. Greenflation increases the production costs of companies and the broader consumer prices. This is likely to cause inflation, resulting in instability in business cycles and asset prices. The shortage of diesel exhaust fluid in Korea that has recently been making headlines is a part of such chain effect. Some are pointing to these side effects to argue that transition to carbon neutrality should be suspended or the timeline to achieve the target should be extended. Projections are being made that suggest that issues such as greenflation will hinder implementation of eco-friendly policies.

 

 

 

 

 

Will these side effects slow down, or even worse, stop the efforts towards net zero? That is highly unlikely. Reversely, greenflation may drive companies and governments to accelerate their efforts to transition to an eco-friendly society in order to respond to the threat.

 

 

Take the aforementioned case of coal, for example. The hike in coal prices is attributed to green policies. However, how many companies will increase their investments in mining coal because of its rising prices? Probably none. The fact remains is that the demand for coal will eventually dwindle. What choices will that prompt from power plants, for instance? They will most likely try to shift away from the power generation business that relies on coal as the raw material as soon as possible. They cannot continue to use coal because the production volume will not increase on top of the frequent fluctuations in production costs and disruptions in supply. The spike in coal prices will ultimately accelerate the demise of coal.

 

 

Parallels to the current change can be found in history. A series of similar developments occurred during the 1920s, approximately 100 years ago. With the surge in petroleum production in the United States that started in the late 1800s, a growing number of projections predicted that the demand for coal would plummet as the raw material was to be completely taken over by petroleum. As a result, new investments in the coal industry almost halted. In the late 1910s, as the global economy began to rebound with the end of World War I and the Spanish Flu, coal prices began to surge again. Companies at the time completely quit coal due to the frequent price fluctuations and accelerated the transition to petroleum, which was superior in terms of supply and energy efficiency. The explosive increase in demand could not be accommodated by America’s domestic production alone, prompting American oil companies to turn to the oil fields in the Middle Eastern region.

 

 

In fact, China and India were the only countries that suffered power outages due to the recent coal price hikes, while most of other countries, including Korea, remained more or less unaffected. The reason why China and India struggled is that the two depend highly on coal for power generation. Countries that had already made the transition to low-carbon power generation remained, by and large, unscathed despite the spike in coal prices. Recognizing the seriousness of the problem, the Chinese government eventually announced its plan to build 150 nuclear reactors to cut down carbon.

 

 

Greenflation, as illustrated thus far, can lead to inflation, creating global economic burden. Therefore, it is crucial to accelerate the transition to green energy while, at the same time, introducing measures to effectively respond to the potential inflation pressures that may arise in the process. Governments and companies are already exploring a wide range of measures, including utilization of alternative energy sources and development of carbon reduction technologies.

 

 

 

SK Group is also working towards the goal of achieving net zero through ESG management. In June 2021, SK Group launched the “SK Carbon Reduction Certification Center,” designed to reaffirm its commitment to net zero and support the efforts to establish and implement a new-zero roadmap. The SK Carbon Reduction Certification Center aims to enhance SK Group’s commitment to carbon reduction as well as its credibility and integrity in such efforts; to internalize eco-friendly management; and to upgrade the environment business capabilities, including identifying and eliminating sources of carbon emissions. SK member companies are carrying out activities to reduce carbon and maximize energy efficiency in line with their respective business models.

 

 

 

The Industrial Revolution has powered advances in human civilization, but at the same time, brought about a wide range of problems in human rights and environment. Similarly, ICT-driven developments have left us with a new set of problems in privacy, copyright, and cybersecurity. Humanity has always managed to address the new challenges during these transitional periods to strive for a better world. We will do the same with greenflation. ESG is an inevitable mission in the journey towards addressing the climate crisis and creating a sustainable future. To be the market leader in the future, businesses will have to set a long-term vision for ESG and underpin the vision with practical action plans to be systematically implemented.