Will the road to net zero be a rocky one for markets?

What’s happening? The transition to net-zero carbon emissions will probably lead to increased inflation and volatility in the global economy over the next few years, according to BlackRock. In its 2022 Midyear Outlook – dubbed “Back to a Volatile Future” – the asset manager suggests investors should prepare for long-term market volatility and higher inflation, with the transition likely to resemble the market conditions seen at the advent of the Covid-19 pandemic. The market has yet to fully price in the climate change impacts of the transition, BlackRock said. Investors can gain exposure to the transition by investing in “already-green” companies, carbon-intensive firms with credible transition plans, and suppliers of transition-related materials, equipment and services, the report said. (ESGToday)

Why does this matter? While the transition to reach net zero may help drive macro volatility and persistent inflation, the economic consequences of sluggish climate action are far worse. Swiss Re has previously estimated that the world economy could lose up to 18% of GDP from climate change if no action is taken.

Is the energy transition inflationary? In January, European Central Bank board member Isabel Schnabel suggested that the green transition could prove inflationary, something also breached in BlackRock’s report. Carbon-intensive energy production may fall faster than lower-carbon alternatives are phased in, which could result in supply shortages and an extended transition period of rising energy prices, according to the asset manager.

The development of carbon pricing schemes globally may also contribute to inflation. Analysts from Goldman Sachs recently said a rise in the cost of carbon to $100 per tonne by 2030 would add 0.25 percentage points to US inflation in the first three years, 0.3 percentage points to inflation in China and similar increases in Canada and Germany.

The energy transition is also increasing demand for raw materials used for renewables technologies and transmission networks. The International Energy Agency (IEA) expects a significant increase in the consumption of these materials in order to reach net zero. A rise in the price of metals like copper and lithium will increase firms’ costs, which may be passed onto consumers in the form of higher prices. In its report, BlackRock advises investment in such commodities as a means of gaining exposure to the transition.

The opportunities from a disorderly transition – Due to the scale of the technological, economic and societal changes required, it’s likely the energy transition will be disruptive and disorderly. Carbon-intensive sectors will of course be hit hardest – it’s estimated that eight million jobs could be lost in the fossil fuel sectors by 2050.

However, a disorderly transition may also present opportunities. BlackRock sees an investment case for assets linked to the transition and advises investors to look to carbon-intensive firms with credible transition plans. Governments are also expected to introduce policies to speed up the reskilling of workers in carbon-intensive sectors. It’s estimated that 42 million people could be employed in renewable energy by 2050.

Importance of a transition plan – It will be advantageous for firms across sectors to have a transition plan in place to navigate the uncertain financial environment projected by BlackRock, as well as to protect against other climate risks. In April, the UK launched a Transition Plan Taskforce to write rules requiring financial firms and listed companies to publish plans for the transition to a net-zero economy by 2050 from next year. In the US, the Securities and Exchange Commission is working to implement climate disclosure requirements for listed companies, which BlackRock is arguing should be more flexible.

Contrary research – Despite the potential for the movement towards net zero to be disruptive, It is worth noting evidence that suggests the energy transition may not be inflationary. For instance, while the cost of fossil fuel production is likely to grow over time, renewable energy costs are likely to fall further, according to Generation Investment Management.

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