Analysis: Greenflation surges create new challenges for portfolio managers
- Green policies add inflation to COVID recovery
- From affected automotive sectors to paper manufacturers
- Bond markets are betting this is a pandemic for now
LONDON, Aug. 11 (Reuters) – Container ships to cardboard, tougher environmental regulations are fueling shortages and price spikes as “greenflation” escalates, adding a new twist to corporate valuations.
Despite all the transitory inflation messages from central banks, two- or triple-digit cost increases have become commonplace on corporate balance sheets, although the green variety has yet to appear in bond markets, the system usual early warning.
While the higher costs are in part due to supply issues linked to the pandemic, fund managers say a powerful push is coming from tough new rules to guide the world’s transition to a greener future.
And these can survive the COVID-19 inflation story.
To reduce greenhouse gas emissions, the European Union will increase the cost of carbon emissions for transport and factories, abandon sales of gasoline cars and impose carbon taxes on trading partners. Read more
Aluminum, electricity and fertilizers are among the targeted sectors, with others such as aviation in the EU’s sights.
Investors widely agree that greenflation is a necessary risk, as with the United Nations declaring that global warming has gotten out of hand, the alternative to frequent floods, droughts and wildfires is worse. Read more
The question fund managers face is which companies will see their profits impacted, which will pass on the costs, and which will thrive.
For Peter Rutter, head of equities at Royal London Asset Management, the solution lies in modeling the impact, for example, of carbon dynamics on cash flow, income and stock prices.
“We are strong supporters of greenflation. There are scenarios that put assets out of order, like cars that can no longer be driven or ships that are not allowed in certain ports.”
“The other part is the injection of additional costs. If companies can pass the costs on, it’s inflationary. Otherwise, it adds inflation to production and hurts margins,” Rutter added.
Company profits reflect higher input costs. But it is difficult to say which are related to the environment.
U.S. retailer Home Depot (HD.N) posted a 35 basis point drop in first quarter gross margins due to a tripling in lumber prices, offsetting a 31% increase in store sales comparable. Read more
And packaged food company Conagra (CAG.N) warned raw material and packaging costs were hurting profits, a headwind that would not abate until late 2022. Read More
BofA analysts have counted references to “inflation” in last quarter earnings calls and estimate they were up 1000% year-over-year for S&P 500 (.SPX) companies and 400% for those of the European STOXX 600 indices (.STOXX).
GROW A TREE
In shipbuilding, for example, orders have plummeted, which officials attribute in part to uncertainty over which technology to adopt for alternative fuels. .
New ships take up to three years to deliver and typically operate for over 20 years, by which time high-emission ships may no longer be viable. And if shipping is added to carbon markets, owners have to buy permits or risk port bans.
This can support already high transport costs (.BADI).
Likewise, stricter forest regulations and the closure of polluting Chinese smelters are impacting timber and metal prices, PIMCO fund manager Geraldine Sundstrom noted.
“It takes time to grow a tree,” Sundstrom said. “In a green and digital world, you have to position yourself in the right place, where there are barriers to entry and therefore pricing power.
Sundstrom believes that sectors such as integrated forestry and maritime transport could benefit from significant price gains “as the markets are still betting on a return to the average price”.
There will also be losers. Global stocks could suffer a 20% pullback if carbon prices – the price companies pay to pollute – rise by $ 75 a tonne, according to a recent study by Kempen Capital Management, which manages € 86 billion.
Within sectors, carbon-intensive companies will lose out as border carbon taxes come into force, according to BofA.
Hydropower-dependent aluminum producers Norsk Hydro, Rusal and Rio Tinto with a carbon footprint of four tonnes of carbon dioxide per tonne of metal, are better placed than Chinese smelters with 16 tonnes of emissions, a-t -he adds.
So does this mean higher inflation for the whole economy?
Greenflation will not last forever as the effects of carbon pricing will spread over years, while the adoption of renewables is expected to gradually lower the costs of electricity generation.
However, this “deflationary turnover” will take time, according to analysts at Morgan Stanley.
The prices of carbon emission allowances have more than doubled this year, which Morgan Stanley said raised retail electricity prices in the eurozone by 8% in June and added 23 basis points to the ‘inflation. An increase to 100 euros will increase retail electricity prices by 12%, he says.
And clean energy faces its own costs, with electrical equipment, wind turbines and fuel cells exposed to higher metal and shipping prices.
Michael Herzum, head of strategy at Union Investment in Germany, said price hikes are inevitable because the price of carbon will be high enough to spur change.
While the effect is expected to wear off over time, Herzum said the green transformation will reinforce a “40-year period of disinflation over.”
Reporting by Sujata Rao and Simon Jessop; Additional reporting by Jonathan Saul and Saikat Chatterjee; Editing by Alexander Smith
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