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Empty Mind after Ten Thousand Reasons

Greenflation and transition risk

Kazumasa IWATA
  President

2021/12/24

 The advent of COVID-19 “omicron variant” has caused not only stock prices but also crude oil prices to plummet.The Japan Center for Economic Research predicted that if economic and social activities were normalized at once, the sixth wave of COVID-19 would start at the end of the year and peak in the latter half of next year.

 The outbreak of the new variant will aggravate the wave of 6th wave infection.

 In Europe, the delay in switching to a green economy and the shortage of fossil fuels, especially natural gas, have led to the “greenflation” arising from a sharp rise in energy prices.

 In the commodities market, there is a “super cycle” which repeats the cycle of rise and fall of prices with 25 years. One of the factors behind the rise in crude oil prices in 2021 is the super cycle, which peaked in 2008 and bottomed out in April 2020.

 Another factor is the delay in the transition to zero carbon society. The International Energy Agency (IEA) predicts that crude oil prices will rise to $77 per barrel estimated in terms of 2020 dollar in 2030 or $94 assuming 2% inflation.On the other hand, if greenhouse gas emissions can be reduced to virtually zero in 2050, the demand for fossil fuels will decrease, and the rise will be limited to $36or $44 assuming 2% inflation

 Emergency stockpile releases and requests for increased production to oil-producing countries will delay the transition to zero carbon society, although they are not meaningless as emergency measures. In Japan, the subsidy policy was adopted for primary oil distributors to cope with rising gasoline prices, but at the 26th session of the Conference of the Parties to the United Nations Framework Convention on Climate Change (COP26), it was resolved to make efforts towards abolishing subsidies for fossil fuels.It is more desirable to provide subsidies to low-income groups with a large share of energy-related spending.

 As US President Joe Biden pointed out, it is difficult to immediately switch to a green economy. A gradual transition from brown to light brown to green is required. Transition finance makes this relay possible. However, it is necessary to carefully examine whether this transition finance will eventually realize a green transition and whether it is consistent with the Paris Agreement.

 The fundamental solution to the rise in crude oil prices is to promote energy saving and shift the industry structure to “digital-green economy.” For that purpose, carbon pricing such as carbon tax, which attaches price to carbon dioxide (CO2) emissions, is indispensable.

 Unfortunately, carbon pricing was not on the agenda at COP26. The International Monetary Fund (IMF) recommends that developing, middle-income and developed countries introduce carbon taxes of $25, $50 and $75 per ton of CO2 emissions, respectively. The tax revenue can be used to support renewable energy, subsidize low-income groups, and reduce the marginal tax rate on labor income.

 However, from the perspective of global resource allocation, a unique carbon price is preferable, not multiple. It is also useful for participating countries to make a common commitment to the strategy of “I will if you will” for the optimal use of common resources, under proper monitoring combined with graduated punishments to offending behavior.In light of the success of introducing the minimum corporate tax rate, we should hurry up to introduce a unique minimum carbon tax rate in the world.

(The english translation of the article was published in the Nikkei morning edition 2021/12/17.)