Opinion: Fighting Climate Change Is Expensive. 'Greenflation' Is Price Worth Paying

How much extra would you pay for a product that's less harmful for the planet? Porsche AG wants future customers to pay a 10%-15% premium for electric versions of its Cayenne and Macan sports utility vehicles.

European steelmakers forecast a roughly 20% boost to prices from low-carbon steel.

It's a vital question for business leaders and investors to contemplate, as companies will have to spend trillions of dollars over the next couple of decades to eradicate carbon emissions. 

A so-called green premium for goods and services can help make those massive investments financially viable while giving companies an incentive to decarbonize sooner.

Of course, green surcharges can be controversial: They may keep inflation uncomfortably high, there's a risk of greenwashing, and lower-income consumers may not be able to afford them. 

Air fares, for instance, must rise due to the high cost of purchasing carbon offsets and using sustainable jet fuel, a UK aviation industry group warned last week, saying this could discourage some people from flying.

Another risk is green price premiums are quickly competed away, as we've seen recently with Tesla Inc. slashing what it charges customers. A price war is great for consumers, but rivals may slow the pace of EV investments.

Green premiums exist due to the additional cost of rolling out clean technology in its infancy before scale economies are achieved. 

One approach to tackle the price gap between clean and dirty products is simply to hand companies billions of dollars in subsidies, as the US is doing with the Inflation Reduction Act. Reshoring and associated US labor shortages may, however, prove to be inflationary in the short term.

Europe is taking a carrot and stick approach. Alongside subsidies, it's making polluting more expensive. The soaring cost of EU carbon credits, a curtailment of free carbon permits for heavy industry, the extension of carbon trading to road transport and buildings, plus a new tax on dirty imports will together erode the price advantage that fossil fuels currently enjoy and make investment in lower-carbon products more appealing.

Companies are growing more confident about being able to charge high prices for low-emission products without worrying they'll be displaced by cheaper, dirtier alternatives. And corporate and public-sector customers are signaling a willingness to pay extra to eradicate emissions in their supply chains.

For example, the First Movers Coalition encourages member companies - among them Apple Inc. and AP Moller-Maersk A/S - to sign advance purchase agreements for lower-carbon materials to make such projects easier to finance. Meanwhile, the Biden Administration's buy-clean initiative directs the federal government to prioritize purchases of low-carbon steel, asphalt, glass and concrete.

Cement is responsible for around 7% of global emissions and is one of the hardest sectors to fully decarbonize. Yet Swiss cement giant Holcim Ltd. has sounded giddy lately about the money-making potential of lower-carbon products. 

The soaring cost of carbon permits has constrained European cement production and contributed to skyrocketing prices. Meanwhile, Holcim's ECOPact lower-carbon concrete (the claimed pollution reduction is at least 30%) accounted for 16% of global ready-mix sales in the first three months of this year. (Amazon.com Inc. has used it to construct US data centers.) 

Any price premium is small so it doesn't remain a niche product, management said in February. The next step is fitting cement plants in Germany and Poland with carbon capture, which Holcim expects to be very profitable due to a combination of EU subsidies, the price premium charged and the money saved not having to buy as many carbon allowances.

Sustainability is "a new unique selling proposition, and of course, there is a premium price," Chief Executive Officer Jan Jenisch boasted last week. "Investments in sustainability have super high returns."

Demand isn't just coming from corporate do-gooders. Offices able to demonstrate green credentials enjoy a sales price premium compared with older, less energy-efficient workplaces that will require retrofitting.

The same is true of housing, where a premium for energy-efficient homes is emerging. 

The UK and Germany are among countries phasing out gas heating in favor of heat pumps that have higher upfront costs; homes that already have such kit installed are potentially worth more.

Maersk's Eco-delivery shipping option, which involves a surcharge for biodiesel, currently accounts for just 2% of its ocean volumes, but it aims to increase this to 25% by 2030, while extending it to air freight and its truck network. 

It thinks consumers won't notice the difference: Green shipping would add only a few cents to the price of a $100 pair of running shoes, it calculates.

Last month, Austria's Voestalpine AG followed other European steelmakers in outlining massive decarbonization investments and quantifying a possible price premium for "green steel" produced without fossil-powered blast furnaces. It thinks a 10%-20% is price uplift is possible. 

"There is appetite for buyers to pay a premium while green steel is scarce," UBS analysts told clients.

Green premiums feature in startup H2 Green Steel AB's plan to raise more than 1.5 billion euros ($1.7 billion) in equity funding for a hydrogen-powered steel plant in northern Sweden. H2GS has pre-sold steel to Mercedes-Benz Group AG, which is also an equity investor, and the luxury carmaker has committed to using the low-carbon material from 2025.

Steelmakers that don't make such investments will see their carbon compliance costs steadily increase. "Companies that decarbonize the fastest are more likely to generate and retain economic rents, while laggards will see their competitiveness, market share and earnings power erode," Morgan Stanley analysts concluded in a report last week.

An imbalance between demand for eco-friendly products and their supply may well cause inflation to linger in coming years, but doing nothing about climate change is worse: Droughts like Spain's are already contributing to soaring food prices. 

"Greenflation" can at least be cushioned by government support for those least able to pay, and surcharges will disappear as manufacturers scale up clean production and polluting becomes more expensive.

In other words, green premiums are a price worth paying, until one day soon we won't have to.

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