Do lower emissions mean higher prices?

Net zero initiatives tend to be welcome announcements for nearly all stakeholders, especially in the energy sector. That said, could energy companies’ net zero initiatives ultimately prove to be inflationary? What are the long-term impacts of net zero corporate strategies on long-term energy prices and therefore, future inflation? We can say with certainty that it’s too early to know. But it’s not too early to consider the interplay of these two variables.
The global energy sector is considered one of the optically “dirtiest” and more controversial corporate sectors from an environmental, social and governance (ESG) perspective. But recently, leading energy companies have announced new net zero goals and initiatives under growing pressure from competitors, investors and other key stakeholders amid the looming energy transition. Shouldn’t this willingness to adopt new, innovative and more eco-friendly corporate strategies be viewed positively?
The answer is mixed. While it is too early to know the long-term macroeconomic consequences of broad-based, industry-wide, net zero initiatives, another key question arises - what is the potential for a long-term positive correlation between the adoption of net zero initiatives and higher energy prices? Could energy transition and net zero-driven reductions in traditional hydrocarbon supply lead to “greenflation”?
It goes without saying that most stakeholders would likely view a corporate focus on the long-term achievement of net-zero emissions as a positive development. The notion of value maximization while coincidentally reducing environmental impact seems like a win-win for all parties. But how do some of the world’s largest energy companies intend to achieve net zero emissions? There is no one answer. Global energy companies are taking a variety of paths to achieve this long-term target. However, there are real examples of industry leaders’ explicit commitments to structural, long-term reductions in the investment in and supply of traditional oil and gas. The consumption of oil and gas is not falling to zero anytime soon and fossil fuels will likely continue to be critical components of the global energy supply mosaic. However, if alternative or replacement energy sources do not become economically viable as traditional oil and gas supplies dwindle, or if oil and gas demand does not correspondingly adjust downward, this net zero-driven, supply-side reduction could pressure energy prices higher.
We have already seen the impact on energy prices of global supply reductions that were forced on publicly traded energy companies in 2020, when global oil demand collapsed under strict lockdowns and travel restrictions. Energy companies responded with deep supply reductions in an attempt to preserve profitability and cash flow. The impact of these severe supply restrictions is still being felt today. Investors have been rewarding companies for a focus on cash generation at the expense of growth and higher capital expenditures that would support new oil and gas production. Oil inventories are low and global investment in new supply and development remains depressed. Demand is now recovering into an increasingly supply-constrained market, leading to energy price inflation that we are seeing in our energy bills and at the gas pump.
As long as energy production remains depressed, as it has since the pandemic began, we expect elevated energy prices to persist, all else equal. While the events of the past two years are unique and caused by a once-in-a-generation global pandemic, the price impact of the structural reduction in supply is worth noting. It is especially important to see it through the lens of the future, as some the world’s largest producers begin to reduce their long-term investment in hydrocarbon development and production. If recent oil and gas supply-demand dynamics have taught us anything, it’s that supply and demand may not move in tandem. This imbalance could have severe pricing consequences in an increasingly tight oil market.
Could net zero-related supply reduction initiatives compound existing industry-wide reductions in new exploration and development? Could this result in a longer-term mismatch in the timing of oil and gas production and consumption, potentially raising the risk of long-term energy price inflation? With some of the largest publicly traded energy companies already committing to sustained reductions in oil and gas investment, we would not bet against it.