Principal Global Investors’ chief strategist Seema Shah says that inflationary pressures will not only affect energy prices but also businesses and governments trying to conform to net zero initiatives.

The risks of “greenflation” — increases to energy prices and consumer costs triggered by global efforts to transition to green energy — have been well-documented.

However, in a new research note alongside the COP26 climate conference and seen by CNBC, Shah argued that “the rapidly changing way that companies across all sectors factor environmental considerations into their business models – and the rising costs of doing so – are potentially still being underappreciated by some investors.”

She highlighted four disparate factors that will contribute to upward pressure on the cost of doing more environmentally-friendly business, dubbed environmental inflation or “en-flation.”

Emissions trading systems in the European Union require that all carbon dioxide emitted by manufacturers, power plants and airlines must be paid for. The bloc gives free permits for certain industries in order to allow them to compete against major multinational companies who aren’t subject to carbon taxes.

They will cease to be available for the major emitting sectors starting in 2026. The EU will reduce the number of permits that are granted to other industries. EU-listed steel companies could be forced to make up 60% of their earnings to offset EU ETS’s emissions. according to asset manager Lazard.

Recent research also supports this assertion. University College London earlier this year estimatedThere could be a 10 fold increase in carbon offset costs between 2030 and 2025, due to increasing demand exponentially and decreasing surplus.

Climate penalties are more severe

Shah also stated that it was normal to anticipate tougher sanctions for businesses who do not meet U.N. targets on climate change.

“The MSCI Net Zero Tracker, which analyses the collective progress of listed companies towards climate goals, recently found these firms are on track to cause a global temperature rise of 3°C (well above the 1.5°C temperature increase agreed in Paris in 2015) and that many are still failing to disclose crucial information on emissions,” Shah highlighted.

Royal Dutch ShellMai became the first companyAfter The Hague District Court ordered that major oil company reduce carbon emissions by at least 45%, it was legally required to comply with Paris Agreement policies.

Shah stated that “with the environment commitments made by governments under greater scrutiny in order to meet the Paris Goals, it’s likely that policymakers will look for harsher punishments.”

The third factor driving upward pressure is talent. Employees from all industries are looking for “green” skills. Shah said that companies will suffer as a result.

She pointed out that a recent modeling from British employment think tank OnwardAccording to a study, new jobs that are created for net-zero goals on average earn 18% more than the U.K. national average.

It U.K. recorded 1.1 million job vacanciesIn the three months ending August, the unemployment rate fell to 4.5%. This indicates that the labor market is tightening. government has pledged 440,000 well-paid green jobs by 2030.

To meet their national targets, companies will have to find these workers.

“Lastly, it stands to reason that, as business models adapt to become greener, investment in technology and R&D spend will increase across the board,” Shah said.

“In a world that is more concerned about climate change, constant innovation will be necessary and it will increase the costs of doing business.”

How do investors make money?

Shah suggested that investors support blue-chip financial franchises, in order to weather the “enflationary” environment. Companies that have the ability to “flex their price rather than take on the increased cost themselves,” Shah said.

She said that luxury retailers can, for instance, adjust their prices without compromising customers.

Companies with deep moats are more powerful in pricing and have the ability to use this power to preserve profit margins, without losing market share to their competitors.

Modern bond proxies such as the FAANGs (Facebook, Amazon, Apple, Netflix, GoogleThe relative stability of ) is also expected to make them perform well, while other bondproxies such as utilities might struggle with energy price increases.

Shah supports the U.S. geographically over Europe because of its ability to weather inflationary shocks from rising energy prices.

She stated that the U.S. was energy-sufficient and that consumers had significant savings in order to absorb higher prices.

Europe, on the other hand, is more vulnerable because it is a net energy importer. A third factor will lead to an increase in equity US performance over Europe within the next few months.

Principal predicts that growth stocks outperform values, and greater capital spending will impact income investors.

Increased innovation spending means less cash in the balance sheet to pay out payouts. Shah explained that investors could see more growth potential if businesses take action to improve their business models than traditional income sector.