Analysts cite recently-agreed reforms to EU Emissions Trading Scheme as a major driver behind recent carbon price surge, but can the cost of polluting keep rising?
The price of emissions allowances traded on the European carbon market reached double digits for the first time in six years yesterday amid strong demand from buyers, fuelling hopes the moribund market is enjoying a significant revival. But experts agree that it remains unclear whether the upwards trend in carbon prices can be sustained.
The EU Allowance (EUA) price had been steadily rising since last May, but a 20 per cent surge since the turn of the year briefly pushed it to €10 per tonne of carbon emitted for the first time since 2011. Prices dropped off slightly later in the day, but the milestone had been reached.
Current prices are significantly higher than the €2-€3 level seen several years ago, which sparked widespread accusations that the high profile emissions market was singularly failing to drive low carbon investment. But the recent price rally is still well below the record €32 briefly achieved in 2006, shortly after Europe's cap and trade scheme was first launched.
And even if the latest milestone is encouraging it is still well short of the level experts believe is required to force coal off the grid and drive investment in low carbon infrastructure. The UK's Committee on Climate Change has previously indicated that prices of £30 per tonne in 2020 rising to £70 would be consistent with domestic emissions goals.
Nevertheless, any increase in the price on carbon emissions from Europe's bigger industrial player is sure to be welcomed in the fight to decarbonise and transition to a greener economy. And indeed, as some analysts have pointed out, the recent rising cost of polluting has coincided with a decline in German power consumption as well as increases in the benchmark price for coal imported into northwest Europe.
This week's jump, though, appears to be largely due to behavioural shifts, rather than any change in market fundamentals or solely due to greater confidence in the long term operation of the Emissions Trading System (ETS). Analysts, too, are divided as to whether or not the upwards trend is likely to continue.
Confidence in the long term future of the ETS was no doubt buoyed by the agreement reached in November last year between the EU Parliament and Council over new rules to govern the ETS beyond 2020 - a provisional deal that was then rubber stamped by MEPs last week after the bill's first reading in Strasbourg.
The "landmark" deal was welcomed at the time by the EU Commission as putting Europe on track to meeting its Paris Agreement pledge to cut greenhouse gases by 40 per cent between 1990 and 2030, but green group Climate Action Network slammed the reforms as too weak and "meaningless".
The reforms now just need approval from the EU Council before they can officially be officially ratified, with the Market Stability Reserve (MSR) - the mechanism designed to double the rate at which the current oversupply of allowances on the market is reduced - then expected to start operating from 2019.
This week's price rise is therefore in part due to buyers anticipating the MSR coming into force next year, analysts suggested to BusinessGreen, with buyers looking to get hold of pollution credits now in the belief there are likely to be fewer available in the near future leading to higher prices.
Julia Michalak, EU policy director at the International Emissions Trading Association (IETA), cited the recent ETS reforms as the main driver of yesterday's price rally. "We believe the price movements in the EU's carbon market are a reflection of the determined effort that EU policy makers made to overcome the problem of oversupply that has plagued the market for many years," she said in a statement.
But as Suzana Carp at climate policy think tank Sandbag explained, the supposed greater certainty for post-2020 from the recently agreed ETS reforms may have actually increased uncertainty in the short term. It means few of the firms covered by the ETS are at present looking to sell their allowances, of which they have built up a huge surplus since the 2008 financial crisis hit industrial productivity and led to lower emissions. The surplus available to the market was recently estimated at a whopping 1.7 billion spare allowances - approximately the equivalent to an entire year of European power and industry emissions.
"The increase [in EUA price] is not justified by market fundamentals, but rather by a change in anticipation and market behaviour, including fear of future shortage towards the end of the Phase III [of the ETS, which runs until 2020]," Carp explains. "In an interesting way, the increase is a response to the uncertainty over ETS related future developments, which the reform, instead of addressing by removing the historical surplus, has kept going, hence increasing incentives for speculative market behaviour."
This time of year often sees an uptick in buying on the market as industrial emitters seek to reach compliance ahead of EU deadlines, but there was an additional increase in speculative buyers in January on top of some small and medium businesses seeking to purchase their EUAs for the year.
Moreover, Carp said she expected Europe's emissions to have increased slightly in 2017 compared to 2016, which might be heightening concerns over an upcoming shortage in carbon credits.
"We are having other elements playing into this dynamic, such as new market participants joining the market and building up portfolios, as well as some mid-size industrials having sold some of their surplus and now fearing the possibility of turning short, hence buying for their upcoming compliance submission," Carp explains.
So, is the upwards trend in the carbon price - so long sought by green campaigners and low carbon economy operators - likely to continue?
At present it seems hard to tell. On the one hand, while some analysts had expected the carbon price to hit €10 at some point in 2018, few perhaps anticipated it happening so early in the year. In October, for example, a Reuters survey of analysts pointed towards a forecast of prices averaging just over €7 per tonne in 2018, and just under €10 next year.
The subsequent swift upsurge this year, then, may provide confidence prices could push even higher than €10 before the year's end, potentially further hitting the profit margins of high emitters such as coal fired power plants that are already suffering from high prices.
Yet despite briefly hitting the €10-high yesterday the price dropped off again slightly due to weak auctioning of free allocations. It demonstrates that, as the period of free allocations from member states gets underway, the handing out of free credits could serve to balance out the EUA price over the coming year, one analyst told BusinessGreen.
With no fundamental driver for yesterday's price strengthening, though, it seems likely that the carbon market is set for increased volatility in the short term, amid uncertainty over potential allowances shortages.
Such news is unlikely to please higher emitters across Europe, nor countries such as Poland which has the second biggest coal industry in Europe and - despite being hosts of the COP24 international UN climate summit later this year - has been a major barrier to stronger ETS reform.
Yet even with yesterday's price rally, the main driver for phasing out coal plants is coming from other quarters, at least in the short term. Indeed, recent studies suggest more than half of the EU's 619 coal fired power stations are losing money anyway due to regulation and competition from cheaper renewables.
The shift towards lower carbon infrastructure is continuing regardless, but the hope remains that higher carbon prices could give it a much needed boost. For businesses of all stripes volatility in the carbon market may make long term planning difficult, but it provides a further signal that the best way to hedge against the risk of higher energy costs is to step up investment in energy efficiency and clean power sources as soon as possible.
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