Higher energy demand coupled with plant shut downs, low wind and hydro production has helped rally EU ETS prices to a seven-year high
As Europe melts in record breaking temperatures, the price of carbon under the bloc's Emission Trading System (ETS) has hit a seven-year high of almost €18 per tonne.
What's going on? Could the two be related? Yes, as it turns out.
Even before the heatwave hit, it's worth noting prices were on the up.
ETS prices have rapidly accelerated over the first half of the year to around €16 per tonne, due to strong demand in the latest auction. Overall, carbon prices have more than doubled this year and more than tripled over the past 12 months. Market confidence has been buoyed by reforms to ETS rules agreed by the EU late last year, which has helped deliver long term certainty in the system, while anticipation of the new market stability reserve (MSR) coming into operation next year has also helped rally prices.
But market analysts suggested the latest price surge seen this week - when prices climbed a further 2.2 per cent - is also partly down to the heatwave across Europe, which has seen temperatures higher than 30C in the Arctic Circle.
The prolonged, unusually high temperatures across Europe - which scientists concluded last week was made twice as likely by human-caused climate change - have led to several nuclear plants shutting down due to lack of cold water available to cool their reactors. A simultaneous wind drought has seen low levels of generation from offshore and onshore turbines. As a result, energy suppliers have been increasingly turning to fossil fuel energy for power, which in turn requires them to purchase allowances to emit more CO2.
Heatwave forces 3 Nordic reactors to be curbed, 1 to close, more expected, & EDF may shut 4 French reactors. Water is too warm for reactor cooling in the sea off Sweden and Finland, and the River Rhone too warm in France. Shut plant: Ringhals, Sweden. https://t.co/U2bOZrLYpS pic.twitter.com/3jLmyfxzRS— Jeremy Leggett (@JeremyLeggett) 2 August 2018
Yan Qin, senior modelling analyst at Thomson Reuters, told BusinessGreen that high demand for energy needed for cooling in the heatwave as well as low wind and hydro production has prompted an uptick in the use of fossil fuel sources, pushing up demand for emissions allowances.
"The carbon price has accelerated this summer buoyed by higher demand from utilities due to the persisting heatwave across Europe combined with low wind and hydro power production," she explained.
But Qin added that as ETS prices rise higher it is likely to curb demand somewhat. "As prices are approaching €18 per tonne, this will trigger a certain degree of switching from old coal-fired power plants to modern gas-fired power plants, dampening the demand for carbon allowances and price rally," she said.
However, the price rally is not only down to hotter temperatures, but also increased confidence in the market. Several years ago, the price of emitting carbon in the ETS was at a low ebb of €2-3, but following a steady rise in 2017, there was a sudden surge at the start of this year which saw allowances hit €10 per tonne in February.
The sustained rise in carbon prices has led to solid demand at auctions, as speculators seek to secure enough allowances before the MSR - the mechanism designed to double the rate at which the current oversupply of allowances on the market is reduced - comes into operation in 2019, according to Hæge Fjellheim, head of carbon analysis at Thomson Reuters.
She said anticipation of the MSR from next year was the "fundamental driver" behind 2018's price rally, which would "soak up big chunks of the oversupply in the European carbon market and leave to a substantially tighter market balance going forward".
"Not only has this triggered increased buying interest from compliance entities, but the prospect of higher prices and increased volatility has also attracted financial players, reinforcing the bullish trend," Fjellheim explained.
The steadily rising CO2 price is already beginning to hit the profits of coal and lignite generators, claims climate policy think tank Sandbag.
Nevertheless, the recent price rally to almost €18 per tonne is still well below the record €32 per tonne briefly achieved in 2006 shortly after Europe's cap and trade scheme was first launched. It's also much further below the €80 per tonne mark experts believe is the minimum required to drive investment in low carbon infrastructure in line with the goals of the Paris Agreement.
But Suzana Carp, analyst at Sandbag, suggested the impacts of the MSR and recently agreed higher EU clean energy targets meant it was "no surprise" the EUA price was going up, hinting there could be yet be further increases on the horizon.
"There is a strong psychological effect on the market and with the MSR starting to hoover out some of the surplus in less than six months' time, it should be of no surprise the price is going up," she said. "Also the end of Phase III [of the ETS] approaching, which sees certain derogations no longer applying in 2020, means that there will be a drive to buy more allowances before the start of next year, as the price will not fall throughout 2019."
There may be a long way to go before carbon prices reach the level needed to avert catastrophic climate change. But with the EUA price rallying after years of criticism from campaign groups, there are at least now green shoots that the carbon market is heading in the right direction - heatwave or no heatwave.
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