Significant bullish momentum has led to a 60% gain in 2018 EU Emissions Trading System (EU ETS) carbon prices (officially known as EU Allowances (EUAs) which represents one ton of CO2). The EU ETS, launched in 2005, has seen significant price fluctuations since its inception. Despite carbon prices starting at more than €29.0/t, they remained relatively low for several years following the financial crash of 2008 which saw prices falling by over 90% as a decline in economic conditions across Europe reduced carbon emissions. This blog will explore recent announcements across the EU that have led to renewed interested in the market and discuss the future of carbon trading in the UK after Brexit.
Price reaches a six-and-a-half year high
EUA prices averaged €8.3/t in January, €9.4/t in February and €11.5/t in March, hitting a seven year high of €14.1/t on 28 March before settling in early April at €13.1/t.
Despite no clear single fundamental driver, these consistent price rises appear to be largely driven by the belief that a cocktail of forthcoming reforms aimed at reducing the number of allowances in the market will result in higher prices in the future.
Further support for prices came from expectations of increased demand from emitters preparing for 2017 compliance, while a European-wide cold weather snap at the end of February and early March saw a rise in coal-fired output. Prices also lifted in response to the recent statement from the UK’s Minister of State for Energy and Clean Growth, Claire Perry, reiterating the desire for the UK to stay in the EU ETS until the end of Phase 3 in December 2020.
The European Commission’s report on verified emissions for 2017 was released on 3 April and is being attributed to causing the seven-year high on Wednesday 28 March. This was due to speculation over analyst’s reports correctly suggesting that EU emissions had increased for the first time since 2010, rising 0.8%. This fresh EU ETS carbon high represents a threefold increase since March 2017, and, if prices continue with bullish momentum, Article 29a of the 2009 ETS Directive could be triggered to stabilise the market due to “excessive price fluctuations”. This would allow Member States to bring forward allowance auctions or auction up to 25% of allowances of the new entrants reserve in an attempt to limit high price variability.
An imminent change – The Market Stability Reserve
The market stability reserve (MSR), which will start in January 2019, addresses the oversupply of allowances since the financial crash. The surplus of allowances stood at 2bn at the start of phase three (2013-2020) but was reduced to under 1.8bn in 2015 when 900mn allowances originally ear marked for auction 2014-2016 were added to the MSR.
The MSR aims to improve the ability of the EU ETS to withstand dramatic macroeconomic changes through controlling the supply of EUAs. The EU Commission is set to announce the current number of allowances in circulation before 15 May 2018 to understand the number that need to be placed or released from the reserve. It is hoped that the introduction of the MSR will support the carbon price and is largely why price are on the rise, and maybe pushing the price of carbon towards the €20-€30/t levels seen in 2008.
Phase four reforms approved
On 27 February the recently approved revision of the EU ETS, which will cover the market’s fourth phase between 2021-2030, was released and proposes significant allowance cuts to increase emission savings. This revision is set to impose an annual 2.2% decrease, currently at 1.74% annually, in emissions year-on-year as European lawmakers push for a 40% reduction in greenhouse gas emissions by 2030 from 1990 levels. This annual decrease in emissions will lead to an extra 556mn tonnes of emissions savings over the fourth phase, the equivalent of annual emissions in the UK. The reform will double the number of EUAs that are placed in the MSR until the end of 2023.
UK decides to stay in the EU ETS scheme
The announcement from Claire Perry on 22 March caused carbon prices to rise €0.9/t on the day, nearly reaching €12.5/t during her testimony to the EU Energy and Environment Sub-Committee. Perry revealed that the UK prefers a cap-and-trade scheme as a carbon pricing tool, and that it was exploring alternatives to the EU ETS post-2020 after Brexit. Perry stated, “It would be a dereliction of duty if we were not to look at ways to deliver a stronger carbon pricing signal in the UK because that is the least interventionist, most sensible way to drive investment where you want.” If, after 2020, the UK decides to remain in the EU ETS then it could be given a very minor role for rule-making, like non-EU members Norway and Iceland who participate in the market, a position which Perry believes will play as a “position of strength for us.”
An EU-wide floor price
On Thursday 23 March, French President Emmanuel Macron’s continued his push for an EU wide carbon floor price causing a further sharp rise in the price, peaking just over €13.0/t, a fresh six-and-a-half year high at the time. The floor price would need to be carefully designed, and lessons could be drawn from the Carbon Price Support levy introduced in GB to prop up the low EUA price.
Future gazing – post Brexit carbon market
Claire Perry made it clear that the UK’s best option for achieving Paris Agreement emission reductions targets is to utilise a cap-and-trade scheme. Other countries have gone it alone with both national and sub-national ETS markets working or being explored in Canada, China, Japan, New Zealand, South Korea, Switzerland and the US.
Going it alone has been successful for countries like South Korea, but, as Perry mentioned, carbon prices will be better supported when implemented on an international scale with inter-country trading. The UK had a voluntary emissions trading scheme that was established prior to the EU ETS, but creating another scheme would take several years from inception to be fully operational. It is therefore unlikely that the UK, with no planning currently underway, will be able to develop its own system by 2020 if it leaves the EU ETS.
The Autumn Budget 2017 outlined the government’s desire to maintain a similar total carbon price to current levels – the value taken at the time of the Budget release was £24.7/t, including the £18.0/t floor price – until coal fired power station have been phased-out in 2025. Although the budget provided little clarity on how this would be achieved, prices in Q1 2018 have already gone well above those of November 2017.
Will we continue to see support for the price of carbon in Q2 of 2018 as industries hold onto allowances ahead of forecasts of tighter supply and higher prices in the future?
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