230%! This is how much the carbon prices, formally known as European Unio Allowances (EUAs for Dec21) have risen since the lockdown back in March of 2020, due the COVID-19 pandemic. Even ignoring that event, this market rose from 25 €/ton to 51 €/ton, more than doubling its value in less than one year.
Figure 1 – EUAs Y+1. Source: M·Tech.
The current trend receives two kind of reactions: In one hand, some have celebrated it, supporting it as the “motivation” needed for businesses to accelerate their decarbonization; In the other, some voices of concern rose due to the impact of this overcost in the profitability and competitiveness of their business.
In the political sphere, the European Committee stands and supports the current trend affirming that no action or “intervention” should occur to stabilize it, while some governments worry about economic damage due to the additional pressure on industry as well as the so-called carbon leakage.
Despite the mixed feelings, the hard truth is that carbon prices must go up to accelerate decarbonization to meet the EU goal of becoming Net Zero by 2050.
But is it working?
The European Union Emission Trading Scheme (EU ETS) is the world’s largest multi-national Greenhouse Gas (GHG) emissions trading scheme and is one of the cornerstones of European Union’s policy to fight climate change and to reach the Green Deal targets set. The system accounts for 40% of total emissions in the EU from power plants, industrial plants and airlines operating in Europe.
Official data from the European Environment Agency (EEA) confirmed a reduction of GHG emissions by 24% below 1990 levels in 2019 with near 80% being reduced in the heat and power sector. Preliminary data points for another reduction in 2020, mainly due to lower energy demand and less use of coal. The numbers below show that the ETS is working since the power and heat sector is the only that doesn’t have free allocation of EUAs, so the impact of carbon prices is higher.
The Emissions trading Scheme (ETS), also known as cap and trade, is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants.
A central authority, normally a governmental entity, allocates or sells a limited number of permits that allow a discharge of a specific quantity of a specific pollutant over a set time. Polluters are required to hold permits in amounts equal to their emissions. Polluters that want to increase their emissions must buy permits from others willing to sell them.
The EU ETS is currently in the Phase 4 that will run between 2021 and 2030.
Figure 2: Emissions EU-ETS. Source: Refinitiv.
ETS is one of the Cornerstones for EU Green Deal
On the 11th of December of 2019, Ursula Von der Leyen announced the EU Green Deal, a group of policies and strategies developed to fight climate change while making it economically and socially sustainable. The ambitious goal in terms of GHG emissions reduction was set, lowering from the 40% to 55% of 1990 levels by 2030 and becoming Net-Zero by 2050.
In order to reach such an ambitious target, The European Union is basing an important part of the strategy in the success of the EU ETS believing that a market base approach is the most transparent way to encourage the adoption of more environmentally friendly solutions.
The new target set led to the necessity to adjust the current Phase 4 package and the first official preliminary discussion about the adjustments took place at the Special Meeting of the European Council last month (24 – 25th May) in Brussels, where the “Fit for 55” package was unveiled before final vote scheduled for July.
From that session, three major points were disputed:
- The EC proposed a new Emissions-trading scheme just for road transport and buildings, excluding those from the current EU’s effort-sharing regulation (EFR).
- The carbon boarder Adjustment mechanism (CBAM).
- End of free carbon permits for heavy industry.
The first point raised concerns about the wealth and social inequality since the creation of such market would expect to directly impact diesel cars and domestic heating systems, therefore, citizens. Low-income families are expected to be the ones to end up suffering due to the lack of capacity to easily change to more environmentally friendly solutions. Expectations point for a lower price compared to the current ETS market, but still, it should follow the same bullish trend in order to push the transition.
The next sensible point addressed was the CBAM, a mechanism designed to ensure that imports of carbon-intensive industry from third countries, that don’t have such strict environmental obligations as the EU, pay an amount similar to the EU carbon price. This mechanism is crucial to reduce the risk of “carbon leakage” by making European industry competitive while meeting the EU’s climate targets, however, important concerns around possible trade wars or hurt European industries that need to import raw materials.
Aligned with the previous point, the guidelines from the EU suggest that the application of the CBAM would mean the end of free allocation for the European heavy industry which could still be impactful in case of competing with other Regions without such strict environmental policies.
Other Emission Trading Schemes
Currently there are few Emission Trading Schemes besides the EU ETS, being the most recent set up last month in the UK. This year China also started its cap-and-trade system which accounts for 30% of Chinese total emissions making it the world’s largest carbon market.
There are also similar cap-and-trade systems in North America, with one linking California (U.S.A) and Quebec (Canada) and other states that have their own ETS markets. Last year Mexico put in place its pilot and is expected to start the phase 1 this year.
In Asia, Tokyo Metropolitan Government and Saitama Prefecture are integrated in a joint cap-and-trade market since 2011 as a national scheme in Japan. South Korea also implemented its ETS market in 2015 and covers 70% of national GHG emissions from industries and buildings. It is currently in the third phase (2021-2026).
In Europe there is another ETS market in Switzerland that was linked to the EU-ETS in January of 2020.
There are other 7 countries, such as Colombia, India and Chile and 8 US states that have legislation under consideration or actively developing it in order to put in plate their ETS markets.
Figure 3 – Emission Trading Schemes Worldwide. Source: Climate Policy Info Hub.
The carbon prices (EUAs) impact directly the electricity prices since the utilities are forced to buy emission allowances for each ton of CO2 emitted through the burn of coal and natural gas to generate power. Carbon price impacts between 25% to 60% of Spanish power prices, depending on the participation of fossil fuels in the energy mix. This fact is one of the main reasons for the current market volatility and price levels in the OMIE.
Besides the cost of electricity, the costs of natural gas and fossil by products are expected to be even more pressured in the coming years, enormously affecting industries and households, not just on the “commodity price” but also on additional taxes that could be enforced by governments under the EFR.
The “Fit for 55” package could bring more clarity about the speed of the rise in carbon prices for the next months (and years), with current projections from different sources pointing to ranges between 80 – 180 €/ton in 2030.
It is yet unclear what would be the final “Fit for 55” package but the European Union would need to balance it between the urgency to meet the climate targets and the social and just transition.
Jorge Seabra | Energy Consultant