European Carbon Faces the Heat

By Johanna Fernandes, Staff Writer

The EU Emissions Trading System (ETS), is a core component of the EU’s climate change strategy, and seeks to provide regulation on the world’s largest and fastest growing carbon market. The EU ETS follows a cap-and-trade approach to regulation, where they set a cap on how much greenhouse gas pollution can be admitted each year, and reduce credits by 2.2% each year so emissions slowly fall. Companies can buy or receive credits that they can trade with one-another as needed. The limit on existing credits supports the value of the system. Each year, companies can submit their credits to cover their emissions, or sell their spare credits to companies that are in lack of credits to cover their emissions. 

The success of the ETS is apparent; ETS credits reduced emissions by 35% between 2005 and 2019. Europe’s carbon prices traded at 98.49 euros ($112) a metric ton on Wednesday, tripling its value in the past year. 

Source: TradingEconomics.com

As emissions permits inch towards 100 euros, traders fear risks of a market bubble. Where did this sudden surge in demand come from?

The natural gas crisis in Europe is squeezing coal as nuclear energy is phased-out – increasing their commitments to offset their higher emissions. While Europe moves environmentally backwards into coal energy supply, they also boast the most climate-forward policies in the world. The EU’s Green Deal targets reduced emissions by 55% by 2030 and net-zero by 2050, forcing companies to implement climate policies and offset their emissions. The UN’s COP26 summit last November also turned on the heat in carbon markets, as hundreds of countries pledged to reduce emissions and set policy to further legitimize the carbon market space. This perfect storm of an energy shortage and growing environmental regulations has led companies to the most cost-effective way to reduce their emissions – buying carbon credits.

Energy intensive industries, like manufacturers and utilities, are concerned about their international competitiveness as they pay new premiums to offset their emissions. How sustainable is a 100 euro credit? Should supply be increased? According to economist William Nordhaus, winner of the 2018 Nobel Prize for economics, carbon prices should only be around $40. 

When the cost of carbon installations is near 100 euros, in theory, it becomes cheaper for companies to invest in renewables or carbon capture storage technologies to actually reduce their output. The limited supply of credits and stricter emission regulations should push companies to invest in clean technologies. However, there are obvious transition costs involved as it can take years to develop, while carbon prices move in mere seconds on the market. 

The ETS does not have any monetary policy tactics, unlike central banks, to sharpen rules and curb the excessive carbon price growth. EU lawmaker Peter Liese has argued for the committee to enact Article 29a which allows countries to increase credit supply for at least six months, if the price has tripled the average price of the previous two years. Technically, current prices have not been sustained for six months, a key barrier for Liese’s success. Amendments will be made to Liese’s proposal until February 16th, and will take to Parliament in May and June, before being negotiated between EU nations.

With lots of uncertainties in this new and surging asset, one thing is for sure – the heat on carbon is not slowing down anytime soon.

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