Reaching new records - assessing the Carbon Market

The price of carbon has been a major story throughout 2021, doubling from around 30€/ tonne at the start of the year, to a peak of around 65€/ tonne in late September. Part of this can be explained by the rising price of fuels (principally gas and coal) but there are also signs that the price of EUAs has now begun to decouple from these markets.   

Ahead of tomorrow’s Green Week Webinar on Carbon - where Marcus Ferdinand from energy market consultancy Thema Consulting Group and Tom Lord from Carbon risk management and procurement firm Redshaw Advisors will take a broad look at recent developments and future perspectives for the market - we spoke to Montel’s Nathan Witkop. Nathan has been covering the carbon market for Montel since 2012 and gave us his analysis of the current situation, plus a short history lesson on how the market has evolved over the last decade.  

“We've got very little time to do this,” says Nathan of the increasingly obvious and necessary need to reduce our emissions to zero. For him, the current price of carbon reflects this increasingly urgent imperative and shows the market is functioning efficiently. “If you’re going to use a market mechanism, then it’s going to need to contain incredibly brutal prices – they will emerge.” 

But why now, after so many years of single-digit prices that were creeping slowly upwards? Firstly, the reforms of previous years, which were aimed at tightening the market and reducing the oversupply that had been present in the EUA mechanism since the start (especially after the 2008 financial crisis) have begun to take effect. “Reforms were introduced to automatically suck up supply from the market when it was deemed to be above a certain threshold.” This is the Market Stability Reserve, which entered into operation in January 2019. The knock-on effect of this mechanism has been an increase in investor confidence, adds Nathan. “Potential financial investors can see that this is a tool that is taken seriously by the European Commission, by the EU, that is meant to drive change.”  

This message has been further reinforced by the Fit For 55 legislative package, which increased the targets for emissions reductions from 40% to 55% - “That's 15 percentage points more, that will have to be closed this decade.” There’s no doubt that the carbon market is a central part of the package, which will expand the scope of the market to transport and housing, as well as introducing an import tax for carbon-intensive products coming into the EU.   

Add to this the specific conditions of this year – with tight markets for gas and carbon driven by increasing demand as the world rebounds from the pandemic, which remain underlying drivers for carbon prices – and we can see the complete picture. The problem is that even at these levels, prices aren’t high enough to drive some of the changes that will be needed. “Hydrogen production is seen as the only technology for decarbonizing steel production. And that needs carbon prices above 100€/ tonne.” Until we get to those prices, says Nathan, “That shift isn’t going to happen.”  

Whilst rising carbon prices are on the one hand a sign of a functioning, efficient market sending the right signals to investors and producers, there is a darker side to them. Across Europe, most notably from countries like Spain, there have been calls to shield consumers from rising energy prices. “Especially among the poorer states in Europe, people are saying ‘We can't put this cost on to our consumers, this is going to put people in the cold, they're going to freeze.’” Nathan expects that either the EU or individual countries will introduce measures designed to “soften the blow of market mechanisms, whilst still achieving the desired purposes.”   

Yet there is no expectation that the market will return to pre-2021 levels. “With the carbon market, I think volatility is baked in. Prices have to go higher to deliver the goal that we need to meet.” Of course, eventually, the current supply squeeze for coal and gas will ease, and the market will soften, which might have a mitigating effect – “They might not get down to where they were 18 months ago, but I don't think they can stay at these prices forever.”

Regardless of that, higher carbon prices seem here to stay says Nathan. “Coronavirus and the climate crisis, these skyrocketing carbon prices, they’re giving us a glimpse of the future.” 

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