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The European carbon market has experienced wild price swings
amid financial tumult and energy policy uncertainty since Russia
invaded Ukraine last month.
The Platts December futures contract for EU allowances (EUA) was
assessed at €95.04 ($104) per metric ton (mt) on 23 February, the
day before the invasion, according to S&P Global Commodity
Insights' data. The EUA price then collapsed to €58.19/mt on 7
March before recovering to €77.42/mt on 15 March.
Companies covered by the EU Emissions Trading System (ETA) can
use one EUA to emit one mt of CO2 for compliance purposes. The ETS
allows speculative trading by financial institutions and other
types of investors not facing emissions caps.
The initial selloff came as non-compliance players went into a
risk-averse mode, according to market experts, with the
Russia-Ukraine conflict pushing up energy costs and down stock
prices.
"Many investors were forced to offload allowances to cover
losses elsewhere to avoid margin calls," said Yan Qin, lead analyst
of carbon research at Refinitiv. "The market was in shock …
investors were not really touching a falling knife."
Elvis Pellumbi, chief investment officer of HFCO Capital
Management, said investors became risk averse as they had to take
into consideration political risks, changes in fuel prices, and
potential demand destruction amid inflation.
"And hedge funds have been long on EUAs in a crowded trade for
some time, so that has led to unwinding of positions as well,"
Pellumbi added.
But the EUA contract has since recovered, in part due to some
compliance players out for bargain hunting. Under the ETS,
companies must hand over enough allowances to cover their emissions
by 30 April.
Moreover, some experts said the supply-demand fundamentals for
the EU carbon market remain strong. In the short run, European
power plants might need to burn more coal and require additional
EUAs as the EU seeks to reduce imports of natural gas from
Russia.
"It should be fairly bullish for the price outlook just from the
sheer fact that we are probably going to be relying on … coal
plants for quite some time," Anders Porsborg-Smith, global lead for
commodity trading at Boston Consulting Group, said in a recent forum.
According to S&P Global's Platts Analytics, the EU could
need an extra 17 GW of coal power plant capacity to meet its
electricity demand amid disruptions of gas flows from Russia.
In efforts to reduce energy dependence on Russia, the European
Commission (EC) on 8 March unveiled plans to raise the rate of wind
and solar deployment by 20% annually in the REPowerEU communication.
The EC has a goal of installing 480 GW of wind and 420 GW of solar
by 2030.
"The initial sell-off in EUAs was also partly driven by fears
that the EU will put climate policy in the back seat … The
REPowerEU communication shows the EU's determination to quit fossil
fuels earlier and double down on renewables deployment," Qin said.
"This, in fact, has restored quite some confidence in the EUA
market."
But S&P Global Commodity Insights' Coralie Laurencin, ENR
senior director for energy futures, believes the EU's efforts in
accelerating renewable energy expansion in Europe are "deeply
bearish for the ETS market" in the long term.
"There will be less demand for credits as Europe will work
tirelessly to reduce its fuel import dependency," she said.
Debate on market functions
In recent months, most market players have been bullish over the long-term
prospects for EUAs on expectations of rising demand and tightening
supply due to the EU's climate policy.
As part of the Fit for 55 climate policy package unveiled in
July, the EC proposed amendments of the ETS and a Carbon Border
Adjustment Mechanism that are expected to result in more demand for
emissions allowances from manufacturers, airlines, and shipping
companies.
The EC also plans a 4.2% linear decrease in the number of EUAs
auctioned annually. Separately, the allocation of free allowances
for stationary installations is set to be conditional on their
decarbonization progress from 2026 onwards.
Pushing against those indicators of a tighter market is the
reality of high energy prices and rising inflation, which could
trigger actions by the EU to temporarily relax some of the plans
for allowances.
German lawmaker Peter Liese, who is drafting
the European Parliament's position on market reforms, has proposed
a rule amendment that can quickly trigger additional EUA auctions
if prices rise excessively.
EUPowerEU also suggested the EU
member states could subsidize vulnerable households, and a
Temporary Crisis Framework that might offer financial aid to
energy-intensive firms is under consultation.
The handouts are expected to be partially financed by the
proceeds from EUA auctions, according to the EC. The revenues
generated from those auctions reached around €30 billion between 1
January 2021 and 28 February 2022.
While recognizing the subsidies could come in handy during the
energy crisis, some think-tankers urged European countries to
carefully design the policy measures so they would not encourage
more energy consumption.
"Financial support based on lump sums per capita or per
household could be a sensible approach," NewClimate Institute's
Founding Partner Carsten Warnecke. "Industry support could be made
dependent to implementation of energy efficiency measures."
E3G's Policy Advisor Domien Vangenechten said ETS revenues can
play an important role but cautioned that their importance should
not be overstated.
"In the short term, these revenues could contribute to
mitigating a part of the costs indeed," Vangenechten. "Ideally,
this shouldn't be done through energy price rebates but through
general dividends or tax cuts."
Posted 16 March 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.