Customer Logins

Obtain the data you need to make the most informed decisions by accessing our extensive portfolio of information, analytics, and expertise. Sign in to the product or service center of your choice.

Customer Logins

EU carbon prices surge in H2 2021 amid power, policy shifts

21 January 2022 Cristina Brooks

Record activity in EU carbon allowances trading last year was driven by both power generation dynamics and policies driving compliance.

Last year, for the first time, 15.2 billion EU Allowances (EUA) were traded on ICE, the leading market for EUAs, each of which entitles polluters to emit one metric ton (mt) of CO2.

Futures prices also rose sharply in the second half of the year. Prices for December 2022 stood at €85.24/mt on Thursday. December 2021 futures climbed to an all-time high of €90.75 on 8 December.

While compliance buyers like power generators have a surplus of unused EUAs, they won't sell them, Vertis Environmental Finance Head of Market Analysis Bernadett Papp told Net-Zero Business Daily.

Fears of future policy shifts slashing EUA supply levels have caused compliance buyers to refuse to sell.

In January, Phase 4 of the EU Emissions Trading System (EU ETS) introduced dynamic allocation of free allowances based on activity level, worrying compliance buyers who fear decreases in free allocations for 2022 due to their lower activity during the pandemic-induced recession.

In July, the European Commission (EC) issued a slew of proposals aiming to target carbon neutrality. Of these, the revision of the EU Emissions Trading System and the introduction of a Carbon Border Adjustment Mechanism will remove exemptions for Europe's manufacturing and aviation industries, which now receive 80% and 85% of their allowances for free.

The EU ETS revision includes a higher target for compliance covering 61% of emissions and a 4.2% linear decrease in the number of EUAs auctioned annually, which is set to raise EUA prices.

In addition, the allocation of free allowances for stationary installations is set to be conditional on parties' decarbonization efforts from 2026 onwards.

Surplus allowances have kept EUA prices low, Bjarne Schieldrop, chief analyst, commodities, SEB, told the Carbon Forward 2021 conference in October. But in 2014, the EC introduced backloading to delay the issuances and in 2019 introduced the Market Stability Reserve system to slash the surplus.

This has tightened EUA markets in the past four years to the point where they began to impact power generators, he said.

Coal power takes over from wind, nuclear, gas

Germany recently vowed to phase out coal power by 2038, nevertheless, its coal generation increased around 38% year on year in the first half of 2021 amid a 20% decline in wind generation caused by less blustery weather.

German coal generation's increased share continued in the second half, according to Energy Charts data, and utility RWE's lignite coal-fired power plants recorded the biggest gain of all in meeting higher post-pandemic electricity demand.

For electricity exporter France, low-carbon power also lost market share as 30% of the country's nuclear capacity was offline in January because of maintenance, said Papp.

Coralie Laurencin, who is senior director, gas, power, and energy futures at IHS Markit, explained that the situation in France had upped EUA buying in fossil fuel generation compliance markets. "The French fleet massively underperforming—in part was planned, and in part was not—also pushed up demand from compliance buyers," she said.

She added that the high EUA futures prices reflected a "perfect storm of a year," when drivers of compliance buying included the cold winter, low wind power availability in the summer and autumn, as well as bullish natural gas prices.

Other experts agree that the 429% increase in wholesale gas prices between 2019 and 2021 is also driving up the carbon price.

EUA prices have traditionally been driven by power market dynamics, for example the switching off of coal-fired plants in favor of gas, Schieldrop said. As the gas price rose, more power generators switched from lower-carbon gas to carbon-heavy coal and needed to use more EUAs for compliance purposes.

The high gas prices mean it is currently more profitable to burn coal than gas. The profitability of coal-fired power plants is significantly higher than it is for gas power plants, even with EUA prices around €70 and 80, said Papp.

Generators in EU states that allow putting coal plants in a reserve in case of economic or technical necessity have switched them on. "What we have seen in our client base is an increase in coal burning, for example in Germany, but also in Central Eastern Europe. I could mention, Hungary, Romania, and Poland, but they still rely heavily on coal so the difference would not be so great there," said Papp.

Emissions doubled for some generators due to coal switching, which in turn created very strong support for the carbon market, she said.

The gas price aspect may be a short-term phenomenon. IHS Market analysts predict lower prices on the European wholesale gas benchmark market (TTF) in 2022.

Policy pushes hedging market

The EU looks set to require ever more low-carbon energy consumption through 2050 under Fit for 55 proposals. They have acted as a signal to investors looking to profit from a greening push. "They believe the story," said Papp.

The proposals have proven to be a "massive boost" to the carbon market, agreed Laurencin.

In January 2018, EUAs became accessible to non-compliance buyers to use as investments. So, credit institutions, investment firms, funds, and non-compliance EUA buyers took open positions that increased in the second half of 2021, said Papp.

Responding to Spain's concerns that that non-compliance EUA buyers were raising prices, the EU's securities markets regulator published its finding that they were not because the EUA market composition had not "significantly changed."

However, energy price volatility—for example in European carbon, power, gas, and coal prices in the second half of the year— has made hedging investments that bet on a rising carbon price more attractive.

The past two years have seen a growing number of financial market participants use instruments such as carbon exchange-traded funds (ETFs) to gain exposure to the rising carbon futures market, a hedge against growing market risks, Rob Pulleyn, head of utilities and clean energy research, Morgan Stanley told the Carbon Forward event.

"Ultimately, I think what we must remember here is that financial demand for capital flows into carbon—whether that's utility hedging, whether that's industrial hedging, whether that's speculation, whether that's ETFs, or whether that's just following what's going on in the gas market—is the primary driver (of the carbon price)," said Pulleyn.

Exchange group ICE launched an ETF tracking European carbon in South Korea in September. "A growing number of market participants are looking to use global markets to offset their carbon footprint, manage the cost of carbon, and assess climate transition risk," said Magnus Cattan, VP, fixed income and data services, APAC for ICE in a statement.

Activist investors, too, are buying EUAs to tighten the carbon market, a move pursued through the SparkChange CO2 exchange-traded commodity, which launched on the London Stock Exchange in November.

Prospects for EUAs and other low-carbon investments are also being lifted by national net-zero emissions targets, such as that announced by Germany last year, as well as the US and the UK.

Posted 21 January 2022 by Cristina Brooks, Senior Journalist, Climate and Sustainability


Follow Us

May 11

RT @SPGlobal: Essential Intelligence from S&P Global helps you dive below the surface. Because a better, more prosperous world is yours for…

{"items" : [ {"name":"share","enabled":true,"desc":"<strong>Share</strong>","mobdesc":"Share","options":[ {"name":"facebook","url":"","enabled":true},{"name":"twitter","url":"","enabled":true},{"name":"linkedin","url":"","enabled":true},{"name":"email","url":"?subject=EU carbon prices surge in H2 2021 amid power, policy shifts | IHS Markit &","enabled":true},{"name":"whatsapp","url":"","enabled":true}]}, {"name":"rtt","enabled":true,"mobdesc":"Top"} ]}
Filter Sort