EC Warned Against Responding to Rising Carbon Prices

“Rattled” policymakers urged to resist temptation to intervene in EU ETS market. 

Political intervention in the EU Emissions Trading System (ETS) would “defeat its purpose”, undermining its role in the decarbonisation of firms with high greenhouse gas emissions (GHG), according to Luke Sussams, Head of EMEA ESG and Sustainable Finance at investment bank Jefferies.

ETS’ are set up by governments to incentivise firms in carbon-intensive sectors to reduce their emissions by controlling the availability and price of permits. The EU ETS is the largest and longest established globally, accounting for 90% of turnover, according to Refinitiv. There are also voluntary markets for companies looking to buy carbon credits which claim to reduce, avoid or remove CO2 emissions they can’t cut themselves.

Pressure to intervene has been prompted by a 137% spike in the ETS carbon price over the past 12 months, according to a Jefferies report. This is proving challenging for industries and consumers already facing price spikes in fossil fuels due to the energy crisis.

On 21 February, EU diplomats debated measures to curb the price of emissions permits, which had reached highs of €98 per tonne of CO2 (/tCO2e) earlier that month. This can be done if all member states agree to lower the threshold at which regulators are allowed to intervene in the ETS under Article 29a of the ETS Directive.

Their concern is that “the price is rising too high, too fast”, prompting some policymakers to consider ways they can “tinker with it to slow it down”, said Sussams.

Recent price trends imply a rising trajectory in excess of prevailing expectations among policymakers.  “If you look at statements from various official sources, they indicate that Europe can expect carbon prices of at least €110 by 2030,” said Markus Zimmer, Senior ESG Economist at Allianz.

The ETS Directive dictates that the current allowance price must be three times the average price of allowances during the two preceding years for more than six consecutive months before Article 29a can be triggered, allowing intervention. Policymakers would then be able to auction or release further allowances to increase the supply of carbon credits available in the ETS while suppressing price.

The Jefferies report warned that such interference would have “significant implications” for investors expecting a higher CO2 price in the EU, while providing a “significant upside” for Europe’s heavy industrial sectors.

“The ETS is designed to place a price on carbon – policymakers knew that the rubber was always going to hit the road but are rattled by the pace,” Sussams told ESG Investor.

Jumping the gun

Energy exchanges have urged the European Commission to refrain from interfering with the ETS ahead of a report by the European Securities and Markets Authority (ESMA).

Expected in April, the report will provide an in-depth analysis of the carbon market and assess whether there is a need for targeted actions to improve it. ESMA’s preliminary findings were published in November 2021.

In the letter, Europex, an association of European energy exchanges, noted that the ETS is “the cornerstone of European climate policy” and that it is “finally enabling decarbonisation at the scale required to reach climate targets”.

Members of Europex include European Energy Exchange and a number of national energy exchange operators.

The exchanges said they were concerned that EU diplomats are considering position limits or restrictions on the participation of financial and non-financial actors.

“It would make it more expensive and complex for compliance entities to hedge for the future and plan for investments into low-carbon alternatives,” the letter said. “It would reduce the ability of this group to access the market via financials and it would cut liquidity, driving up transaction costs and uncertainty for all participants. The result of lower liquidity would be increased volatility and would significantly reduce the economic relevance of long-term price signals.”

The current price trajectory does not meet the existing requirements in the Article 29a clause, the Jefferies report said, which means that “the overall likelihood of this intervention in the EU ETS being implemented [at this time] remains low”.

Expanding the system

The Commission published a bloc of sustainability legislation, ‘Fit for 55’, last year, which includes a comprehensive set of changes to the existing EU ETS.

These changes aim to achieve a 61% emission reduction in all covered sectors by 2030 compared to 2005 levels.

Proposed changes include extending the ETS to cover emissions from maritime transport, phasing out the free allocation of emission allowances to sectors covered by the planned carbon border adjustment mechanism (CBAM), and implementing the global carbon offsetting and reduction scheme for international aviation (CORSIA) through the EU ETS.

The Commission also plans to create a separate ETS for buildings and road transport, which it predicts will ensure a 43% emissions reduction for these sectors by 2030 compared to 2005 levels.

A vote on final amendments is expected to take place in June.

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