New year, new carbon prices. Prosposals by the European Commission and Parliament made in December have pushed European carbon prices to a new high this week and once fully voted in they will create a backdrop for stronger prices for the rest of this year.
How does it work?
The EU obliges companies to hold a permit for each tonne of CO2 they emit and in order to give them time to reduce the amount of carbon they emit the EU also allots some free emissions allowances. The allowances are then traded on the European Emissions Trading System, currently the world’s largest carbon market (although China is slowly expanding its own emissions trading).
The stricter December proposals have lifted prices of the benchmark EU Allowance (EUA) contract for the first time above EUR100 a tonne this week, briefly hitting EUR 103 before settling down at just below the EUR 100 threshold. The EUR 100 barrier is significant because the market had two attempts at it last year, both of which failed and were followed by a sharp decline
What has changed?
Two months ago the EU proposed to signficantly step up is emissions reduction by the end of this decade, aiming to reduce the emissions levels in 2005 by 63% by 2030, up from the previous target of a 43% reduction. The proposal will result in approximately 23 million tonnes of C02 emissions being cut compared with the EU Commission’s proposal from 2021, a much more aggressive target.
The final details are still being discussed with some relatively small differences in place between what the European Commission and the European Parliament would like to see (Parliament wants a 63% reduction and the Commission 61%), but overall, the final reduction will still be above 60%. The upward pressure on prices is being magnified by a deadline in April when companies have to buy and submit enough CO2 permits to cover last year’s emissions.
More significantly, this system, which currently covers over 10,000 power stations and other industrials will be changed in that the free allowances that the EU currently provides will be phased out over the coming years. To achieve this stronger reduction of over 60%, the legislators agreed on a rebasing of emissions: a further 90 million EUA will be taken out of the market in 2024, creating the first level of tightness, following by another 27 million EUA which will be taken out in 2026.From 2026 onwards, the number of free allowances handed over to industries will be reduced gradually until 2034 when industries have to procure all of their needed allowances through the auctioning mechanism or on the market. After that day there will be no free allocations.
Looking at the time frame for the rest of the decade the emission cap will be reduced by 4.3% each year between 2024 to 2027 and from 2028 onwards by a factor of 4.4%. The system that currently includes power generation and industrial production will expand to include maritime shipping and civil aviation.
This means no more slow burn for carbon pricing. Expect to see tighter supplies of EUAs and new higher prices as companies either reduce their emissions or, if they can’t, buy more allowances.
An ETF that tracks the Carbon price
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