How European carbon prices jumped from €5 to over €63 in less than five years

On 8 September 2021, the price of carbon in Europe reached over €63 – its highest ever price since the emissions trading scheme (ETS) launched in 2005. For the majority of 2017 however, it stood at just €5 a tonne. In less than five years, emissions trading has transformed from being an annual procurement exercise with negligible budget-impact to being a key liability driving emission-reduction targets.

From feast to famine

As recently as 2017 the EU carbon market was characterised by a surplus of EU Allowances (EUAs) and price stability, with the price of carbon staying in around the €5 mark for a five-year period (Figure 1). Free allocations covered the majority of industry emissions, and the oversupply created by the 2008 financial crisis - which reduced economic activity and industry emissions - still pervaded. Whilst the risk of this oversupply undermining the function of the market was highlighted as far back as 2012, it wasn't until 2019 that a mechanism was finally implemented to correct the problem: the Market Stability Reserve (MSR).

EUA Price 2017-2021
Figure 1: EUA price over 2017-2021

Fast forward to 2021 and the picture has changed dramatically, with the implementation of Phase 4 of the EU ETS seeing a significant reduction in the levels of free allocations. As the number of sectors receiving 100% free allocation under the carbon leakage list is reduced and benchmarks are tightened, compliance costs are set to soar.

Fit for 55 and increased UK constraints

In July, the EU released its 'Fit for 55' package: a range of measures aimed at reducing Europe’s net greenhouse gas emissions by at least 55% by 2030 (compared to 1990 levels), further tightening the market.

Under these proposals the EU ETS now faces a -61% emissions reductions target by 2030 (vs -43% under current regulation), resulting in a doubling of the annual Linear Reduction Factor to 4.2% as well as a one-off downward adjustment of the cap.

The UK ETS is also expected to see a significant cap adjustment from 2024 to meet a 68% cut in GHG emissions by 2030, and 78% by 2035. The impact of these proposals on the carbon price have already been felt (see Figure 2).

Recurring trends

When the EU Green Deal 2030 target was first proposed in the post-COVID summer of 2020, EU carbon prices were lingering around €20. Analysts quickly highlighted that to achieve such ambitious emissions cuts, the cost of carbon would have to rise to drive abatement within sectors covered by the EU ETS, and forecasted prices to double.

The result was a sharp increase in buying interest from both traditional market participants and new investors. Over the 12 months that followed, the EU carbon price followed analysts predictions and more than doubled to an all-time high of €63.

Figure 2: ICE Front DEC EUA Contract at ICE Futures Europe to 21st May 2021

So, what does this mean for EU and UK based operators trying to manage carbon costs now running over ten times what they were back in 2017? Industrial and manufacturing firms face rising compliance costs combined with the challenge of procuring EUAs in an increasingly volatile market.

An active risk management strategy which forecasts future emissions and seeks to hedge carbon allowance purchases throughout the year is now key. The same approach used for other energy commodities now applies to carbon, but requires internal approvals, budget allocation and carbon market access.

A volatile but functional market

With carbon prices over €60, industrial abatement projects should start to emerge. These projects present an opportunity for operators to use the ETS as a carbon finance tool to help finance abatement measures, via the sale of surplus allowances.

The intended function of emissions trading - to provide economic incentives for reducing emissions and encourage innovation – may not have been felt when prices were as low €5. In today’s market however, industries are compelled to take action and find solutions to weather the peaks.