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EU CO2 prices hit Eur10.00/mt for first time in six years

London — The cost of a right to emit a ton of carbon dioxide in Europe moved into eurodouble figures Wednesday for the first time since 2012.

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EU carbon dioxide allowance futures prices under the EU Emissions TradingSystem for delivery in December 2018 rallied as high as Eur10.02/mt($12.38/mt) Wednesday morning, up from Eur9.90/mt at the close Tuesday.

The return to double-digit carbon pricing follows more than two years oflegislative work in Brussels to overhaul Europe's flagship cap-and-tradesystem following years of oversupply that led to carbon prices sinking as lowas Eur2.50/mt in 2013.

Prices last traded in double euro digits in late 2012 and were as high asEur30/mt in 2008 before the market become oversupplied with allowances.

The EU Council, representing all 28 EU member states, is set to meet February27 for its General Affairs Council.

The EU ETS is on the provisional agenda, and this is expected to provide anopportunity for the Council to give its final approval on proposed post-2020reform legislation that aims to strengthen the system.

The Council's expected sign-off will be procedural, because it has alreadyendorsed the legislation in November.

The EU Parliament voted February 6 with a large majority in favor of a deal itreached with the council in November to overhaul the EU ETS. Both institutionsneed to formally approve the proposals for the legislation to become law.

The EU ETS reform legislation includes a raft of measures that seek to equipthe system to deliver on the EU's emissions reduction goals for 2030,including a steeper annual decline in the CO2 cap from 2021-2030, moretargeted free allocation for the non-energy industrial sectors, and newfunding mechanisms for energy innovation and modernization.

Chief among the reform measures is a mechanism that will take effect before2020 -- the Market Stability Reserve.

The MSR seeks to cut the long-term surplus by removing allowances fromauctions each year, effectively rebalancing supply with demand under the EUETS.

The EU passed the MSR into law under separate legislation in October 2015 butits parameters were strengthened more recently as part of the post-2020 marketreforms, such that it will remove 24% of the cumulative surplus of allowanceseach year starting January 2019, double the originally proposed 12%/year.

This is expected to return the EU ETS to a more balanced state by cutting thesurplus of around 1.694 billion mt in 2016 down to a much smaller range of 400million to 833 million mt.

Even though the MSR still allows a net surplus to persist, the surplus will bemuch smaller than in the past and is now less likely to be brought to market.Industrials holding excess supply may see an advantage in holding inventory ofallowances to cushion against looming shortages which could otherwise limittheir profitability or curb production.

The MSR was designed in such a way that it would remove surplus volume inan automatic way, linked to quantitative thresholds, irrespective of thefactors driving the surplus. This was intended to remove the need for futureregulatory intervention if the market were to become imbalanced again.

However, the rules set down under the EU ETS legislation do provide ongoingscope for EU regulators to reassess the rules and propose further changes ifnecessary in the 2020s. That means further supply-tightening measures could beintroduced if the existing set of policies were deemed insufficient.

Over the long term, Europe continues to decarbonize its economy, and thisincludes goals in many EU member states to phase out the mostemissions-intensive fuels such as coal and lignite from power generation.

These emissions reduction measures are a clear negative for EUA demand.However, the net result for carbon prices is likely to continue to be bullishif the annual supply cuts mandated by the MSR are more rapid than the rate ofCO2 reductions due to all other factors combined.

Analysts note that carbon prices are still potentially vulnerable to asell-off in the short term, with a well-supplied market in 2018 ahead of theMSR becoming operational in 2019.

In addition, the CO2 intensity of power generation in the bigger EU countrieshas fallen by about 20% so far this year amid warmer than normal temperaturesand strong wind availability, which could act as a brake on carbon's pricegains.

--Frank Watson, frank.watson@spglobal.com

--Edited by Maurice Geller, maurice.geller@spglobal.com