The EU is taking steps to prevent Brexit from inadvertently crashing the EU carbon price next year. Policy-makers fear that UK companies could decide to sell all their EU allowances issued from 2018 if they believe they will no longer need them for compliance with the EU Emissions Trading System after March 2019, when the UK is currently due to leave the EU.
Such a sell-off in an already oversupplied market would likely weaken carbon prices, just as the EU is also finalizing post-2020 reforms intended to strengthen them. S&P Global Platts editors Siobhan Hall and Frank Watson, and PIRA analyst Jeff Berman, discuss the policies, price impacts and next steps for the EU carbon market.
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EU acts to protect carbon price from Brexit-induced crash
With Siobhan Hall, senior editor for EU energy policy, Frank Watson, senior writer for EU carbon markets, and Jeff Berman, director for emissions and clean energy at PIRA analytics
SIOBHAN HALL: Hello, and welcome to this Brussels to Beijing policy podcast from S&P Global Platts. I’m Siobhan Hall, Platts’ expert on European Union energy policy based in Brussels.
Today we’re talking about the latest developments on the EU carbon market, including new measures intended to stop Brexit crashing the price from next year and post-2020 reforms intended to cut the massive surplus of allowances that has built up in recent years.
To do this I’m joined from London by Frank Watson, Platts’ EU carbon market expert, and from New York by Jeff Berman, director for emissions and clean energy at analytics company PIRA, which is also part of S&P Global Platts. So Jeff, why is the EU so concerned about the impact of Brexit on the EU carbon market?
JEFF BERMAN: Thanks for having me Siobhan. Well, policymakers in Brussels have been grappling with how to protect the European carbon market from Brexit. Now, the carbon market is already massively oversupplied, and now there is the risk that if UK leaves the carbon market on Brexit day in March 2019, UK companies will be holding a lot of allowances for a compliance obligation that they will no longer have. This can introduce a new wave of oversupply, as UK companies can sell off these allowances, and in the meantime, it’s introducing a new element of market uncertainty.
SIOBHAN HALL: Right, so I can see why the EU is worried. Frank, what’s the plan to protect the EU carbon market from this?
FRANK WATSON: Well, thanks Siobhan. The plan is to change the EU ETS rules to enable all UK allowances issued from the first of January 2018 to be clearly marked as UK allowances. And that includes those sold in auctions and those allocated for free to industrial installations. So companies would not be able to use these UK marked allowances for compliance purposes under the EU ETS until there is a future agreement between the UK and EU on participation after the Brexit date in 2019.
JEFF BERMAN: But more immediately it means that as soon as 2018, there is a possibility that carbon allowances won’t have the same value across the European Union. One price could emerge in the UK, and another price entirely for all other countries.
FRANK WATSON: That’s exactly the risk and it may be that UK companies decide not to buy UK issued allowances in auctions, and instead buy those allowances issued by the other 27 EU member states as a way of hedging against any possible future compliance requirements, because they could always sell those other EUAs to other companies if it turns out they’re no longer part of the ETS.
SIOBHAN HALL: OK, so essentially this policy reduces demand for UK allowances and could increase demand for non-UK allowances. Jeff, how likely is it that the proposal will be approved and in place by the first of January?
JEFF BERMAN: I think it’s certainly possible. Negotiators from the European Parliament and EU Council have already agreed to it informally, and the European Commission has already presented a formal proposal this week. And so the timing is certainly tight to have it in place by January 1, but it’s absolutely possible. At the same time any delays to this regulatory timeline could also delay sales of allowances starting next year.
SIOBHAN HALL: Right, well, this must be very unsettling for everyone involved in the EU carbon market, particularly because I understand that carbon prices have been rising recently. So Frank, where are EU carbon prices now?
FRANK WATSON: That’s true Siobhan, to your first point, it does add a lot of uncertainty for the market, especially for UK-based operators and traders are not too happy about the uncertainty. It’s too early to see a specific price impact that can be discernable just yet, but certainly on your second question about the prices, carbon now for delivery in December this year – 2017 -- is currently trading around the mid-seven euros per metric ton level, and that’s up on the sub-six euro prices that we saw a couple of months ago, but also down on the two-year highs that we saw of just under eight euros earlier this month.
JEFF BERMAN: And really the biggest factor driving current carbon prices is uncertainty about the availability of French nuclear generation as we head into the peak winter season. Any additional outages will have to be covered by higher thermal power generation, which increases demand for carbon allowances.
FRANK WATSON: Yes that’s definitely a good point on the underlying demand there with the power market certainly a factor. But also some of the rises that we’ve seen recently are almost certainly linked to the EU’s planned post 2020 reforms to cut the surplus being almost certainly priced in already. In particular, we understand that EU negotiators have informally agreed to double the volume of allowances going into the new market stability reserve from 2019. So effectively that would see 24% of allowances earmarked each year for auction instead going into the reserve.
SIOBHAN HALL: Right, now that sounds like a big change in supply. How long would that go on for?
FRANK WATSON: The expectation is that it would continue for five years, so from the start of 2019 to the end of 2023. And EU policymakers are hoping that putting allowances at that rate into the reserve could help bring the market oversupply back to levels last seen around about 2010 or 2011, when prices ranged from around about 10 euros to 17 euros.
JEFF BERMAN: Now, that’s an interesting view, Frank, and certainly a lot of folks in the market have been using that supply-side information as a guide to where prices could go, but our view at PIRA is that there’s a more important demand-side story that needs to be considered.
There are other EU policies that could further reduce demand for emissions -- things like improving energy efficiency or using more renewable energy. And domestic policies play a huge role too. In the last few weeks, two countries, the Netherlands and Italy, have announced new domestic initiatives to add additional prices to carbon and to phase out coal-fired generation entirely.
All of these policies have a major impact on demand for allowances in the broader European carbon market. And so it could take far longer for prices to recover to previous levels.
FRANK WATSON: Yes that’s a good point and we’ve seen similar aspects to that in the past where more aggressive phasing out of coal has affected verified emissions. One thing that we are looking at closely is that the MSR reserve will actually deal with surplus based on an automatic rate of 24%. So even if there were additional elements that reduce demand for carbon, we see that MSR as an automatic self-balancing mechanism.
JEFF BERMAN: In theory, yes, but that doesn’t mean that the MSR works quickly. Even as the MSR is removing oversupply, new oversupply is continually building in the market from weaker demand. And remember that the percentage of oversupply that is due to be placed in the market stability reserve will fall to a lower level of 12% starting in 2024.
SIOBHAN HALL: OK, so there are these efforts to reduce the oversupply, but there are also these other policies going on that are reducing demand, so there are still lots of variables, but overall it still seems that carbon prices will tick up in the medium term – it’s just a question of when not how. What’s happening next on the post-2020 reforms?
FRANK WATSON: Well, the next meeting of EU negotiators on the post-2020 reforms is on November 8, and we could see an informal agreement then, or if not, certainly soon after.
JEFF BERMAN: Absolutely, an agreement by the end of this year on the broader market reforms is definitely possible.
SIOBHAN HALL: Right, so basically these are very interesting times for the carbon market. So we have a potential agreement on post-2020 reforms maybe even as early as next month, and then there is this potential change to the UK allowances starting from January 1, 2018.
Interesting times! Thank you, Jeff and Frank, for all your insights. That’s all we have time for today. Thank you for listening, and tune in next time for more Platts perspectives on policy.