Carbon allowance prices under the EU Emissions Trading System rallied as high as Eur8.00/mt in early November, as proposed post-2020 market reforms moved forward. After agreement between the EU Parliament and Council, the main political hurdles have now been overcome in efforts to revamp the market, including measures to curb a long-term oversupply of allowances. Europe's carbon market is facing a well-supplied year in 2018, but significant supply constraints are coming in 2019. S&P Global Platts senior writer for European carbon markets Frank Watson reports.
Related article: EU ambassadors approve post-2020 CO2 market reform deal
Post-2020 EU carbon market legislation clears major hurdle
By Frank Watson, senior writer for European carbon
Welcome to the Snapshot – our series which examines the forces shaping and driving global commodities markets today. Carbon allowance prices under the EU Emissions Trading System rallied as high as eight euros per ton in early November as lawmakers from the EU Parliament and Council worked to agree legislation to overhaul the carbon market after 2020.
That compares with as low as four euros fifty in May – a 78% increase within six months. After more than two years of legislative work on this file, the parliament and council managed to strike an informal agreement on November 8.
This is a major milestone in the legislation becoming law. So what’s been agreed, and why does it matter?
One of the defining characteristics of the EU carbon market is a long-running oversupply of allowances that has kept carbon prices in single digits since 2012.
The most significant element in the latest proposed reforms is a strengthening of the so-called Market Stability Reserve -- a mechanism to withhold 24% of the cumulative surplus of allowances each year starting in 2019.
Other elements of the agreed reforms include a steeper decline in the annual CO2 cap to 2.2% per year from 2021 to 2030 and a cancellation of any volume of allowances held in the Market Stability Reserve in excess of the previous year’s auctioning volume.
Taken together, these measures are expected to tighten the market surplus starting in January 2019, and are expected to prompt a rebalancing of supply and demand that is likely push carbon prices higher over time.
The legislation still needs formal approval by the parliament and council, but the main political hurdles have now been overcome.
On the demand side, the German clean dark spread – profits on coal-fired power plants including the cost of coal and carbon allowances – continues to look robust for higher efficiency coal units on a quarter-ahead and year-ahead basis, and that’s maintaining forward hedging demand for carbon for the time being.
However, until those supply side constraints kick in in 2019, the market is still facing a significant oversupply of allowances in 2018, and this may limit the upside.
Furthermore, EU member states are looking increasingly bold in their plans to phase out coal from power generation.
Some analysts say this could provide a headwind for carbon prices over the long term, even as the EU ETS regulations work to tighten the supply side of the equation.
How this plays out for the price is uncertain, but one possibility is that the first half of 2018 could yet see bearish pressure on the price, but with a strengthening taking place later in the year as we get nearer to the start of reduced supply of allowances from government auctions in 2019. Until next time on the Snapshot - we’ll be keeping an eye on the markets.