Rising EU emissions trading system (ETS) allowance (EUA) prices are supported by fundamentals and not simply a function of increasing speculative activity in the carbon market, delegates at a recent online event heard.
The EU ETS benchmark front-year product has made continuous month-on-month gains since November, almost doubling in value from €23.68/t of CO2 equivalent (CO2e) at the beginning of that month to an all-time high of €47.03/t CO2e on 22 April, Argus data show.
Some market observers have linked the rally to growing interest in carbon from speculative investors, sparking calls from some participants for regulatory intervention, such as additional position limits. EU financial regulator Esma said in February that it was unaware of any such plans by the European Commission, which itself declined to comment.
But current prices are "fundamentally justified", according to carbon investment platform Sparkchange's head of research, Jan Ahrens, who points to the decarbonisation that will need to take place to meet the EU's stricter 2030 emissions cut target and net zero goal for 2050.
The EU ETS is now in a "period of structural inventory destruction" owing to the introduction of the market stability reserve (MSR), trading firm Hartree's head of environmental products, Ariel Perez, added. The MSR removes 24pc of excess allowances from the market each year.
And higher gas prices mean that no ground has been made on fuel switching, Perez said, as they have pushed the price at the top of the fuel-switching stack higher.
Environmental consultancy Carbon Cap Management's chief executive, Michael Azlen, pointed to a buyer squeeze in the transition between the ETS' third and fourth trading phases.
Installations are unable to use permits issued this year to cover 2020 emissions, while a delay in the allocation of free allowances to qualifying firms means they are also unable to swap these in the market for eligible permits.
The role of speculators
Investor activity does appear to have played a part in the recent rise in EUA prices, Ahrens and Azlen said, given that compliance demand will have dropped because of last year's Covid-driven fall in emissions.
But while some aspects of this are problematic, others are healthy for the market, Ahrens said, highlighting that long-term investing can lower volatility.
And speculators can have a "control function" in the market, narrowing the band between market prices and the fair value of carbon over time, Perez added.
The EU ETS needs a "full ecosystem of participants" to ensure liquidity and price discovery in the market, Azlen said. "We are in favour of a free and open carbon market."
Downside potential
A number of factors could contribute downside to EUAs in the shorter term, including continued significant abatement of emissions, the unwinding of forward hedges, and free allowance allocations, Azlen said. The start of UK ETS auctions is also likely to see participants swap EUAs for UK allowances, further increasing EU ETS supply, he added.
The UK launched its domestic ETS at the beginning of this year, but allowance sales do not begin until 19 May and large UK installations are likely to have purchased EUAs to hedge their carbon exposure in the intervening period.
But while there may be short-term volatility, prices should be on an upward trajectory this decade to meet the EU's 2030 emissions cut target, Ahrens said. "In the long run, the fundamentals are clear."
