For commodity traders in 2021, the EU carbon market has been close to a one-way bet. Ending 2020 at €32.72 a tonne (t) of carbon dioxide, the benchmark EU allowance (EUA) contract broke record after record, peaking in intraday trading at €90.75/t on 8 December. The question for anxious industrial emitters is whether these prices can be sustained, or whether they can expect some relief in 2022.
As is often the case, market analysts are divided: some see prices softening somewhat, as the forces that have driven energy prices higher weaken. Others see carbon prices continuing to rise, to €100/t and beyond, following the logic of a market that is designed to become increasingly tight over time.
This year’s rally in carbon prices is the result of a number of factors. First, EU policymakers have clearly signalled the direction of travel. A European Climate Law that entered into force in July 2021 increases the EU's climate target to a 55% emission reduction by 2030 compared with 1990 levels, up from 40%. To get there, the 'Fit for 55' package proposes to steepen the annual reduction in the emissions cap for the EU carbon market – the linear reduction factor – from 2.2% to 4.2%. In addition, new sectors are due to join the EU Emissions Trading System, with maritime emissions to be incorporated from 2023, and aviation from 2024, creating additional demand for allowances.
Although there is currently a substantial surplus of allowances in circulation, the anticipated tightening of the market has encouraged speculators to enter the fray. Analysts at THEMA Consulting say: “Speculative demand from investors has structurally raised the CO2 price.” An investigation by the European Securities and Markets Authority found no evidence of market manipulation, but speculators betting on rising carbon prices have helped push them higher.
In addition, unexpectedly strong demand for energy in 2021 met with supply constraints, especially in natural gas, sending prices rocketing in the autumn. Power generators responded by ramping up production from carbon-intensive coal-fired capacity, driving demand for additional carbon allowances.
At the time of writing, some of the heat had come out of the EUA market, with prices cooling off to close at €81.80/t on 14 December. However, continued volatility in the energy markets will guide EUA prices in the near term. “We expect EUAs to stay very sensitive to the evolution of the gas market, amid sustained low EU gas storage levels and supply tensions,” says THEMA. Questions continue over when – and if – German regulators will approve the Nord Stream 2 gas pipeline.
Nonetheless, in what would provide some relief to European emitters, several analysts expect prices to continue to slide as we head into 2022. “We think that EU emissions trading will enter calmer waters next year,” wrote Barbara Lambrecht, energy analyst at Germany’s Commerzbank, in late November 2021. “If, as expected, gas prices fall towards spring, this should also weigh on carbon prices.”
Carbon market analysts at information provider Refinitiv also see carbon prices softening in 2022, with their latest forecast pegging prices averaging €59/t over the year – albeit a forecast that is €10/t higher than their last, published in July. They see a fall in emissions from Europe’s power sector next year, as energy efficiency measures begin to bite and as fossil fuels supply a much smaller share of power, as a key factor.
Volue expects prices to soften to around €60/t by the end of 2022. Espen Andreassen, a senior analyst at the Norwegian technology provider, says the longer-term tightening of EUA supply ushered in by the 'Fit for 55' package has been largely priced in by the market. The package was actually more lenient than expected, he adds. In addition, Andreassen argues that output from most of Europe’s energy and carbon-intensive industries has been lower in 2021 than in 2019, which itself was not a particularly strong year, dampening demand for EUAs.
Similarly, THEMA Consulting thinks it most likely that EUA prices will remain in a range of €60–65/t over the next two years, in its central scenario. “Short-term corrections [below this level] cannot be ruled out especially in expectation of a correcting gas market, but EUAs will likely be supported by dip-buying when getting close to the €50/t level. Volatility will remain high,” its analysts say.
Others, however, are more bullish. Vertis Environmental Finance’s “bearish scenario” pegs EUA prices over calendar year 2022 at just shy of €70/t, while its “bullish scenario” foresees prices at €108/t. It cites “upside risk” from continued high European gas prices caused by delays to Nord Stream 2 approval and political tailwinds, including an aggressive push on 'Fit for 55' when France takes over the rotating EU presidency for the first half of 2022 and the new German government’s call for a €60/t carbon floor price.
Similarly, Berenberg – one of the few houses to anticipate this year’s high carbon prices – increased its carbon price forecast by 40% earlier this year. It is now forecasting EUA prices of €110 in 2022, before dipping to €75t in 2023 and then rising again to €87/t in 2024.
In a note in August 2021, the bank warned that “the carbon liquidity crunch begins this year”. It points to “deep analysis [that] offers a high degree of certainty that the market faces a significant supply-demand imbalance”, implying a significant increase in carbon prices.
The carbon market is a market created by policy, and the response to high prices will similarly be a political one, Berenberg’s analysts argue. They believe that a price of €110/t will trigger a “political reaction” that eventually brings it down to €75/t.
However, that relief for emitters will be limited, Berenberg says, with carbon prices rising above €90/t again in 2025 and spending the rest of the decade between there and €100/t.
Renewables set the pace
Similarly, Andreassen at Volue believes prices are likely to rise over the medium-term, given slow growth in the roll-out of renewable energy capacity. “We consider renewables growth to now constitute the largest uncertainty to EUA prices for the coming decade,” he says. “We are still not getting the accelerated growth that is needed to reach compliance with EU member states’ very ambitious 2030 renewable energy targets.”