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As carbon prices reach record levels in the EU, many UK-based energy managers will be considering how their organisation could be affected by increasing emissions market costs. Although we’ve left the EU Emissions Trading Scheme (ETS), the UK’s own scheme is set to launch this month. Carbon markets will therefore continue to impact UK wholesale prices – which means it’s important for all businesses to stay informed of market dynamics to mitigate its effect on their energy bills.

The EU carbon price has pushed well past €50 per tonne in May 2021, surpassing this milestone in the EU’s drive to reduce bloc greenhouse gas emissions. With climate change action and speculative interest in the commodity only set to grow, the price of carbon is expected to continue rising over time. In fact, it’s estimated that prices could reach €90 per tonne by 2030.

What’s pushing carbon prices so high?

A range of factors have contributed to the recent rally of EU carbon prices, adding upside risk to wholesale energy markets in the years to come.

The biggest driver behind carbon’s appreciation is the strengthening of the EU’s 2030 emissions goals. The EU’s emissions reduction target now sits at 55% below 1990 levels, extending the previous target of 40%. Brussels is expected to publish further decarbonisation policies for businesses across all sectors this summer, to aide prospects for meeting this ambitious target. This has already increased compliance-based demand for EU Allowances (EUAs), increasing permit scarcity as we move towards a lower-carbon future.

It’s not just compliance-based market participants purchasing EUAs. Financial investors are also being tempted into the market, with carbon seen as a lucrative investment vehicle given historic, recent, and prospective returns for this green financial instrument. Investment funds are taking up more space in the market, with speculative participants currently holding around a quarter of the long positions in the EU ETS, leaving fewer permits for compliance-based participants.

What does this mean for UK businesses?

Since the end of the Brexit transitionary period on 31 December 2020, UK businesses have ceased to be subject to the EU ETS. That doesn’t mean that emissions markets will cease to affect UK businesses. The UK is instead moving to its own ETS, with the Intercontinental Exchange facilitating the auction of permits, and trading of carbon futures/spot contracts.

With UK ETS trading set to begin from 19 May 2021, we’re still awaiting information on whether the UK market will be coupled to the EU ETS. Both schemes are similar in nature, covering emissions from e.g. the power sector, aviation, and energy intensive industries. Whilst the UK ETS has a tighter annual permit cap and a higher fine for those exceeding emissions limits, there seems to be no real barriers preventing scheme coupling as other non-EU regional states have.

The International Emissions Trading Association (IETA) in particular has called on UK and EU leaders to link markets to “allow emissions reduction targets to be reached more quickly, easily, and at better value”. If the two markets aren’t linked, then the UK ETS could have limited market liquidity and price discovery, which could increase market volatility. Within the Brexit withdrawal agreement, both the EU and Britain have committed to “a strong principle of non-regression, including on carbon pricing”. Whether this sentiment translates to carbon market linkage remains to be seen.

Whether or not the nascent ETS is coupled to the EU, carbon markets will continue to impact wholesale energy costs given the UK’s continued reliance on non-renewable power (e.g. gas/coal). If carbon prices rise, power plant costs will be passed on to wholesale markets, and therefore business energy users. Although the current UK ETS permit supply cap is higher than total forecast emissions, the supply cap will be reduced over time, to align market fundamentals with net zero goals. In the Sixth Carbon Budget, the Climate Change Committee proposed reducing the cap to a level below business-as-usual emissions from 2023. This heightens prospects for future permit scarcity, adding upside risk to both UK carbon and wholesale energy costs.

Want to know more?

Contact Wayne Brown, Head of Strategic Partnerships at Inspired Energy, wayne.brown@inspiredenergy.co.uk t: 07587 617912.