At what point has the discreet European emission rights market become a financial product that attracts investors en masse? To what extent is the energy transition responsible for the energy price crisis in Europe? The European Commission has finally agreed to review the role of speculative purchases in the escalation of the carbon price in the European CO2 market.
The European CO2 market is a system for the sale of quotas with the right to pollute. The European Commission establishes the number of quotas, increasingly limited to encourage the transition to cleaner energy. And the more expensive it is to pollute, the more expensive our energy bills are. Emission rights represent between 10% and 20% of the bill, according to different calculations.
Several countries, including Spain, arrived at the European Summit in Brussels in October with the demand that speculation in the European carbon market be controlled, the price of which has soared to almost 65 euros per ton, almost double than at the beginning. of year.
To understand the keys to this market and its influence on energy prices, we spoke with Gregory Idil, Senior Corporate Trader at Vertis, a specialist company in the European CO2 quota market with a presence throughout the Continent.
What is the European carbon market?
The EU Emissions Trading Scheme or EU ETS(EU Emissions Trading System) is the main tool of the European Union to reduce greenhouse gas emissions (it regulates, in addition to carbon dioxide CO2, nitrogen oxide N2O and fluorinated gases).
There is an international market for CO2 emissions (the one discussed at the COP summits, among others), and other regional emissions markets, but the European one is the most ambitious system and the first in the world.
It was launched in 2005 and is based on a logic of “permits to pollute” that some 11,000 especially polluting facilities (power plants, refineries, cement plants, metallurgical plants …) must obtain. The 27 members of the EU, Iceland, Liechtenstein and Norway participate. (The UK abandoned it as part of Brexit creating your own system).
The EU ETS is estimated to cover 45% of the European Union’s emissions.
When did its price start to rise?
Some industries receive free permits to pollute, which reduces the number of permits available. As the goal is to reduce emissions over time, the quotas are being reduced.
Since 2009, a surplus of quotas has been accumulating due to the reduction in economic activity due to the 2008 crisis and the purchase of carbon permits in international markets.
To counteract a drop in prices that made the European carbon market uninteresting (reducing the incentive not to pollute), the Stability Reserve which, among other things, decides how many of the surplus permits are to be auctioned on the market.
Poland brought this mechanism before the European Court of Justice but its claim was rejected.
According to Gregory Idil, the first inflow of speculative capital occurred in 2019 when the European Union announced the creation of the Stability Reserve, “which would function much like a central bank, regulating the number of CO2 rights in circulation.”
Speculative players understood that emission quotas would be an increasingly scarce and therefore profitable market: “many speculative players, including investment funds and banks, decided to take long-term positions in this market by starting to buy huge volumes of CO2 rights ”explains the specialist in the EU ETS. Now there are more than three times as many financial players not directly linked to emission rights – non-industrial – than in 2008, he adds.
Why convert emission quotas into a financial product?
The European carbon market has always been open to any person or entity, not just polluting companies, according to EU sources consulted by euronews. Idil assures that it is a question of market liquidity. The presence of financial actors is “necessary to guarantee liquidity in the market and facilitate the price formation process. The absence of financial intermediaries would render this market ineffective ”.
In 2018, CO2 quotas become a financial instrument more regulated by the Markets in Financial Instruments Directive (MiFID2). According to EU sources, it was to adapt to the growth of the carbon market, making the entire market regulated by the rules of financial markets, including mechanisms against abuse of market position or money laundering.
“It has always been a market open to investors or banks and other actors not involved in the emissions markets, but were there incentives to enter that market? Not too many. ” Idil assures.
Many websites offer guides for investors as is done with all other financial products and merchandise.
How have the recent speculative movements been generated?
In September 2020, with prices still slowly climbing from the COVID-19 lockdown “downturn”, the European Union announced its ambitious plan to multiply emission cuts to 55% by 2030 “instead of the 40% that was provided”. Idil details that the Commission was tasked with creating the necessary legislation to reduce emissions faster than anticipated.
“This political action implied that the supply of emission rights in the market would be reduced even more in the long term. Naturally, this encouraged new financial players to take speculative positions, as the demand for emission rights should increase. This speculative impulse, as well as a series of events in the energy markets, and particularly in the gas market, have caused prices to exceed 60 euros per CO2 emission right today, ”says Idil.
The European Union has consistently rejected calls from countries such as Spain and Poland to take exceptional measures, arguing that arbitrary interventions would affect the reliability of the market for investors and remove incentives to invest in cleaner technologies.
However, in the current context of the price crisis, Brussels has agreed to review the role of speculative actors and has in its hands Article 29.1 that allows the Commission to intervene when the price of CO2 shoots up to three times the average in recent years. two years, although this is not the case at this time.
How does the price of CO2 influence consumer energy bills?
The question is complex. “According to some studies we speak of 10% of the electricity bill. The current price hike is attributable 90% to the rise in gas prices. Finally, the rise in CO2 has a relatively small role with respect to the iceberg of gas prices ”says Idil.
The calculation is similar to that given by the European sources that we have consulted. They specify that although the price of a ton of CO2 has increased by around € 30 since the beginning of the year, this translates to € 10 / MWh for electricity produced by gas and € 25 / MWh for electricity produced by coal. On the other hand, “the additional cost of increasing the price of gas to produce electricity is about 90 euros / MWh,” they say.
a Bank of Spain report This summer it estimated the impact of emission rights prices at 1/5 of the bill, that is, 20%.
Electricity is especially sensitive to the increase in the price of CO2 emissions because the European electricity market sets the price based on the latest technologies used to generate it, which are usually the most polluting, and those that pay the most emission quotas. And of course this ends up having an impact on the bill.
There are also differences between countries, due to their energy infrastructure. Spain is one of those with the highest price volatility.
On the one hand, the very objective of this emissions market is to go towards high prices. The logic is that they generate income for the states and encourage the reduction of the consumption of fossil fuels. However, in the current state of prices and with the repercussions in all pockets, the carbon market is unpopular despite its climate “good intentions”.
The war of the European emissions market
The European carbon market is in the sights of many for various reasons. Spain or Denmark denounce the entry of speculative capital, but defend its validity as a tool to decarbonize the economy. Other countries such as Hungary or Poland, highly dependent on coal, question its validity. Hungarian Prime Minister Viktor Orban recently said that the Brussels plans “will kill the middle class.”
Some governments denounce that the rise in prices is hitting the households most threatened by energy poverty with particular force. Consumers wonder what proportion of the increase in carbon prices is driving up the price of exorbitant energy bills.
European industrialists, some of them forced to close due to the high price of electricity, are asking for more carbon quotas and fossil fuel lobbies are taking advantage of the situation to protest against this strict system.
The Commission defends that it is an effective instrument to discourage the use of fossil fuels.
Carbon market reform is left in parentheses
In this context and in order to achieve the ambitious 2030 targets, the Commission proposed in mid-July to cut the free allowances for air transport, integrate maritime transport into the system and, above all, create a second emissions system for transport. road and building heating.
The project, which was already criticized by some member states, is now further weakened by rising energy prices.
The debate is highly political “it is a totally political market” concludes Gregory Idil.
The battle divides those who consider it an effective instrument, led by the Vice-President of the Commission and in charge of the Energy Transition Frans Timmermans, who want to overthrow it like Hungary and Poland and who accept the idea of the carbon market but reject that speculators may distort prices up to this point, which is Spain’s position.
The most “rigorous” countries such as Germany and the Netherlands refuse to change the market rules due to a situation that they consider transitory.
The ball is once again in the court of the Commission.