Political statements cause swings in EU carbon prices

The influence of political acts or statements is just as easy to see when it comes to the EU's carbon market.

When assessing whether to buy or sell EU carbon permits - which give companies the right to emit greenhouse gases - several traders note they are looking “mainly” at what politicians are saying about the EU's emissions trading system (ETS).

The price for emitting greenhouse gases has fluctuated between €6.60 and €7.46 per tonne carbon since November 2014.

The two largest swings in the EU's carbon price during the past three months can be directly linked to policy events occurring in Brussels.

On Monday 12 January, the price of an EU allowance to be delivered in December was €6.80 at the ICE exchange in London.

Tuesday morning, Bloomberg published a report titled 'EU Nations to Discuss Latvia Bid to Strengthen Carbon Fix'.

In recent years, a batch of 900 million allowances had been put aside, instead of auctioned on the market. But auctioning of these "backloaded" allowances cannot be cancelled, only delayed.

So the batch of 900 million hangs over the market like a sword of Damocles.

But Bloomberg reported that European countries would discuss that day a proposal by Latvia to transfer the backloaded allowances directly into the market stability reserve, instead of allowing them to flood the market.

(They did, and according to one member state official backloading is a "done deal".)

The carbon price, or EUA price, shot up to €7.38, an increase of 8.5 percent, the largest price change in one day since the end of April 2014.

“The volatility in the EUA price is mainly caused by information like this”, Guillaume Picard, a broker in Amsterdam for STX Services, which focuses its activities on environmental commodities, said.

The following week, on Wednesday 21 January, the carbon price stood at €7.41.

But the next morning the European Parliament's industry and energy committee surprisingly voted to ditch its own report on the market stability reserve, after it failed to reach a majority for an earlier launch date for the reserve.

The price dropped by 7.7 percent, to €6.84.

'Massive impact'

“Political comments on the future of ETS have a massive impact on the price of carbon”, said Picard.

The ETS was launched ten years ago as a way to encourage energy and industrial companies to reduce their greenhouse gas emissions.

The EU gives or auctions a limited number of allowances to companies. Every year, companies have to hand in an allowance for every tonne of carbon dioxide (or equivalent) they emitted.

The idea is that a company that can relatively easily reduce its emissions by investing in cleaner technologies, will sell its carbon permits, while a company that has a harder time will buy allowances to cover the polluting gases it emits

However, the system for several years has faced a surplus of allowances. The market has been flooded partly because the economic crisis has lowered the demand for polluting permits. But the supply is set - the number of allowances that is created annually cannot be lowered.

"It's absurd when you look back at it, economically absurd", said Tomas Wyns, an ETS expert at the Institute for European Studies in Brussels.

"We've created a market where demand is flexible - as it always is - but supply is vertical, and very rigorous."

Market stability reserve

EU governments and MEPs are now considering a commission proposal for a market mechanism for the ETS, a so-called market stability reserve, which can prevent some allowances from entering the market.

"We should have had this market stability reserve from the beginning," said Wyns.

Several traders have told this website that some of the recent fluctuation in the price of an EU allowance is caused by this political debate about the future of the ETS.

“We have seen in the past weeks that the comments on market stability reserve have made the price move up and down significantly”, said Picard.

The political debate on the future of the ETS “influences the behaviour of our customers”, one trader, who spoke on the condition of anonymity, told this website via e-mail.

“If a customer expects to emit more in the coming years and thus has to buy permits, he will be inclined to buy more in the short term when there are positive EU ETS developments in Brussels”, the trader noted.

“EU discussions and policy formulations are the most important source of information for our trade.”

No 'mature' market

The anonymous trader also noted that the CO2 market is not yet behaving like a mature market.

“In theory [the price of] EUAs should have a strong correlation with the weather and other raw materials, but in reality any such link is hard to find.”

He added when the EU took a short-term measure by backloading the 900 million allowances, it temporarily “saved” the market.

In a way, the fact that politicians are currently talking about how to implement measures that will rise the carbon price, may already have an effect on the price, as a self-fulfilling prophecy.

“The discussion about market stability reserve is maintaining hope that the carbon price will increase”, said broker Picard.

“A market stability reserve is expected to move the price upward, which is just what the market needs.”

The European Parliament's environment committee is expected to vote on the market stability reserve in the last week of February.