Commodity traders are betting that Europe’s carbon futures will soon catapult higher as Brussels drains the glut of carbon allowances on the market.
Prices are likely to smash the all-time record of €30 a tonne within months, profoundly reshaping the EU’s energy architecture.
The killer detail in the European Commission’s 140-page climate impact report for 2030 released last week is a "one-off" rebasing of its cap-and-trade Emissions Trading Scheme (ETS) to dry up excess permits, followed by a faster pace of tightening from next year onwards.
“The price will go ballistic. The only question is timing,” said Lawson Steele from Berenberg Bank.
“Right now we have a big surplus of permits because Covid caused emissions to fall through the floor. But next year there is going to be a 30pc deficit because they are only issuing 600 million permits a year.”
Barclays said the rebasing clause has caught markets by surprise and amounts to a new “elephant in the room” for Europe’s climate policy. The Commission is clearly relying on a higher carbon price to do the heavy-lifting as the EU tightens its CO2 target: now a 55pc cut in emissions below 1990 levels this decade, versus 50pc before.
It is also a tacit recognition that EU funds for investment in renewables, battery storage, green hydrogen and heat pumps are scarcer than headline figures suggested by the €750bn Recovery Fund.
Mr Steele said the carbon price is shifting to a much higher structural level and spreading to more sectors.
“There will be a snowball effect. What will stop the price going to infinity is a political reaction, but it could go to triple digits before that happens. Coal can rest in peace,” he said.
“I am not a fan of the carbon scheme. It is a big clunky bureaucracy, but governments love it because it generates €18bn in revenue each year. That is as much as the whole Brexit divorce bill, and it could double again.”
The commodity trading firm ICIS also expects prices to blow through €100, though it might take several years. This implies a violent shock to Europe’s market pricing mechanism. Investors and capital markets will pull forward the energy switch by acting on the signal.
“The Commission thinks they can manage this process, but they have been wrong before. The carbon market could go really wild,” said Phil MacDonald from energy consultants Ember.
Carbon futures have already jumped sixfold in three years after Brussels revamped a broken system that had been captured by special interests and become a byword for market illiteracy. It has created a Market Stability Reserve that acts like a central bank, with powers to dial down the permits. While it remains a centralised monopoly, and gives a free pass to some bad polluters, it is acquiring teeth.
The reforms turned the ETS futures contracts into a red-hot commodity in 2018, enriching hedge funds quick to spot the implications. Europe’s sleepy utilities were forced to chase an upward spiral to cover their own needs. We may see a replay once the pandemic recedes.
Carbon prices in the high €20s have already caused a "fuel-switch" from coal to gas, which emits half as much CO2. German coal consumption fell by a quarter last year. The next phase is potentially revolutionary.
The Commission plan sketches a carbon price of €44 a tonne by 2030 under its mid-ambition scenario, already high enough to render Poland’s coal industry obsolete and finish off the cheapest and dirtiest brown lignite in Germany, still being dug out in huge open mines that disfigure the Hambach Forest.
The new €1.5bn Datteln 4 coal plant that opened this year in North Rhine-Westphalia is effectively still-born, as are three Dutch plants built without carbon capture four years ago at a cost of €3bn, all bizarre exhibits of financial self-harm.
However, the Commission’s "all-in" scenario takes carbon prices to €65. This is clearly the direction of travel. Germany has tightened its own internal carbon price and aims for a price corridor of €55-€65 by mid-decade.
A carbon price much above €40 eats into the economics of natural gas as well. Russia’s Nord Stream II pipeline becomes pointless before the first cubic litre of gas actually flows. “These prices are a huge signal to anybody building unsubsidised wind farms. Gas is really going to struggle unless carbon capture becomes more competitive,” said Ember’s Mr MacDonald.
The old assumption was that it would take a carbon price above €100 to make a dent on emissions. This has been overtaken fast by tech.
Mark Lewis, chief sustainability strategist for BNP Paribas Asset Management, said there is a scissor action as rising carbon prices intersect with the plummeting cost of wind, solar and, with a lag, energy storage. “All of a sudden you can see what the end game is going to be," he said.
"We will have a 2050 net-zero target written into EU law by the end of the year and that changes everything. The carbon price signal will bring in the financial markets and they will drive the transition.”
Mr Lewis said that once prices reach €50 to €60, the switch goes beyond the power sector and starts to open up whole swaths of transport, infrastructure and industry to rapid carbon abatement.
Consultants Refinitiv expect the renewable share of power to double to 70pc by 2030 and (with nuclear) almost “wipe out” fossil fuels. Natural gas will not play the bridging role long assumed even for electricity. Demand will drop by a third to 500 terawatt/hours. Countries will “leapfrog from coal to renewables”.
The question is how quickly clean hydrogen comes into play for heating, or fuel cells for haulage, shipping and trains, or for industrial uses in steel, cement, chemicals and fertiliser production. That depends on whether the EU delivers on the other side of the equation and backs its Hydrogen Strategy with real money to reach critical scale.
Refinitv’s Ingvild Sorhus said the EU plan is so far just a “sneak view” of the future – frustratingly vague on detail. It talks of extending the carbon tariff to buildings, road transport and intra-EU shipping, yet nothing is fleshed out.
Half of EU emissions are still exempt a full five years after the Paris Agreement, either because sectors are excluded or because they are in globally traded products and are granted carbon allowances for free to maintain competitiveness.
What is new this time is that no country can block the plan. Poland has lost its veto. The measure will be pushed through by qualified majority vote. Seventeen states have already signed up.
Ultimately, the shape of the EU’s green strategy depends how quickly it presses ahead with parallel plans for carbon border adjustment tax, a devilishly complicated policy to craft without causing trade wars.
That in turn depends on whether Joe Biden is elected US president and wins the Senate. His comparable plan would open the way for a North America-European border tax alliance with global political clout.
Once the border tax is in place, it ends the risk of "carbon leakage" to dirtier plants abroad. The EU carbon scheme can then be extended safely to all industries. The price signal reaches the last holdouts.
The game is not yet over for fossils in Europe, but the epitaph is already being scratched on the wall.