As of October 2023, EUA prices are trading in the same range as at the beginning of the year (€83.3 on Jan 1st, €80.84 on Oct 1st). This is unusual for an asset that has displayed a 30% average annual growth rate between 2012 and 2022.
- In the 2018 - 2020 period, prices were multiplied by 4.4x (€7.77 to €32.04)
- In 2021, prices were multiplied by 2.4x(€33.54 to €79.61)
- In 2022, the difference between the lowest and the highest points had a factor of 1.7 (€57.92€ and €97.58)
The main factors impacting EUA prices are the energy market dynamics on the demand side and regulatory decisions on the supply side. In 2023, both were affected by the war in Ukraine.
Revisiting the European energy scene
1. The end of cheap Russian Gas
There was a massive and sudden gas supply decrease because of the war in Ukraine. The European Commission imposed drastic cuts to Russian imports (⅔ initially with a final objective of a total phase out by 2027). The European economy was very reliant on those resources. Around 50% of natural gas imports to Germany andItaly were coming from Russia, more than 75% for Bulgaria, Hungary, andAustria.
2. Macroeconomic deceleration and activity reduction
Some power producers and manufacturing industries could not afford the high energy costs due to the supply reduction. In only 2 months in the summer of 2022, gas prices were multiplied by more than 4. This was combined to a heavy inflationary environment and an overall economic slump. This reduced industrial production due to higher prices, and reduced demand due to inflation, came at the same time as an unseasonably warm winter with limited heating needs.
The sum of these factors led to lessCO2 emissions, and therefore less EUA demand.
3. A new energy mix
Chinese solar panels and components were much cheaper in 2022, helping Europe add 41gigawatts of solar capacity in the year. In total, renewable energy capacity increased by 8% in 2023.
Wind and hydro power generation were also strong in 2023, respectively increasing by 6% and 11%, with higher precipitation than previous years.
Finally, as French nuclear production got back to full capacity, it made up for German nuclear facilities being decommissioned. The net effect was a stable nuclear production. Greener energies emit less carbon and need to be matched by less EUAs.
4. Increased EUA Availability
There was a risk that industries would be tempted to opt for cheaper, more polluting energy sources. Governments considered it crucial to intervene through funding programs to help producers face the sizable energy shock. The REpowerEU plan was engineered to diminish the dependency on Russian fuels. It increased the2023 supply - 16.21 million EUAs were “front-loaded”. This means that they were initially supposed to be auctioned in future years. However, the urgency of the political crisis has made the European Commission release them earlier (the total budget over time being unchanged).
The purpose of this is to make it easier for industries to keep up to their production needs (emit CO2 and surrender allowances) without being jeopardized by high carbon prices.
An optimistic sentiment for the post energy-shock world
The EUA market did not consider the above factors strong enough to engender a massive selloff.The medium and long-term outlook brought resilience to EUA prices, with a bullish near-term forecast. .
1. The end to blurriness
2024 will be an important year for the European Emissions Trading Scheme from a regulatory standpoint.For now, regulators have set clear 2030 and 2050 environmental targets, using the EU ETS as a tool. The “Fit for 55” aims at reducing net greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels. The major end-point objective is to arrive at net-zero emissions by 2050. Nonetheless, the 2040step is still blurry in terms of major market instruments and supply volumes.
In the first quarter of 2024, an official Commission Communication will announce how to keep the ambitious environmental targets while still preserving a well-functional economy.
2. A substantial supply reduction
The EU fixes a limit on the quantity of CO2 emissions that can be produced. This “cap”corresponds to the number of EUAs released every year. It is fundament ally built in such a way that the issuance of allowances diminishes over time.Currently, every year, the maximal amount of EUAs that can be supplied is reduced by 43 million. From 2024 on, this reduction will be expanded to 84million to speed up the path to the end-goal environmental objective. This willbe topped-off by a one-time, fixed-amount reduction in 2024: a 90 million allowances “rebasement”. The one-off scaling down was deemed necessary by policymakers when setting the more ambitious climate goals within the“Fit-for-55” plan.
3. Fewer needs for adjustment mechanisms
The Market Stability Reserve is one of the main adjustment tools used by the European commission. If more allowances are released than needed, the MSR “soaks up” the oversupplied volumes. Conversely, should there be an inadequate shortage, it releases theEUAs required to suppress the disproportion. As the market gets closer to equilibrium demand and supply volumes, it will not need such instruments. There is a “threshold imbalance level” below which the MSR gets closer to its dormant end-phase. This “buffer zone” is expected to be reached in 2024. Analyst sbelieve that the allowance surplus will get below 1096 Mt which is the key threshold level. As the market gains in maturity and stability, regulatory intervention gets less crucial.
4. Market expansion
In 2024, the market will expand to maritime shipping, initially covering around two thirds of emissions in the sector (90 million tons of CO2). Free allowances for aviation activities will be reduced by 25%. And the implementation of the Carbon Border AdjustmentMechanism will encourage foreign companies to purchase EUAs to hedge future carbon price risk.
While prices have traded sideways in 2023, they are expected to rise in 2024 due to the decrease in supply and to regulatory updates.
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