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Carbon prices are supposed to provide a readout of progress — or the lack of it — in the energy transition. The EU’s Emissions Trading System prices the element at about €86 per tonne of carbon at present, close to historic peaks.
That looks odd to one trader, Per Lekander at Clean Energy Transition. He thinks ETS carbon prices are overvalued, partly because Europe has done a great job in cutting emissions.
He may be right on the first proposition, wrong on the second. Europe’s natural gas and thermal coal prices more than halved this year alone. Historically, ETS carbon prices move in line with gas prices, given their link to power costs.
Under the EU’s “cap and trade” emissions system, higher carbon credit prices should discourage purchases of polluting fuels and encourage investment in renewables. That explains the relationship with natural gas and coal. On this basis, ETS prices look high and should fall in parallel with fossil fuel prices. After all, gas tucked away in European storage is a quarter above the five-year average.
But persistently high ETS prices also hint that the industry’s progress on decarbonisation is slow. Companies cannot feel confident that emissions are falling rapidly. Carbon pollution in the EU dropped about 3 per cent from 2019 through to December 2022. That included pandemic effects and gas demand cuts because of Russia’s reduced supply.
More importantly, the supply of ETS credits is declining. Free allowances to help heavy emitters change their businesses are on the way out. This follows a reform of the scheme in July 2021 to meet EU-wide carbon goals. The supply of credits will fall more than 4 per cent annually until the end of 2030, estimates Rystad Energy.
If energy prices keep declining this summer, EU carbon prices should do the same. That would reward investors such as Lekander, whose payback horizons are as short as their positions. Longer term, supply and demand of carbon credits will make them a decent investment.
The Lex team is interested in hearing more from readers. Please tell us what you think of ETS prices in the comments section below
