Europe’s $38 billion a year carbon market is finally starting to work the way it was intended, reining in pollution with a minimum of squealing from industry.
Thirteen years after it was created to limit carbon-dioxide (CO2) emissions, prices for the allowances are rising.
European Union (EU) policy-makers have enacted measures expected to keep the cost of pollution on an upward trajectory through 2030, prompting hedge funds that abandoned the market to pile back in.
“For a five-year-plus period, this market was in the desert,” said Per Lekander, a fund manager at Lansdowne Partners UK Llp. in London. “What’s happened over the past five months is the investment community is getting behind it again and putting on positions.”
Big polluters have heard the message and are starting to adapt. From automaker Volkswagen AG to RWE AG, which is Germany’s largest power generator, industry is cleaning up its smokestacks by turning toward renewables and bracing for a time when coal plants are regulated out of existence.
Some are buying before allowances get even more expensive.
All this is happening without noticeable complaints from industry in part, because policy-makers from German Chancellor Angela Merkel to UK Prime Minister Theresa May have made it clear they want to phase out coal within the next decade, slashing greenhouse gases.
Companies favor the carbon market because it gives them more flexibility on how to comply with tighter emissions rules than regulation or taxes. The alternative to a market could be much worse for industry.
It’s also a good sign for the global effort to rein in climate change, showing that market mechanisms and government policy can persuade industry to step away from fossil fuels in a way that doesn’t create turmoil in the broader economy. Europe’s carbon market is the biggest of more than 45 systems working worldwide and a model being tried everywhere from China to Mexico and parts of the United States.
“We are very much in favor of the European Emissions Trading System,” said Klaus Schaefer, CEO of the German power generator Uniper SE. “In order to deliver the CO2 reductions that we all agreed to in Europe, you will have to see higher prices.”
Carbon trading was not an immediate success. Europe’s permits surged to more than €29 a ton in 2006 and 2008, only to plunge more than 90 percent after the financial crisis hobbled the industry and helped create a surplus of the pollution rights.
That glut took policy-makers years to mop up, culminating in an agreement that got final approval only last month. Utilities like Uniper will feel the brunt of the impact of higher carbon prices—governments cut off the supply of free permits to most power generators while doling out allocations for industries like steelmakers.
EU emission allowances are the best performing energy commodity this year, according to a report by Bloomberg New Energy Finance (BNEF). They’ve surged 57 percent to as much as €13.04, for each ton emitted on March 22, on the ICE Futures Europe exchange.
Higher carbon prices drive up the cost of using hard coal and lignite to run power plants. It’s one of the mechanisms the 28-nation EU is using to move industry away from the most polluting fuels and reaching the goals for curbing climate change set out in the 2015 Paris Agreement.
“Climate policy will drive accelerating coal phase-outs in the next few years,” said Phil MacDonald, an analyst at Sandbag, an environmental research group.
Jan Kresnik, a portfolio manager at broker Belektron, said prices of €30 a ton or more “could be reachable.” BNEF estimates it will reach €32 by 2023.
All this is in step with the ideas that percolated over the past two decades from economist Richard Sandor, father of both the modern carbon market and interest-rate futures and derivatives on the Chicago Board of Trade.
His theory was that putting a price on pollution would be the most efficient way to curtail the greenhouse-gas emissions damaging the atmosphere. The idea won official backing at the United Nations climate talks in Kyoto, Japan, in 1997.
Some of the biggest energy users remain concerned about the upward drift in prices. Steelmakers especially blame the carbon market for reducing their competitiveness. At Britain’s Engineering Employers Federation representing manufacturers, Roz Bulleid, who is head of climate policy, supports emissions trading but says her members are “increasingly jaded” about the impact.
“The original intention to deliver emissions reductions at least cost has been replaced by a focus on achieving a certain carbon price,” Bulleid said. “There are a number of overlapping policies in this area muddying investment signals. Overseas competitors are not facing the same policy costs.”