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This morning, the price for a tonne of carbon was hovering around €6.50 (the price to destroy carbon with Sandbag is £7.42, slightly higher because we don’t buy in bulk). Yet a few months back the carbon price was €2.63, and a few years back it was higher than €20. What factors affect the carbon price, both hour-by-hour, and then in trends across months and years?

Lightning in spain

Thunderstorm, captured from Garajau (Madeira, Portugal) by Don Amaro

Short term factors

Weather: Cold weather causes a peak in energy use, as people switch on their heating. More energy use means higher emissions, and so the allowance price rises. Rainfall, windy or sunny weather influences how much energy renewable sources produce, thus affecting the chunk left to be covered by fossil fuels.

Commodity prices and fuel switching: An example is helpful here; if coal becomes more expensive, power stations switch to burning gas, thus need less allowances, as they are producing less CO2. When less allowances are bought there are more available in the market, the price falls. Fuel switching, in the building of a gas rather than a coal-fired power station, can also have long term effects.

Rumour and speculation: traded commodities, such as carbon allowances, are sensitive to the decision making process which sets the framework in which they operate. When the legislation or ‘rule book’ is up for change the market is eager to understand what’s happening and how this might affect them. In such circumstances the desire for information, especially when it’s wrong, can have a destabilizing effect as the market loses confidence prices become volatile. The carbon market experienced this recently when a Conservative Finnish MEP, Eija-Riitta Korhola, gungho tweeting sent the carbon price into a downward spin.

Long term factors

Free allocation; the percentage of allowances which are handed out free to companies, ostensibly to protect Europe from the threat of ‘carbon leakage’ (companies leaving the EU to set up somewhere cheaper). The greater the free allocation, the lower the carbon price, as fewer allowances need to be bought.

Banking of allowances: Storing up allowances bought at one price, to be used in future Phases when the price will likely be higher. An allowance to emit carbon, once created, lasts forever. This is why, as Sandbag’s research shows, targets for emissions reductions out to 2020 or 2030 are undermined by a banked up surplus of carbon allowances.

The economy: Higher production means more emissions, and thus a greater need for allowances. In 2008, when the global economic crisis began, the price of carbon fell dramatically, as businesses found they had many more allowances than they needed to cover emissions.

Offsets: The percentage of emissions (currently 10%) that can be covered by international offsets is one issue, and then the price of offsets available is another. The market here fluctuates hugely, for example for a UN Certified Emission Reduction (CER) went from as high as €23 for an offset tonne in 2008, down to around €0.30 today. International carbon offsets are not currently planned for use on the EU ETS after 2020.

Regulatory changes:

  • Directly changing the ETS For example, Backloading (the removal of 900million allowances temporarily to boost prices over the next decade), changes to the Linear Reduction Factor (the LRF currently cuts the cap by 1.74% a year, and is proposed to increase to 2.2% in 2020), the long term GHG target (currently aiming for a cut of between 80% – 95% by 2050). For example, the record low carbon price directly followed Parliament’s initial rejection of the backloading proposal (though they’ve now changed their minds). At this point, some thought the market would collapse completely, and so allowances became worth a lot less. Other changes to the price come from including new sectors in the market (the battle over the inclusion of Aviation emissions is ongoing), or including new schemes, for example the expected linkage with the Swiss carbon market next year, or the (now on-hold) Australian scheme.

  • Secondary policies Renewables target & subsidies: Promotion of renewables reduces the need for allowances and so lowers prices. Fracking subsidies: For example, the tax breaks and other sweeteners offered for hydraulic fractured gas in the UK. These could increase the price of carbon allowances, if it leads to an increase in fossil fuel power in the EU and so a greater need for allowances, but it’s possible that the gas may displace (more polluting) coal-power, as has happened in the USA, and lead to a reduction in emissions and so a reduction in the allowance price.

 

EUA Price 2012 to 2014

Data from IntercontinentalExchange Auctions

Futures trading and hedging

The futures market is a market in agreements; looking forward to 2020, I will buy a certain number of allowances from you, and you will sell them to me at a certain price. This gives stability to an emitter; they know the price they’ll pay in the future, and won’t be caught out by a price spike. However, it also means if the price falls, the emitter might pay more than they would have had to.

By hedging correctly (buying futures at a price lower than the eventual spot price), an emitter can make money e.g. by surrendering €1 million worth of allowances which they bought on the futures market for just €750,000.

ADD COMMENT
Aldyen Donnelly on 14th Feb 2014:
The article omits a number of price-influencing factors, not the least of which is accounting standards. International accounting bodies have yet to agree on basic standards for accounting for either carbon discharge entitlements (allowances, reduction units, offset credits) or corporate GHG liabilities. It is also the case that most entitlement trades are inadequately accounted for. When, in the absence of clear and disciplined accounting standards, companies can change their accounting treatment of the instruments of carbon entitlement and any GHG-related contingent liabilities from year-to-year–to maximize short-term earnings estimates and minimize net liabilities on the balance sheet–the result can be significant apparent "price" volatility. I put the word "price" in ""s because it must be noted that the methods of price discovery in global over-the-counter GHG entitlement markets is very unreliable. Rules governing price disclosure in regulated securities and commodities markets lead to much more reliable price disclosure than we get out of existing carbon/GHG entitlement markets, which are "regulated" in that regulations define supply and demand, but still "unregulated" in the sense of financial/commodity market regulation. Sometimes (often) apparent shifts in the apparent market price of entitlements simply reflect short-term adjustments of the reported "market price" towards or away from market participants' actual carbon costs. SOme of this apparent price volatility would disappear if/when carbon exchanges become regulated and:(1) traders are obliged to report the actual bid/ask and settlement price for each individual spot and forward market transaction and (2) traders are compelled to assign a $0 price to trades that are swaps/round trips, and (3) swaps/round trips cannot be included in estimates of traded volumes.