Carbon market clampdown puts utilities on notice

Jonathan Boyd
Carbon market clampdown puts utilities on notice

Research from Carbon Tracker suggests that a regulated decrease in the supply of carbon emission credits in the EU is pushing prices of carbon up to the point where certain utilities may face financial difficulties, while both utilities and heavy carbon users could also benefit from a higher price creating a better marketplace for trading.

The price of European carbon allowances are up 310% since May 2017, as the market reacts to the mandated 24% reduction in cumulative surpluses annually between 2019-2023 – starting from 1 January coming. This supply shock is pushing prices towards the €35-40 range between 2019-2022, according to the forecasts provided by Carbon Tracker.

Mark Lewis, head of Research and managing director at Carbon Tracker, said of the latest research that there were considerable implications for sectors such as utilities against which European investors may be exposed.

(Source: Carbon Tracker)

Energy utilities in the Stoxx 50 index include Iberdola, Engie, E.ON, while there are even deeper implications for the Stoxx Europe 600 Utilities index.

“Higher carbon prices are good for lower carbon intensive generators, but bad for those with high carbon intensive generators. This would have a knock on effect on European power prices,” Lewis said.

But it is not a uniform effect, he adds. For example, the selling cost may increase, but input costs may not increase at the same rate, as utilities such as EDF have much lower carbon emissions per kWh than others.

“That’s a nice position to be in,” Lewis adds.

On the flip side, it is also not a straighforward calculation for generators emitting high levels of CO2. But still, there are implications for the likes of RWE and E.ON, which earlier this year did a deal that has been described as significant for the German energy sector, and which was largely driven by considerations of renewables. Lewis describes RWE as the largest carbon emitting generator in the EU.

More broadly, and other things being equal, the carbon price changes forecast mean that coal and lignite plants will be less profitable going forward, Lewis said

And there are implications for big energy users and energy intensive sectors, which are also covered by European carbon agreements and the carbon trading market – areas such as the steel and cement industries.

These have been protected from higher carbon prices because they have tended to access allowances for free, in the main. But over the next couple of years, industries too will have to start paying for carbon allowances. Psychologically, this may make such companies reluctant to sell any surplus carbon allowances on their books. Broadly speaking, Lewis estimates that industries hold some 700m-800m tonnes worth of allowances, but it is more challenging to estimate precisely on a company by company basis the situation being faced.

The surpluses may help for now, but the further forward in time the more they are likely to have to go into the market to buy allowances. The assumption is they will hold on to any existing cushion for as long as possible. However, if prices to go a certain level, they will sell those allowances.

On the basis of the modelled price increases in the latest Carbon Tracker report, Lewis said it is certain that a number of industrial players will consider this free money: the ability to obtain free allowances, and cash in at €30-40 per tonne.

Another aspect of the supply shock forecast is that the market has never dealt with a situation in which prices are sustained above €30 per tonne. The price has only twice before gone above that price, but only for very short periods of time, such as two days in the summer of 2008. There has never been time to assess the impact on industry. The new price levels being forecast mean that it becomes economically rational to make investments to reduce emissions.

“When  talking about industry – steel, cement and so on – it’s going to be a very interesting to see how they respond.”


Regarding any changing EU regulations there is always a Brexit question nowadays.

Lewis says the situation may actually benefit the UK in this instance. This is because the UK already has carbon prices at these levels because of the carbon price support mechanism put in place by the UK government in recent years. UK power generators and industry are already paying via this mechanism.

“This is why already coal powered generation has fallen significantly in the UK – the price is close to €80 per tonne for coal,” Lewis said.

In the extreme case of a no deal Brexit, in the short run there would be volatility in the carbon market, as UK installations sell allowances as they will no longer need them. But on a longer term basis, the UK has a higher carbon emissions reduction target than the EU average already – 57% by 2030. Instead, it would be the EU27 that would have to tighten its own target, because the current average includes the UK. Effecively, the UK currently makes it easy for those with less ambitious targets in the EU. Others will have to run faster to maintain the target, Lewis added.

Before Carbon Tracker, Lewis was head of European Utilities Research at Barclays, chief energy economist at Kepler Cheuvreux, and managing director and global head of Energy Research at Deutsche Bank.

To read the latest Carbon Tracker report, click here: Carbon Countdown Final_17_08_18