Defying the broader slump in energy prices, the cost of EU emissions trading is on an upward trajectory, having climbed a solid 9% since the start of the year, with Commerzbank AG analysts predicting this trend will continue into next year.
Both demand and supply factors are contributing to the support.
The EU economy is expected to see a slight recovery, which will likely boost demand, according to a Commerzbank analysis.
Demand factors underpinning price
Although the eurozone’s manufacturing purchasing managers’ index recently dipped just below the expansion threshold, the combined impact of easing monetary policy and fiscal stimuli (particularly in Germany, the largest economy) is anticipated to take effect throughout the coming year, the German bank said.
Demand for emission allowances is projected to increase, driven by a slight anticipated recovery in the industrial sectors currently covered by the EU ETS.
Furthermore, as maritime and intra-European air traffic will be fully included from next year, companies operating in these areas will need to acquire the necessary emission allowances.
The demand for emission allowances from utility companies is expected to keep decreasing as renewable energy sources become more prevalent.
“After what is expected to be only a moderate decline in the current year due to weather conditions, a sharper decline is expected again next year, especially as a fuel switch within fossil fuels from coal to gas is likely to remain attractive due to the sharp fall in gas prices,” Barbara Lambrecht, commodity analyst at Commerzbank AG said.
Lower supply as main price driver
However, the significantly lower supply of emission allowances is the main factor supporting prices.
Next year, the supply of emission allowances is projected to drop by 21% compared to the current year, according to estimates from the BNEF research unit.
This reduction is partly due to the fact that the benchmarks used for the free allocation of allowances to industrial sectors are updated every five years.
It is anticipated that the announcement for those affected from 2026 will be released early next year.
The new benchmarks, drawing from the 10% lowest-emission technologies across each industry as of 2021-22, are anticipated to be notably stricter than the current ones (which are based on 2016-17 technology).
“This would mean lower (free) allocations of emission allowances,” Lambrecht said.
Despite current expectations, BNEF has recently suggested the revision might be less significant than anticipated.
Conversely, the front-loaded auctions that financed the RePower EU plan are concluding, which removes an additional source of supply from the market.
Outlook
Lambrecht said:
All in all, we therefore expect the upswing in EU emissions trading to continue.
While the recent disagreement regarding the 2040 emissions reduction goal suggests that the momentum for strong climate policy might be slowing, several factors that already support higher prices are established.
These include both the accelerated decrease of the annual emissions limit and the implementation of the Carbon Border Adjustment Mechanism (CBAM).
Emission allowances will need to be purchased on the market, as the free allocation for the relevant industrial sectors will be gradually phased out, starting next year and continuing until 2034.
The decrease in hedging requirements from utilities is being offset by a rise in hedging interest within the industrial sector.
We therefore expect the carbon price to continue to rise gradually and reach EUR 85 per ton by the end of next year.
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