Carbon markets in Europe and North America have shown resilience in the face of a changing political and regulatory landscape. The winners of Environmental Finance's Market Rankings commented on the year that was and what promises to be a dynamic twelve months ahead.
The politics of carbon was again a key talking point for the year, with Britain's impending departure from the European Union, the Western Climate Initiative (WCI) and the state of California facing legal action by the Trump administration, and wrangling over Article 6 of the Paris Agreement at COP25 in Madrid.
Nevertheless, the market concluded the year in a bullish style, as it entered the final part of Phase III of the EU's Emissions Trading System (ETS). Throughout the year the prices of EU allowances hovered at around €25 ($28), although peaking at €29.81 in July. This is a marked comparison to previous years, with the EU ETS closing in 2016 at €6.57 and still at less than €10 a tonne at the beginning of 2018.
According to Peter Zaman, partner at Reed Smith, winners of Best Law Firm for the EU's ETS: "Carbon is a product that has gone up dramatically within a relatively short period of time, primarily due to the market stability reserve mechanism that the European Commission has put in place to address the surplus in the market. It could be argued that EU allowances were the best performing commodity in 2018, with no reason to believe that that isn't going to continue into 2020 given the state of play."
The Commission launched the revision process for Phase IV of the EU ETS in 2015, when the carbon price generated by the system was at a relative low. This phase will begin in 2021 and is expected to run to 2030, and signals a significant escalation in the project, coupled with the European Commission's intention of cutting greenhouse gas emissions by at least 40% compared to 1990 levels.
"2020 will still be bullish. Brexit will hopefully be solved and then as we go past 2020 it will be a new phase in the EU ETS and a new phase in the WCI. Things are going to get tighter and tighter", says Nicolas Girod, founding partner and managing director of ClearBlue Markets, winners of Best Advisory/Consultancy in the EU ETS, California and overall North American Markets.
Article 6 of the Paris Climate Agreement is intended to assist governments in implementing nationally determined contributions (NDCs), and resolve issues such as two nations claiming to the same emissions reduction or 'double counting'. At COP 24 in Katowice countries failed to agree on a defined rulebook on Article 6.4, in part due to Brazil's desire to exempt developing countries from this double counting legislation, leaving much to do at COP 25 in Madrid.
According to the International Emissions Trading Association (IETA), Article 6 has the potential to reduce the total cost of implementing nationally determined contributions by more than half (equating to savings of $250 billion a year in 2030), and facilitate the removal of 50% more emissions, at no additional cost.
"We want to see the rules, we want to understand how Article 6 will be implemented so that we have the certainty to then develop our own activities under Article 6. Without this rulebook it will be very hard for us to make these investments because we will have uncertainty", says Jeff Swartz, formerly of IETA and now director of climate policy at South Pole, which was winner of Best Broker, Secondary Market and Best Advisory/Consultancy for the Kyoto Project Credits and was highly involved in the initial drafting of Article 6.
One early success from COP 25 was the Partnership for Market Implementation, unveiled on the side-lines of the event by the World Bank and country partners including Canada, Chile, Germany, Japan, Norway, Spain and the UK. The partnership will provide technical assistance to countries to design, pilot and implement carbon pricing and market instruments. It will support the direct implementation of carbon pricing in at least 10 developing countries and help a further 20 countries to do so.
Meanwhile as the UK prepares to host COP 26 in Glasgow in November 2020, well over three years following the referendum on the issue, three prime ministers and two general elections later, the UK remains for now in the European Union and its position within the EU ETS remains uncertain.
The UK currently represents about 10% of the EU ETS compliance market, so if UK compliance entities are not included in the EU ETS, in theory, you would need a 10% reduction on the EU ETS supply itself in order to maintain balance with demand. On this logic, Zaman says: "While there is some grounding to this I suspect that it is slightly underestimating the significance of UK based market participants, who along with the UK compliance entities, are historically more active in the market compared to many of their European brethren."
On the subject of Brexit and its effect on pricing in the EU ETS, Girod says: "If you look at the investor side of things, the financial participation has reduced quite a bit, that is what has driven prices to come back down to around €25. A lot of those are financials that have had a very good year in 2018, probably waiting on more certainty on what will happen in the EU ETS, and that means waiting to see what happens with Brexit."
Gordon Bennett, managing director for utility markets at ICE (winners of Best Exchange/Clearing House in the EU ETS), notes the UK's energy position in comparison to Germany: "Historically the politics of European primary fuels and carbon produced very diverse outcomes, especially at times when the price of carbon in Europe was low. The Carbon Price Floor, introduced during 2013 by the UK Government, helped natural gas replace coal in the generation stack, whilst at the same time in Germany, natural gas was seen to be marginalised by renewables and coal."
Marc Falguera, managing director of Vertis, winner of Best Trading Company, Spot and Futures and Best Trading Company, Options in the EU ETS, and Best Trading Company, Secondary Market in the Kyoto Project Credits, said: "High carbon prices have incentivised the decarbonisation in many sectors already. Higher available renewable capacities also contributed to the decrease of emissions in the power sector. 2019 might be the first year when the share of renewables in the German power mix was higher than that of coal."