EU ETS front-year contract trades above €100/t of CO2e

The benchmark front-year contract under the EU emissions trading system (ETS) has broken above the €100/t of CO2 equivalent (CO2e) mark for the first time in the market's history.

The front-year product was seen to trade at as high as €101.16/t of CO2e at the Intercontinental Exchange this afternoon, having pulled above €100/t of CO2e for the first time since the EU ETS launched in 2005 at about 10:40 GMT today to surpass its previous all-time high trade of €99.99/t of CO2e recorded on the afternoon of 20 February.

The value of the front-year contract has increased significantly in recent years. The Argus closing assessment on 20 February stood at 23pc above where the contract had ended 2021 and at 200pc above where it had ended 2020.

This rise has been driven in part by the EU's increased climate ambition, which has encouraged forward hedging in the carbon market. In July 2021, the EU passed a new target to cut its net greenhouse gas emissions by 55pc by 2030, compared with 1990 levels, which will entail reforms to the EU ETS that will significantly tighten the market's supply-demand balance this decade.

Proposed reforms would see an increase in the emissions reduction target for EU ETS sectors to 62pc by 2030, compared with 2005 levels, from 43pc currently. The system's supply cap will be lowered, while its scope will be widened to new sectors and free carbon allowance allocations to aviation and energy-intensive industry will be gradually phased out.

The approval of these reforms by the European Parliament's environment committee earlier this month provided additional support to carbon prices. The proposals must still be passed by the parliament's plenary and EU member states before becoming law.

Weaker moves in the wider European energy complex in recent weeks probably have also freed up participants' capacity to forward hedge in the carbon market.

In the shorter term, the approach of the market's annual compliance deadline will be encouraging buying interest. Emitters subject to the EU ETS must by 30 April surrender sufficient carbon allowances to cover the previous year's emissions, which will have been boosted last year by increased coal burn made more profitable by high gas prices.

Expectations of unseasonably cold weather in the region at the beginning of next month could also increase the carbon intensity of the region's power mix as plants ramp up to meet heating demand, prompting further demand for carbon allowances. Minimum temperatures in Berlin are forecast to turn out on average 1.7°C below the seasonal norm next week.

Downside risks remain

But a recent fall in European gas prices has led to gas-fired production becoming more profitable against coal in key European power demand hubs, which could in turn reduce compliance demand for allowances, given that gas generation produces lower emissions than coal burn.

German front-month clean spark spreads for 55pc-efficient plants currently stand at an advantage to clean dark spreads for 40pc-efficient units.

February is also when free allocations tend to be handed out to eligible installations, which could take some buying demand out of the carbon market and might also increase supply if holders decide to sell part of their allocation.

And the REPowerEU initiative, which was formally adopted by the EU council today, presents the prospect of a further increase in carbon market supply. The bloc intends to raise €20bn for the plan - which is designed to help wean the bloc off Russian energy imports by 2027 - through the EU ETS.

Of this, 40pc would be generated by bringing forward the sale of carbon allowances originally planned for the second half of this decade. The remaining 60pc would come from the EU's innovation fund, 10pc of which would be "replenished" by auctioning carbon allowances held in the market stability reserve, increasing supply in the short term and beyond the system's scheduled annual supply cap.

By Victoria Hatherick

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