EU emissions trading: anniversary with a lot of momentum

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  Serge Nussbaumer
  Chefredaktor

Spring is just around the corner and Lisbon beckons in February with mild temperatures of around 15 degrees, romantic alleyways and delicious pastéis de nata (custard tarts). Swiss is offering a low-cost return flight from Zurich for less than CHF 130 – and with this attractive price is also offsetting greenhouse gas emissions: The trip to the western edge of Europe generates around 740 kilograms of_CO2 per passenger. The price for the right to purchase this amount of climate-damaging gas is currently just under CHF 60 on the eex commodity futures exchange.

This information would not be possible without the European Emissions Trading System (EU ETS). With this system, the EU implemented the climate protection protocol agreed in Kyoto, Japan, in 2005. The aim of the EU ETS is to regulate, limit and price the emission of greenhouse gases. The trading system therefore works according to the “cap and trade” principle: ETS participants are credited with a maximum number of _C02 allowances (cap). As soon as this is not sufficient or a company has too many pollution rights, trading comes into play. Here, certificates can be offered or purchased. It took a while for the EU ETS to develop from a toothless tiger into a central instrument of EU climate policy. Initially, there were simply too many certificates on the market.

Effect with a delay

Brussels has removed these and other obstacles with a series of reforms. 20 years after its introduction, the EU ETS covers 40% of total European greenhouse gas emissions. In addition to electricity and heat generation, industrial production, aviation and, since last year, shipping are also affected. “By 2023, the EU ETS will have helped to reduce emissions from European power plants and industry by around 47% compared to 2005 levels,” explains the European Commission. Switzerland linked its emissions trading system to the ETS five years ago.

“We believe that European _C02 prices will rise significantly over the next three years.”

Trading in pollution rights is left to the commodity futures exchanges by politicians. One of these is the aforementioned European Energy Exchange (eex). The _C02 futures traded there are structured like commodity futures contracts. One future comprises 1,000 pollution rights, known as EUAs. The C02 _price reached its highest level to date on the trading venue in Leipzig just under two years ago: At the end of February 2023, it cost just under EUR 103 to emit one tonne of the greenhouse gas.

Violent ups and downs

The future was unable to maintain this level. It has almost halved within a year. On the one hand, the weak industrial economy in Europe put pressure on the _C02 price. As soon as the capacity utilization of the production facilities covered by emissions trading decreases, the demand for pollution rights also falls. Added to this is the energy transition. On the old continent, more and more electricity is coming from renewable sources. The climate-damaging combustion of coal and gas is decreasing accordingly. The EUA future recently turned upwards, rising by almost a quarter within three months.

Experts cite rising gas prices as the trigger for the upturn. Due to the relatively cold weather and the interruption of Russian gas supplies to Europe via Ukraine, the price of gas in the EU has risen to its highest level in 14 months. In addition, the ongoing reform of the EU ETS is driving up the _C02 price. In particular, ETS participants are to receive successively fewer free certificates from next year. The aim is to end the free allocation of EUAs in 2034. “The EU ETS is gradually evolving from an oversupplied to a balanced market,” says Haege Fjellheim, analyst at _C02 consultancy Veyt. Pollution rights could become scarce as early as next year.

Offensive forecast

Veyt’s forecast is correspondingly positive. “We expect European _C02 prices to rise significantly over the next three years,” explained the research house at the beginning of October. The experts set a price target of EUR 95 per tonne for 2025. The C02 _price could climb to EUR 160 by 2027. “The short-term outlook depends on political decisions,” the analysts emphasize. They cite the EU’s approach to the auctioning of EUAs as an example.

Of course, global climate policy also plays a role. As one of his first acts in office, the new US President Donald Trump has ordered the withdrawal from the Paris Climate Agreement. If Europe moves further to the right politically, there could also be cuts in the fight against global warming on this side of the Atlantic. It is not that far yet. Instead, the EU ETS remains firmly anchored in European politics and business and is seen as a global role model.

Different structural solutions

The financial industry has also long since discovered the_{CO2 price} for itself. In addition to a low correlation to other asset classes, it offers the opportunity to integrate the trend towards decarbonization into asset management. UBS has integrated the EU ETS into its CMCI family of commodity indices. The CMCI Components Emissions EUR Total Return Index builds up a constant future maturity through the ongoing exchange of the particularly liquid December contracts. This underlying has been investable via the EMOCIU tracker certificate for almost four years.

The high volatility of the_{CO2 price} is also interesting for traders. For example, they can use the Mini Future Long MMOAHV to bet that the price will continue its recent countermovement. For this product, Vontobel uses the EUA contract listed on the ICE with a term until December 2025. The mini future currently participates in rising prices with a leverage of around 3. Whether simple or leveraged participation: investors should be aware of the risks of this special asset class and not overdo the capital investment.