As the compliance deadline for the EU Emissions Trading System (EU ETS) approaches, benchmark EU Allowance (EUA) prices have dropped by as much as 20% (€1.62) from their highs earlier this year. This presents an opportunity for companies facing a EUA shortfall for their 2014 emissions to save up to 20% on their carbon costs compared to the market peak. Additionally, the deadline for offset swapping is looming, with only two weeks remaining. After March 31st, only the more expensive “Commitment Period 2” Certified Emission Reductions (CERs) can be used in place of EUAs.
The drop in prices can be attributed to several factors, including free carbon allocations to industrials, reduced profit from coal-fired power generation leading to decreased carbon purchases by electricity utilities, uncertainty surrounding the Market Stability Reserve (MSR) proposals, lower carbon emissions in Europe and unexpected regions like China, and speculators unwinding their positions, resulting in losses. However, long-term price forecasts for EUAs remain high in most scenarios.
Industrials are rushing to buy EUAs as verification reports are in, and companies with short positions seek to meet their compliance requirements before the April 30th deadline. The reduced allocations due to the Long-Term Reduction factor and the Cross Sectoral Correction Factor have led to more EUA buyers this year compared to the previous year. The current low prices present an opportunity for companies not only to purchase carbon for 2014 compliance but also to secure some for 2015 compliance.
The offset swapping deadline is approaching, with only two weeks left for companies to use the cheaper “Commitment Period 1” (CP1) CERs and Emission Reduction Units (ERUs). After March 31st, the use of CP1 offsets is prohibited, while CP2 CERs can still be used but are in shorter supply and priced higher. To take advantage of the discount to EUA prices and the lower cost of CP1 offsets, companies should swap them now.
According to Redshaw Advisors, a typical installation with an annual allocation of 50,000 EUAs could face an annual compliance cost of up to €360,000 by 2020. This projection is due to a growing allocation shortfall caused by the Cross-Sectoral Correction Factor and the Long-Term Reduction Factor, as well as the projected rise in prices to as high as €24.00 by 2020. This represents a substantial increase compared to the projected compliance cost of €50,000 in 2015.
To mitigate their exposure to rising compliance costs, some companies are buying EUAs ahead of need and building strategic reserves.
