With the majority of commodities suffering from the fear of global economic meltdown, led by a China slowdown, there appears to be one commodity bucking the trend – take a bow EU carbon allowances. EUA prices have risen to over €8 from below €5 in the middle of 2014, in contrast to the the oil market, where prices have fallen from over $110 to below $50 since the middle of 2014. It is not just oil that is suffering, coal has followed a similar path recently falling below $50 per tonne on front year delivery, a decline of 25% this year alone. Natural gas has also followed a similar path albeit not so steep.
Global macro-economic turmoil has impacted most markets with equity markets feeling the strain as investors look to sell stock in the face of a slowdown in growth in the world’s second largest economy seeking safer havens, typically in the form of the bond markets and gold. The fear returned to markets recently as the US Federal Reserve held interest rates at their historically low level, citing concerns over the Chinese economy, at a time when a rise seemed inevitable. The already nervous and bear-ridden equities markets have had their woes compounded by this week’s VW scandal and further losses seem inevitable.
So how is it that the carbon market, that until a few years ago was in a long term bear trend caused by a massive supply glut, is in a position to post gains while the wheels come off every other investment in town? The answer is political intervention, on an unprecedented scale. Several measures aimed at pushing the price higher are apparently slowly but surely taking effect. EU politicians believe that carbon trading is the most cost effective way to tackle greenhouse gas emissions but it wasn’t working, too much allocation and use of international offsets undermined the long term price signal needed for investments required to meet the much bigger cuts Europe has committed to in the future (40% by 2030 and 80-95% by 2050). Backloading, a measure to reduce auction supply in 2014, 2015 and 2016 was the first short term measure taken. On Friday last week truly fundamental market reform was passed, the Market Stability Reserve (MSR) will start in 2019 and will remove nearly all surplus allowances and thus effectively eradicating over-supply, permanently. As a result of these two measures alone prices are forecast to rise throughout 2015 to 2030. As a pre-emption of the future impact of the MSR companies with excess allocation are now less willing to sell off surpluses as they sensibly bank excess allowances for a future rainy day. Pro-active ‘short’ companies are purchasing more allowances than they need.
With Phase 4 (2021-2030) EU ETS proposals recently released looking to further tighten the cap and realign free allowance allocation, companies are facing an unprecedented increase in carbon costs. As things stand the price of carbon is not only likely to buck the current market downtrend but it will outperform the next uptrend too.