Changes to the EU Emissions Trading System (ETS)

Throughout this week, Ramnikh Kular, Energy Trader at NGP, will be commenting on five key policy changes affecting the energy industry.

The energy crisis has led to an in-depth review of EU climate policies. This includes the revision or postponement of the “Fit for 55 package” legislation proposed in July 2021.

The surge in energy prices has had a direct impact on all EU citizens. Accordingly, countries such as Poland have strongly lobbied for changes in the fit for 55 package, amid current economic conditions. 

The EU is projected to make significant changes to the EU Emissions Trading System (ETS) and revisions to the Fit for 55 package as a result of the volatile price environment over Q4 2021. Whilst the target to cut the bloc’s emissions by at least 55% before 2030 remains, significant reforms are expected in the EU ETS.

Price drivers of the European carbon market

Speculation by banks and hedge funds were a significant price driver of the European carbon market in 2021. Hedge funds have taken positions on the EU carbon market in line with expectations that the EU will tighten climate policies, and, accordingly, increase the cost of carbon permits. The financial positions taken by hedge funds have contributed to the bullish price rally in carbon markets.

A policy change is expected from the European Commission, following pressure from countries such as Poland and Spain. It’s expected that the enacted legislation is to exclude certain financial entities from ETS auctions in the first quarter of each year. This should allow sufficient companies to purchase on the market without having to pay a premium, due to significant purchases by financial institutions.

Involvement from the European Council

The European Council has been urging the European Commission to deepen the examination of the functioning of EU ETS trading and to take any necessary initiatives. The European Commission, due to the pressure faced from the European Council amid the current energy price setting, is expected to exclude certain financial entities from the ETS auctions. 

In the short-term, this is projected to lead to a selloff in European carbon prices and an easing of energy prices in the European market. Lower carbon prices will make it more profitable for industrial users to use coal over gas in the fuels mix, and would support gas-to-coal switching in the European market. This would in turn reduce industrial demand for gas and therefore provide the European market with additional supplies.

Further changes to the EU ETS are expected. However, there is currently no consensus amongst European countries with regards to timelines. There has been lobbying from businesses to increase the number of EU carbon allowances this year so that the bullish sentiment evident in the current market eases.

The outlook moving forward

To what extent the European Commission conform to this policy is yet to be decided. From the European Commission perspective, if changes are made with regards to the number of carbon allowances issued, this will weaken the EU ETS’s credibility and the European Commission’s commitment to the target of net zero emissions for 2050.

Overall, the key change expected to be enacted by the European Commission over the coming weeks with regards to the EU ETS is the exclusion of financial entities from the ETS auction. This is expected to ease inflationary pressures across the European energy commodity markets.

By Ramnikh Kular

Energy Trader – Northern Gas and Power

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