The world’s biggest carbon market is joining the long list of victims of the economic fallout from the coronavirus.
The price of certificates allowing companies to emit carbon dioxide in the European Union has crashed by 40% so far this year, including two drops of more than 10% in the past week. That has erased two years of gains in the market that was worth more than 200 billion euros ($215 billion) last year, when prices were buoyed by ambitious EU climate goals and reforms that had tightened the number of permits that could be sold.
As governments across Europe impose ever-more draconian limits on public life because of the pandemic, questions about the economic toll those measures might exact are opening the possibility that the carbon market loses its force as a tool for helping the environment. Thousands of industrial plants and power generators are required to hand permits from the market to cover their emissions, and the current price is about half of the 30 euros-a-ton level that executives and economists have identified as the place where the carbon market starts to bite.
The outbreak has forced manufacturers from Airbus SE to Volkswagen AG and Renault SA to shut up factories, reducing both energy use and pollution. That also slashed the need to buy permits to cover those emissions. The implications of a prolonged period of lower prices will have a profound impact on European Commission President Ursula von der Leyen’s strategy to make Europe the world’s first climate-neutral continent.
Europe formed its Emissions Trading System 15 years ago, building on structures outlined in the Kyoto Protocol on climate change. The aim is to put a price on the emissions blamed for driving up the earth’s temperature and give polluters an economic incentive to move toward cleaner forms of energy. It’s also at the heart of the Green Deal that von der Leyen is pushing to zero out Europe’s climate pollution by 2050. A lower price on those discharges removes some of that pressure.
The last week’s move already is having an impact on the finely-balanced economics of generating electricity, the source of about half of emissions covered by the the EU’s carbon market. Allowances fell about 35% this month to as low as 14.30 euros a ton on Monday. That included an 18% drop on March 18, the biggest interday decline since 2013.
Lower carbon prices have reduced the cost of burning coal, the fossil fuel that does the most damage to the climate. It made some coal plants in Europe profitable to run for the first time since November and helped keep the price of that fuel steady as cleaner-burning natural gas plunged.
It’s the opposite of what the carbon market was expected by many to deliver — gradually advancing prices. By making carbon emissions costly, the market is supposed to shift investment toward cleaner alternatives like wind and solar.
Some EU politicians have mentioned ambitions to drive the price to 50 euros a ton, and green lobbies urged policies to boost it to 100 euros, a level where it would make sense to fund expensive environmental technologies like nuclear reactors and carbon capture and storage.
“That the price of carbon falls when the economy falters is logical, and even desirable, as in hard times companies face other challenges,” said Peter Vis, senior adviser at Rud Pedersen Public Affairs in Brussels and a former commission official who helped design the ETS. “By 2030 the emissions covered by the EU ETS will be reduced by 43% compared to their level in 2005. The falling price of allowances will not change that.”
For von der Leyen, who pledged to further tighten the 2030 emission-reduction goal, mapping the way forward for the carbon market will be no easy matter. The commission said Monday it’s monitoring the market. Any change would require careful diplomacy among member nations, which often diverge on the political priorities.
Allowances trade based on complex patterns of supply and demand, fixed by distribution of permits the EU allows member governments to sell and give for free to companies. While pollution rules have been tightening for years, calibrating the system to produce the gradually rising carbon price that ETS designers intended has proved tricky. Following overgenerous allocation of allowances to companies and imports of international credits in the 2008-2012 trading phase, the last recession left the program damaged for years.
Carbon prices languished at an average 9 euros a ton for almost a decade after the financial crisis that started in 2008. Policymakers debated for years how to mop up an excess of allowances that built up after industrial production fell short. Eventually, a deep overhaul of the program and expectations that it will further tighten the market pushed prices to a peak of almost 30 euros in July.
The coronavirus pandemic is almost certain to trigger a deep recession, according to the European Commission, and some countries are already calling for the Green Deal to be put on the back burner. Von der Leyen’s plan to deepen the 2030 emission-cut target looks increasingly difficult to achieve.
Czech Prime Minister Andrej Babis said on March 16 that “Europe should now forget about the Green Deal,” and focus on the coronavirus instead. A day later, Poland’s deputy minister for state assets Janusz Kowalski said on Twitter the EU should abandon the carbon market as of next year, or at least Warsaw should leave the cap-and-trade program.
Long before the coronavirus, the EU had to clean up a supply glut that depressed the price of permits following the last big economic slump a decade ago. Those steps included:
- A policy known as backloading, which delayed auctioning of some allowances to help alleviate the surplus of permits.
- The Market Stability Reserve, which included automatic controls on the supply of allowances.
But it was only the third overhaul that made a difference in lifting the price. That was further strengthening of the MSR and accelerating the pace of emission cuts in the 10-year period that starts in 2021. The law entered into force in April 2018, and the stability reserve started operating in January 2019, mopping up excess permits at a double speed.
While the stability reserve will continue to absorb a glut, it is unlikely to work quickly enough to prop up the market in the next few months.
The result is that the carbon market’s influence on Europe’s energy system may wane in the months ahead, becoming less relevant as a tool to push a green transition.