Rocketing EU carbon prices spell big trouble for careless companies, and for coal
Europe's carbon market is on fire. New rules and a shortage of permits have driven futures contracts to an 11-year high of €27 a tonne, with an extra twist from the vagaries of Brexit.
The contracts have jumped sixfold over the past two years and have been the hottest trade in the commodity universe.
The German bank Berenberg said prices are likely to double or triple again over coming months as companies bid up the contracts in a desperate scramble to avert fines for pollution.
The spike spells trouble for industrial companies and airlines across Europe that have run out of permits, or those that tried to play the market by selling their allowances in the hope of buying back contracts at a lower price later. This trade has blown up in their faces.
“Industry has been ignoring the carbon price issue and now they are going to face a really big surprise,” said Phil MacDonald from Sandbag, which monitors the carbon market.
The EU contract is the price that 11,000 power plants, steel foundries and factories – covering 45pc of Europe’s greenhouse emissions – must pay for each tonne of carbon emitted under the “polluter pays principle”.
Lawson Steele, Berenberg’s utility strategist, said a twist in the EU rules has led to a chronic deficit of
allowances. “Companies should be trying to buy as many permits as they can to protect themselves but the level of knowledge in the industry is really low,” he said.
Mr Steele said it may ultimately take prices of €107 to clear the market. This is the penalty level for companies that fail to cover their C02 emissions.
British Steel has already had to request an emergency loan of £100m from the Government to avoid fines when the deadline expires this month, prompting sceptics to ask whether it tried to cash in its permits to create cash flow or to flatter its books.
“They sold their 2019 allowances to cover their 2018 emissions. They messed up,” said Mr MacDonald. The company’s allocated permits would be worth almost £140m at today’s prices.
He said a string of European companies in steel, chemicals and energy have been playing the same trick and are now in trouble.
The wise virgins such as German’s power utility RWE snapped up carbon contracts when they were going cheap and are now largely hedged into the early 2020s. The shake-out will produce a generation of winners and losers.
British Steel says it needs the emergency loan to manage the uncertainties of Brexit. Brussels has suspended the new allocation of permits this year for UK firms until the Withdrawal Agreement has passed.
Airlines are also under pressure because the growth of aviation has outstripped their permits, which they need for intra-EU flights.
Exeter-based Flybe said last October that carbon costs were part of its undoing. Lufthansa reported losses of €335m (£290m) for the first quarter. It blamed most of the damage on rising fuel costs but its short statement left many questions unanswered.
The carbon trading scheme is the spearhead of EU efforts to cut emissions by 40pc by 2030, compared to 1990 levels. It has so far been a rolling disaster, a byword for market illiteracy. It issued too many carbon permits, with no way of adjusting when industrial output collapsed during the Great Recession and again during the eurozone banking crisis. The carbon price collapsed. Coal use surged.
Brussels is now trying to restore sanity. A new structure launched this year empowers a market stability reserve (MSR) to soak up the glut of contracts. In theory it is supposed to operate like a central bank, tightening and loosening to keep the market in balance. In reality the scheme is lurching from one extreme to the other.
The price surge has become self-fulfilling. Industries with a stash of unused credits are hoarding them for gain rather than putting them up for auction.
What the new regime has achieved is to erode the cost advantage for coal, although it may take prices of €35 to €40 to force a full switch to natural gas. Wind and solar are gaining the edge even without subsidy. “We’re now at the tipping point where the cost of building new renewables is competitive with the running costs of existing coal and gas,” said Sandbag.
Britain has imposed an extra £18 a tonne on top of the EU carbon prices. This has already priced coal out of the UK market but it has also come at a competitive cost for heavy industries in the North that must compete with EU rivals.
The roles are now being reversed to some degree. The higher the price of EU carbon permits, the more it vindicates the UK’s huge investmentin offshore wind and zero-carbon power. Green countries come out ahead. Laggards in Eastern Europe pay a penalty that reduces their cost advantage on wages.
The Government plans to keep Britain tied to the EU trading scheme after Brexit. However, if there is no deal, the EU’s carbon prices could suddenly plunge again. British companies would no longer be able to use their permits. They would sell them and flood the EU market.
The EU carbon price has now become a Brexit barometer. Every time the pendulum swings towards no deal the contracts surge: as it swings back to a softer Brexit the price falls again.
Perhaps it is time for Europe to find a better way to tax carbon.
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