The growing market for European carbon emission rights

According to “Our World in Data”, fossil fuels accounted for 84% of the world’s total energy production in 2019. The societal consequences of continued carbon emissions and of climate change have become ever more evident and have been on the agenda of the European populace and their elected officials. In an attempt to mitigate climate change and its consequences, the European Union has agreed upon ambitious goals with regards to the reduction of carbon dioxide emissions. The member states have set the goal of reducing carbon emissions by 55% by the year 2030 (compared to the 1990 level) and to be carbon neutral by the year 2050. In order to achieve the agreed upon goals, the European Union has set a cap on carbon emissions and developed a market in which so-called carbon emission rights can be traded.

The Carbon Market

The market for carbon emissions was initiated in 2005 and builds on an agreement between all EU member states, together with Norway, Iceland, and Lichtenstein. 16 years later, the system encompasses roughly 13 000 European facilities operating in energy-intensive industries and energy production. As of the year 2012, flight operators flying in the EU are also encompassed by the system. The European Union has set a cap on carbon emissions by auctioning out carbon emission rights. Each right provides the owner with the right to emit 1 ton of carbon dioxide equivalents. Companies that would otherwise have high costs for reducing their carbon emissions can thus purchase carbon emission rights on the market. Companies that have a surplus of emission rights or experience low costs for reducing their emissions can equivalently sell their rights on the market.

During the first years of the system, a surplus of carbon emission rights was built up. This led to low costs of continuing carbon emissions and disincentivized companies form reducing their emissions. In order to reduce the surplus, the European Union initiated the Market Stability Reserve (MSR) in 2019. The MSR adjusts the supply of carbon emission rights through increasing and decreasing the number of rights that are auctioned out. The new rules and regulations stipulate that by the year 2023, all carbon emission rights that exceed the previous year’s MSR rights, will be annulled. Furthermore, the new rules require that the cap on carbon emissions be reduced at a pace of 2.2% annually.

Mini Futures on European Emission Rights

According to Carbon Market Survey 2021, carried out by Refinitiv, a majority of the 303 respondents believe that the price of European emission rights (EUAs) will increase gradually to the year 2030. In March of this year, EUAs traded at a price of EUR 40/t. A majority of the respondents believe that the price would increase to EUR 50/t by 2022. This can be compared to a price of EUR 20/t before the COVID pandemic. As for the price of EUAs in the year 2030, the respondents had differences of opinions. However, a majority believe that the price interval will be in the vicinity of EUR 80/t to EUR 100/t. Through Vontobel’s new Mini Futures, investors can participate in the growing market for European carbon emission rights in either direction (long or short), based on their individual expectations.