Carbon Traders Brace for U.K.'s Possible Exit From EU Market

(Bloomberg) -- Carbon traders are again preparing for the worst after the U.K. government suggested that it might withdraw from the world’s biggest emissions-trading market when the country leaves the European Union next year.

The British government last week said it wanted to avoid signing up to “wider” environmental and climate change rules as it negotiates a new relationship with the EU. It’s considering options including leaving the single market in energy or staying in, retaining possibility that the U.K. won’t remain part of the carbon market after Brexit.

“There’s a good chance the U.K. leaves the European carbon market,” said Trevor Sikorski, head of natural gas, coal and carbon at Energy Aspects Ltd., an industry consultant in London.

A British withdrawal threatens to flood the carbon market with a portion of the 1.6 billion euros ($1.9 billion) of allowances held by British polluters. That would erode a six-year effort by EU leaders sealed this spring to cut away a surplus in the market that had depressed prices.

Carbon allowances dropped at the fastest pace in a month after the government’s plan was published on July 12, snapping the biggest rising streak since 2014.

Carbon Traders Brace for U.K.'s Possible Exit From EU Market

The impact on prices would depend on the timing of the withdrawal, because the EU Emissions Trading System’s current program is geared to cover emissions through 2020. Britain is scheduled to depart the EU at the end of March 2019.

Not all the roughly 100 million tons of spare allowances would come to market because many of the companies holding them for future needs also own factories or power stations covered by the system in other EU nations.

Scrapping U.K. participation in the carbon market is just one option the government is considering. Prime Minister Theresa May’s paper outlining the thinking of ministers said Britain wants to retain a close relationship with the EU on energy. It was the first time the government gave any detail on its thinking.

Staying in the EU single market for energy might help smooth trading of electricity and natural gas. Over the past two decades, Britain joined EU nations in seeking to smooth borders in energy markets, allowing commodities to flow more freely.

Carbon Traders Brace for U.K.'s Possible Exit From EU Market

The government said the U.K. and the EU also could benefit from a consistent approach to carbon pricing, “which, for example, could be delivered by remaining in the EU’s emissions trading system.” At the same time, the U.K. suggested it wants to avoid tighter environmental targets coming from the EU, which remaining in the market would suggest.

The EU also has renewable-energy targets, energy efficiency directives, industrial emissions laws and vehicle-emissions standards that membership in the bloc has required the U.K. to adopt and sometimes overlap.

There could be benefits from leaving. U.K. polluters already pay about double what other polluters in Europe do because of the country’s carbon-floor support policy, introduced because the EU price was deemed too low. Britain would probably replace the EU market with a new program or tax, because it has its own stringent legislated emission limits.

Carbon traders are also placing more options bets in the carbon market than ever before and that is partly because of the uncertainty surrounding Brexit, said Louis Redshaw, founder of Redshaw Advisors, an emissions trading outfit in London.

The appetite for options has been “heightened due to the uncertainty that Brexit adds to the potential outcomes for EU allowance prices,” he said by email.

Carbon Traders Brace for U.K.'s Possible Exit From EU Market

Energy companies are eagerly waiting for more signs from the government about how the post-Brexit relationship with the EU will be structured. Natural gas and power are physically interconnected with Europe. Allowing tariffs to reemerge at the U.K. border would mean higher prices because fees would need to accommodate them -- “this kind of policy uncertainty is never good for energy markets,” Sikorski said by phone.

“We would welcome more clarity,” said Wolfram Vogel, director of public and regulatory affairs at Epex Spot. “As a prudent and responsible market operator, we continue to prepare our Great Britain and European markets for all possible scenarios, one of which would be coming out.”

The government’s document shows the U.K. hasn’t done enough yet to guarantee a stable transition for its carbon market, said Phil MacDonald, spokesman at London environmental lobby group Sandbag.

“The departure of the U.K. would slightly tighten the market” ultimately, because the EU would need to install a lower emissions target, and British emitters have cut greenhouse gases at a faster pace so far, MacDonald said. “In terms of the carbon price this would be unlikely to compensate for the damaging political signal of the U.K. crashing out,” he said in an email.

©2018 Bloomberg L.P.