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Carbon Market’s Virus Blow Softened by Brussels Technocrats

Carbon Market’s Virus Blow Softened by Brussels Technocrats

(Bloomberg) --

The carbon market’s automatic stabilizers are set to kick in, softening the blow of the economic slump in the European Union caused by the spread of the coronavirus.

The system, known as the Market Stability Reserve and introduced last year, will absorb some of the supply of allowances that factories and utilities need to buy to cover their greenhouse gas emissions. That will reduce the scale of the glut likely to build as industrial production plunges along with economic activity.

The reserve will soften but not eliminate the impact of the virus on the world’s biggest pollution market. That helps explain why carbon had its first weekly gain in more than a month, even as the chaos from the health crisis roiled other markets.

“The market stability reserve will be able to counteract some demand shocks, but its delayed impact may not shield EU allowances from immediate further volatility,” said BloombergNEF analysts, including Bo Qin in London.

The system will to some extent help support carbon prices, which have plunged by a third so far this year. While the reserve was set up to clear excess supplies that built up during the last recession, it’s likely to assist in the current downturn too.

The distress in the market was revealed in the failure of two auctions so far this month. Still, allowances this week have had their strongest performance since February.

Carbon Market’s Virus Blow Softened by Brussels Technocrats

The reserve will eat away at the oversupply that’s likely to build now that factories are shutting down across Europe, reducing energy consumption and their need to buy allowances. About 24% of the surplus will be removed each year.

BloombergNEF Market Stability Reserve model

That means the number of allowances sold by nations into the market will plunge by 34% next year versus 2020, according to Energy Aspects Ltd., a research company in London. Total supply of allowances will be one-fifth less than emissions.

In theory, the allowances can also reverse flow out of the reserve and into the market if there’s ever a shortage. So far, the system has only been tested with mopping up excess supply.

The increased size of the glut that is likely to appear at the end of this year means a bigger volume will be withheld starting September 2021.

That suggests a “delay in the period when the market will become tighter,” said Trevor Sikorski, a carbon and gas analyst at Energy Aspects. “We are looking at a reasonably big reduction in 2020 carbon emissions.”

Sikorski is assuming a 5.4% drop in greenhouse gas production this year, about the same as the 5.8% decline in 2019. Commodity information provider ICIS cut its emission output forecast for 2020 by more than a fifth, saying prices may have already dropped too far. Official data for last year are set to be published starting next month.

Last week, power demand in Italy was 17% below the business as usual level BloombergNEF would have expected in the absence of the pandemic.

The factors cutting demand for carbon allowances are piling up, said Gergely Molnar, an energy analyst at the International Energy Agency. So the market stability reserve will come in handy.

“The emissions trading system took a big hit in the last days, suffering the perfect storm -- compounded by expectations that economic growth is set to slow down in Europe, a very mild winter and a deep shrink in oil and gas prices,” he said.

©2020 Bloomberg L.P.