Why Brexit Is Rattling Europe’s Market for Pollution Allowances
Why Brexit Is Rattling Europe’s Market for Pollution Allowances
(Bloomberg) -- Britain’s exit from the European Union is also likely to end its participation in the region’s market for carbon dioxide emissions, but exactly how the break will happen is still rattling traders.
The market started in 2005 to limit greenhouse gases from thousands of industrial sites including power plants, steel mills, cement factories and airlines. It requires polluters to hand in allowances covering their annual emissions, raising about 11 billion euros ($12 billion) for governments in 2018.
Britain accounts for about 7% of the permits issued, so the timing and nature of its departure could shift prices. The U.K. general election on Thursday will shape the next government’s ability to act, and speculation about who will win already is influencing sentiment in the market.
The Current Situation
At the moment, the risk of the U.K. leaving without a deal has weighed on carbon prices, since that scenario would leave British companies holding allowances they no longer need. Those could quickly tumble onto the market in a no-deal case.
A supply infusion threatens to damp lawmakers’ efforts to curb a glut of allowances, limiting price gains. The securities have averaged almost 25 euros a ton so far in 2019, quadruple the price just 2-1/2 years ago.
Brexit has drained some of the momentum from that rally. The credits flirted with 30 euros a ton in July and have eased since, partly on concern about a no-deal exit.
Impact From the Election
Prime Minister Boris Johnson’s Conservative Party and the Labour opposition led by Jeremy Corbyn have the two biggest groups in Parliament, with Liberal Democrats, the Scottish National Party and Democratic Unionists holding the balance of power.
The election could prove to be an inflection point for the market, mainly because it could sharpen the view of how Brexit will be settled. Removing the risk of no deal might bring a relief rally, according to Barbara Lambrecht, an analyst at Commerzbank AG in Frankfurt.
“It may be a trigger for higher carbon prices.”
A hung Parliament with no party holding control would extend unease. Following are two scenarios traders are weighing:
1. Conservatives win a majority
Johnson’s effort to break away from the EU has been stymied by Parliament, since no party has overall control and no single vision of Brexit dominates. A Conservative triumph would smooth the way for a separation.
Johnson wants to leave the EU by Jan. 31 with a transition period where the U.K. would negotiate a future trading relationship with the union. If he were able to push that package through Parliament, Britain would probably remain in the EU Emissions Trading System at least thorough the end of 2020.
In that case, a flood of new allowances covering 2019 emissions would probably come onto the market. That’s because the EU prevented the U.K. from auctioning permits this year over Brexit concerns. Putting in place transition arrangements would allow the U.K. to bring the new allowances to market.
Some of those expectations are already priced in, since polls show the Conservatives have maintained a wide margin over Labour.
Those new allowances could hit the market in the first quarter, the first four months of 2020, or even spread over the year -- it’s subject to negotiation between the EU and U.K.
2. Labour wins, or hung U.K. Parliament
If the result of the U.K. election is unclear, or if the Labour party wins, uncertainty may unnerve carbon traders.
Either result may revive the risk of a no-deal Brexit. In that case, the government will impose a Carbon Emissions Tax from Feb. 4, replacing the EU program and prompting some U.K. permit holders to sell.
The U.K. Department for Business, Energy & Industrial Strategy has said it will post details on the tax rate “as soon as possible.”
Corbyn has promised to hold a new referendum on whether the U.K. should leave the union, which would delay the exit. He may seek a deal that keeps Britain close to the single market, which might mean it remains in the EU carbon market after all.
Longer-Term Outlook
The transition out of the EU market may extend beyond the end of 2020, said Trevor Sikorski, a carbon and gas analyst at Energy Aspects Ltd. in London. A one-year transition “doesn’t sound long enough given we’ve spent three years discussing how we are going to exit.”
And after the U.K. election, the annual United Nations climate talks will be ending and the EU will consider more ambitious target for greenhouse gas emissions in the period through 2030.
Carbon allowances could be trading at double their current value if the Brexit uncertainty didn’t exist, said Berenberg Bank’s carbon analyst, Lawson Steele.
His view is that traders are overstating risks such as whether U.K. emitters will offload permits in a no-deal scenario.
“We’re still dealing with a market that does not always follow fundamentals,” Steele said.
To contact the reporter on this story: Mathew Carr in London at m.carr@bloomberg.net
To contact the editors responsible for this story: Reed Landberg at landberg@bloomberg.net, Andrew Reierson
©2019 Bloomberg L.P.