Pollution Market Gets a Boost in EU With Move to Reduce Glut

(Bloomberg) -- European Union nations are poised to endorse the biggest overhaul of the market they created more than a decade ago to rein in pollution, a move that may lift prices of power generated from fossil fuels.

The measures, due for final approval in Brussels on Tuesday, impose tougher requirements on thousands of companies to reduce greenhouse gases or pay higher costs for their carbon dioxide emissions. They’re part of a plan to clear up a flaw in the market that left the cost of CO2 permits well below the level needed to stir investments in green energy.

Plans to rework the system already have boosted carbon prices to near a six-year high. They’re a sign big EU nations are are getting serious about fighting climate change even as President Donald Trump promotes the dirtiest fossil fuel. It also will add to pressure to close aging power stations especially in Germany, which are becoming increasingly unprofitable with ever-rising environmental standards.

“Trust in the political will to create a strong carbon price signal, the positive development of the EU economy and a touch of ‘EUphoria’ created the environment for the significant recovery of European carbon prices,” said Ingo Ramming, the London-based co-head of commodity solutions for Commerzbank AG.

The most immediate impact will be to support the price of carbon allowances in the EU Emissions Trading System, which have surged 25 percent since negotiators reached a preliminary deal on the overhaul in November. The package was then formally approved by the European Parliament last month. Tuesday’s endorsement by member states is the last regulatory step needed for the reform to become a law.

Carbon permits in Europe closed Friday at 9.80 euros a metric ton. That’s near the latest peak of 10.02 reached on Feb. 14, a level last seen in November 2011.

The market overhaul will reduce a glut of pollution permits in the ETS that built up after the recession that started in 2008. That will support prices. The cap-and-trade program, which covers almost half of the EU carbon discharges, is one of the EU mechanisms including targets for renewables and energy savings. Together, the measures are aimed at slashing emissions by at least 40 percent by 2030 compared with 1990 levels.

“After difficulties in recent years due to the economic crisis, today, with a carbon price at close to 10 euros, the EU ETS is back,” EU Climate and Energy Commissioner Miguel Arias Canete told Bloomberg News. “Not only is the worst over for the EU ETS, but it has also inspired other large carbon emitters to implement similar systems."

Under the ETS reform, the annual emissions caps on companies from Electricite de France SA to Germany’s EON SE to Poland’s PGE SA will decrease faster starting in 2021. The tougher limits will save the planet from an additional 556 million metric tons of carbon-dioxide over the next decade, equivalent to the annual emissions of the U.K.

In Germany, the dirtiest power stations are already losing money. Mostly run on lignite, a cheap form of coal usually gathered from strip mines, the economics of those plants is looking so poor that operators may opt to shut them rather than keep losing money, said Bruno Brunetti, managing director of global power at Pira Energy, a unit of S&P Global.

“We see more upside left for power prices,” he said. “We’re fairly bullish especially as additional coal retirements could be on the cards.”

The EU cap-and-trade program for emissions is the cornerstone of the region’s plan to cut greenhouse gases that scientists blame for global warming. It imposes annually decreasing pollution limits on around 12,000 facilities owned by power producers, airlines and industries from steel to cement makers. 

Market Rules

For every metric ton of carbon dioxide they discharge, emitters have to submit one emission permit, bought or received for free, or pay a fine of 100 euros ($117) per ton. Companies that pollute less than their cap can sell excess permits, getting an incentive for going greener.

Some energy-intensive industry lobbies, including WV Metalle group representing Germany’s aluminium and copper sectors, have criticized the reform for boosting the price of carbon.

“What we challenge is the notion that climate protection is necessarily better when it becomes more expensive,” said the association’s managing director Franziska Erdle. “Power can add up to as much as 50 percent of production costs, and many of our companies operate on a knife edge of competitiveness.”

A market glut depressed carbon prices to as low as 2.46 euros in 2013. Oversupply will shrink thanks to the strengthening of a mechanism that absorbs excess permits from the market. The volume swept into the so-called Market Stability Reserve will double to 24 percent of permits in circulation over a five-year period.

Tight Supply

“Traders are not used to a tight market because it’s been oversupplied for a decade,” Commerzbank’s Ramming said.  “This might create additional volatility. In general, we have a positive price outlook.”

Shrinking supply of permits and increasing carbon prices mean that energy from fossil fuels, particularly from its dirtiest type, coal, becomes more expensive. That in turn should encourage power producers and manufacturers to shift to natural gas or renewables and seek cleaner technologies.

Coal and gas generation are in constant competition for the portion of electricity demand that renewables can’t cover. The switch from coal to gas will happen when carbon is high enough to price out coal at about 15 euros, according to RCB Europe Ltd.

The International Emissions Trading Association, whose members include banks, brokers, emitters and commodity exchanges, says the reform will strengthen the market.

“As the price of allowances is expected to rise, carbon-reducing investments will become more cost-effective, speeding up decarbonisation of the EU economy,” said Julia Michalak, IETA’s director for EU policy.

--With assistance from Brian Parkin

To contact the reporters on this story: Ewa Krukowska in Brussels at ekrukowska@bloomberg.net, Rachel Morison in London at rmorison@bloomberg.net.

To contact the editors responsible for this story: Reed Landberg at landberg@bloomberg.net, Jones Hayden

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