High EU carbon prices: does ambition exceed reality?

The carbon price in Europe is soaring, currently approaching AUD$100 a tonne. That’s while the European economy is forging out of its COVID-19 recession with the EU’s economy predicted to grow by around 4.8 per cent in 2021 and more of the same in 2022. Pricing emissions doesn’t appear to be holding the European economy back.

EU carbon price (EUAs) 2021

Source: Amber

That’s the good news. The bad news is that sustained increases in carbon prices reflect growing scarcity for permits. This scarcity is being pushed by a rage of short-term market factors, but there may be a deeper, underlying problem. The EU’s political ambitions on climate are moving faster than technology can solve them.

Currently the carbon price is hovering above 60 EUR, double its value from a year ago.  This year’s surge has been driven by a range of factors: economic recovery and increased demand for energy and certificates. Very tight European gas supplies and higher gas and oil prices have meant coal generators will be needed more for electricity, and coal needs around twice the certificates that gas does.

But it may not stop there. Some analysts predict the carbon certificate price (EUAs) could reach 110 EUR by the end of 2021. That’s nearly AUD$180 a tonne. The EU carbon price prioritises electricity generation, deferring expansion intotrade exposed, emissions-intense manufacturing. Big emitters like gas and coal power stations have to buy and surrender certificates for each tonne of greenhouse gas they emit. When they don’t have any viable lower emissions options, they are forced to pay whatever it takes to supply electricity, and these prices are passed on to consumers.

The price confidence may also be driven by increasingly ambitious political targets being proposed by European governments. Their headline act is the “Fit for 55” package designed to deliver emissions reductions at 55 per cent by 2030. 

The closest thing Australia has in way of a carbon price is the artificially low price of ACCU’s, produced under the emissions reduction fund. It is trading around AUD $23 a tonne. It is still more a political prop than a genuine price signal of the scarcity value of greenhouse emissions.

The strength of the EU carbon price suggests more long term than short term drivers at play, as investors look to increasingly tight carbon markets and pricing in the future. This is being fuelled by populist ambition out of Brussels out of some national governments. In turn, the higher the cost of carbon gets, the more pressure there will be on EU lawmakers to enforce carbon border tariffs in imports flagged at the end of 2019.

There is a small problem. The carbon border tariffs proposed by the EU may breach WTO rules, and countries disadvantaged by them, like China, may challenge and win. That’s why the EU is trying to enlist support from the US and other key economies, so that the case for applying carbon border tariffs is more widely supported.

So far it has struggled in its campaign to broaden support for a carbon price. The EU took 5 years to design its scheme and has been bedding it down since 2005. The Biden Administration will not move on carbon pricing this term at the very least. It cannot afford to risk backlash in key, marginal industrial and rust belt states.

High carbon prices increase demand for lower abatement alternatives. This is working: there is an urgency from companies looking to develop green steel and other zero emissions solutions. But they’re still in the lab. Right now, it doesn’t look like there are enough deliverable solutions around, at any price.