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Accelerating Energy Convergence, Pt I: The Revival of Carbon Pricing

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In part I of this blog series our experts will discuss the global trend of the carbon pricing renaissance and explain the potential impacts on energy procurement decision-making. In part II, we will summarize recent updates on the EU Emission Trading System (EU ETS) along with an outlook for what to expect in the coming years and recommendations for the next trading period.

An Old Idea Gaining Global Traction

To put a price on carbon is not a new concept: in 1997, over 2,500 economists including nine Nobel Laureates signed the ‘Economists’ Statement on Climate Change’, arguing that carbon pricing - either price-based (taxes) or quantity-based (emissions trading) - is the most cost-efficient market mechanism to implement climate policies. But the global implementation of carbon pricing as means to effective carbon abatement is still limited: according to recent evidence presented on the OECD’s report on Effective Carbon Rates, 90% of global CO2 emissions are priced zero or below the minimum level of their climate costs. The 2018 OECD report presents the first full analysis of the use of carbon pricing on energy in 41 OECD and G20 economies, covering 80% of global energy use and CO2 emissions.

But the revival of carbon pricing is underway. Faced with the undisputable challenge of climate change to our society, 195 countries have committed to decarbonize their economy in the 2nd half of the century with the Paris Agreement, effective from November 2016. Many countries and organizations are considering or have already implemented carbon pricing to achieve climate targets or accelerate progress on carbon reduction. According to the World Bank, 40 countries and over 20 cities, states and provinces already use carbon pricing mechanisms.

Some global examples:

  1. European Union

Accounting for around 45% of Europe’s GHG emissions, and covering more than 11,000 installations, the EU ETS is one of the EU’s key policies aimed at achieving the Paris commitment. The business sectors covered by the EU ETS must reduce their emissions by 43% compared to 2005 levels. The revised EU ETS Directive, which will apply for the period 2021-2030, strengthened the EU ETS for the next decade.  The market stability reserve (MSR), one of the primary market-driving components of the regulatory changes, began in January 2019. From January 2019 to August 2020, around 660 million European Emission Allowances (EUAs) will be removed from the market and placed in the reserve. Stay tuned for part II of this series where we will discuss the regulatory updates in more detail.

  1. China

China has highest total GHG-emissions out of all countries, accounting for 29% of global emissions. Building on its experience of successfully piloting carbon markets in seven regions, China launched its national ETS politically in December 2017. The Chinese system is by far the largest national emission trading system, to cover more than three billion tonnes of CO2 (equivalent) in its initial phase.

  1. France

The 2018/19 ‘yellow vest’ movement in France demonstrated that carbon pricing can lead to disputes in society. President Macron introduced new carbon taxes in 2018 to urge motorists to change behavior and protect the environment. France’s goal is to cut carbon emissions by 40 percent by 2030 and boost the use of cleaner energies at the same time. Emissions are currently rising, and 75 percent of energy use in France originates from fossil fuels. But French people rejected the carbon tax plans, with complaints about rising living costs and the fact that proceeds from the fuel tax are not automatically allocated to the energy transition. This regulation is now on hold, but recently, France announced to introduce an eco-tax on airline tickets. From 2020 up to 18 euros per ticket are due, the revenue should benefit the railway.

  1. USA

While the Unites States has not agreed upon a national carbon pricing scheme, several states have taken the initiative to install regional carbon pricing programs. California, for example, has enacted a cap-and-trade system that obligates not only power plants, but also manufacturers, refineries and other heavy polluters. Prices in this market have been moderate thus far, but regulators are working to drive greater emission cuts through the program in future years.

  1. Internal carbon pricing in the corporate world

Companies are also beginning to use of an internal price on carbon, especially in global corporations. According to CDP, in 2017, almost 1,400 companies disclosing to CDP were factoring an internal carbon price into their business plans, representing an eight-fold leap over four years. The adoption of internal carbon prices not only illustrates the growing importance of climate change concerns in companies' strategic planning, but also provides a great tool to capitalize on opportunities. Companies usually adopt this tool as a ‘shadow price’, meaning a theoretical price on carbon that can help support long-term business planning and investment strategies, but currently has no market to be traded. Recently observed prices vary significantly by company, region and sector, ranging from $2-$893 per ton, but show a tendency to increase as carbon markets develop. As an example, a price analysis by the UK government’s Department of Energy and Climate Change and the Carbon Trust estimates that, in a scenario where warming is limited to less than 2 degrees, the global price of carbon is expected to converge at $140 per ton of CO2 by 2030 and $400 by 2050.

Society at large is also beginning to understand the pressure to act to limit the impacts of climate change: Greta Thunberg, a Swedish teenager, became famous for launching the student movement, FRIDAYS FOR FUTURE, to convince adults to take action on climate change. Instead of going to school, Greta has been spending her Fridays in front of the Swedish parliament with a sign reading: “School Strike for Climate.” Students in more than 70 countries have since followed her lead. The moral authority and urgency of children calling on leaders to act has created a powerful global momentum.

CO2 Price a Commodity to Consider

In the EU, carbon prices have increased significantly over the past two years. The carbon allowances (EUAs) currently trade ~€27/tonne; more than a 400% increase since the end of Q2-2017. The fundamental bullish market driver is the regulatory shift in EU ETS, designed to create tighter supply conditions. Carbon prices have a direct impact on electricity markets in Europe, as coal is still a significant part of the power generation mix. As the cost of emitting CO2 increases, utilities face higher input costs, especially when burning coal, as it is the most carbon-intensive means of electricity generation. Therefore, amid high carbon prices, forward electricity prices across continental Europe have remained elevated despite a fall in gas and coal prices since October 2018. During this same period, we have seen a switch towards higher profitability of gas power plants, as high carbon and weak gas prices increased the margins of burning gas as opposed to coal in electricity generation

Energy Convergence Benefits

The revival of carbon pricing is only one component of the changing energy landscape and resulting implications for companies to consider. For example, growth and price decrease in renewables create a variety of new energy sources and suppliers for corporations to consider. While many firms likely have a range of ‘traditional’ sourcing options at their disposal, too often companies overlook the bigger picture of energy convergence, including the opportunity to proactively integrate cleaner electricity sources into energy portfolios. Organizations that begin to shift their energy supply portfolios toward cleaner sources now will be set up to achieve financial benefits as a result.

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Click here to read part II of this series. To learn more about the trend of convergence in global energy markets, with recommendations and resources to help you incorporate an integrated renewable and traditional energy sourcing strategy for your business, read this FAQ.