Chronicle of September 2023
The Most Legitimate Squeeze
Here's a sneak peek at the European carbon market, where anyone can try to stop climate change while becoming richer in the process.
The Most Legitimate European Carbon Market
In order to prevent climate change, the European Union established an emissions trading system (EU ETS) in 2005. Ideally, this system will severely dissuade industries (and, eventually, all individuals) from emitting CO2 into the atmosphere. The EU ETS will eventually include coverage for other greenhouse gases, such as methane and nitrogen oxide.
The EU ETS operates on the cap-and-trade principle. A cap is a limit on the amount of greenhouse gas that participants can emit. The cap under the EU ETS is expressed in emission permits, with each allowance granting permission to release one ton of CO2 equivalent. Companies must relinquish an allowance for each ton of emissions they produce each year. If they exhaust their allowances, they must pay penalties for the remaining emissions. Companies can sell their allowances to other businesses. This is especially likely if they have unused allowances.
Currently, EU ETS applies to all EU member countries, as well as Iceland, Liechtenstein, and Norway. Power stations with combustion engines and industrial facilities must surrender emission allowances. Many industrial sectors are covered, including oil refineries, steel mills, metals, cement, ceramics, pulp, paper, chemicals, and many others, including aviation. The sectors covered will be added gradually. In the coming years, the EU ETS will extend to the maritime, transportation, and building sectors. These are the required buyers of allowances. Emission allowances can also be purchased by financial entities for investment and speculative purposes.
Governments are the ultimate sellers of allowances. The governments of EU+ nations distribute allowances among plants and installations under their jurisdictions. If those plants and equipment release more emissions than their allotted allowances, they must purchase additional allowance units on the open market.
EU ETS is the largest, multi-national carbon market in the world. The value of CO2 permits traded there was €751 billions in 2022, or 87% of global carbon market. It’s massive.
The EU ETS exists solely to cut emissions. Thus, it is normal for the government to reduce the cap, i.e., the number of allowances granted to plants and installations. As the supply of allowances decreases and more industries become mandatory buyers, the price of allowances rises in the long run.
As the price of allowance increases, companies must find ways to reduce their emissions, hopefully by innovating less-emission technologies. Otherwise, they will lose their competitiveness.
What happens if a corporation fails to fulfill its allotted target? Companies are often unable to purchase allowances due to rising prices. Then they must pay penalties, which are now set at €100 per ton of emissions. However, even if they have paid penalties, they must surrender the remaining required allowances the following year.
Making Sure There is a Squeeze
In order to prevent excess allowances, a Market Stability Reserve (MSR) was established in 2019. The reserve enables governments to increase or decrease the quantity of allowances available in the market by selling or purchasing them.
Furthermore, the MSR has the authority to revoke allowances that they have received, resulting in a permanent reduction in the outstanding allowances for a given year. This canceling mechanism is scheduled to begin in 2024.
This is what happened in the carbon market.
Looking at the charts, it appears that the effect of the carbon market on emission reduction is still debatable. But one thing is certain: the price of carbon must rise.
S&P 500 went down by 4.77% this September. Similar to previous month, Energy was the only sector that gained in September as oil price surged to the highest level in over a year. Crude reserves were at lowest level since July 2022.
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