It won’t be cheap for industrial companies to wean themselves off fossil fuels. Luckily, investors have a way to sit on the opposite side of this trend: European carbon credits.
Whether from California, China or Europe, pledges from politicians to decarbonize their economies have come thick and fast in recent months. One cornerstone of the European Union’s strategy is a cap-and-trade system of emission allowances that puts a price on carbon. Futures that anticipate this price give investors direct exposure to the regulatory fight against climate change.
Launched in 2005, the bloc’s international Emissions Trading System was the first of its kind globally. Once a year, polluters from a host of industrial sectors—including power, cement, steel, chemicals and refineries—hand over allowances for their carbon-dioxide emissions or pay a fine. While some free allowances are given, an increasing share must be bought from regular primary auctions or on the secondary markets.
There have been growing pains: The price declined for years following the 2008 financial crisis. Yet there have also been reforms. Next year, new rules kick in that tighten the supply of allowances.
So far, the ETS has been “a wash” for everyone except the power sector as other industries covered by the program were given sufficient free allowances, says Per Lekander of hedge fund Lansdowne Partners. From next year, though, companies outside the power sector will need to buy credits too. The additional demand helped push prices up this summer and is likely to persist as most of the affected industries have few quick or easy ways to decarbonize their operations.
The EU has no official target carbon price, which is considered a matter for the market. But this logic only applies up to a point. If the carbon price is too low to prompt investment in green technologies, officials will likely adjust the rules, as they have in the past.
Europe’s carbon price is widely expected to rise. Royal Dutch Shell estimated that it needs to be over $200 a ton by 2050, compared with around $30 today, for the EU to deliver on its net-zero promise. BP’s latest long-term price forecast assumes carbon will cost $100 a ton from 2030. Insurer Swiss Re recently set a $100-a-ton internal carbon levy from 2021, rising to $200 by 2030.
Such projections assume Europe is serious about decarbonizing its economy. This seems reasonable: The bloc announced a green deal in January and this month European Commission President Ursula von der Leyen said she wants to accelerate emissions cuts, will consider a carbon border tax and suggested expanding the ETS to cover new sectors such as transport, buildings and agriculture. Others want a minimum carbon price.
Such proposals are still work in progress. Regulatory changes to the ETS require the approval of a qualified majority of the 27 member states and, if approved, could take months or even years to come into force. ETS reforms could also create market dislocations. So might a disorderly Brexit if it prompts U.K. polluters to sell off their credits en masse.
Yet emissions allowances are likely to become more expensive even without further reforms. Any dislocations might be a useful opportunity for long-term investors to buy into the market. Even if the timing isn’t completely clear, the general direction of travel is: Europe’s carbon price is going up.
Write to Rochelle Toplensky at [email protected]
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