The European Union’s carbon emissions trading price reached an all-time high at the end of August due to tighter environmental regulations and an insufficient supply of natural gas. EU futures prices passed €61 ($72.15) in intraday trading on August 30—doubling their levels from a year ago, and then fell to close at €60.60 ($71.68). One reason for the increase is the anticipation of tight natural gas supplies in Europe resulting in high gas prices and possibly more coal to be burned for power and heat this winter, which would create a greater demand for carbon allowances to cover the carbon dioxide emissions. Also, low levels of wind output affects the amount of natural gas and coal used to generate electricity. Recently, the United Kingdom had to start up an old coal plant to balance supply due to low output from its wind turbines.
EU’s Emission Trading System
The EU Emissions Trading System was set up in 2005 as a “cap and trade” program. The European Union sets a cap on the total amount of greenhouse gases that the installations covered by the system can emit and reduces the cap over time so that total greenhouse gas emissions continue to fall as the system continues to meet the lowered cap. Facilities covered by the program must buy or receive emissions allowances which they can trade with one another. Each year, the facility must surrender enough allowances to cover its total emissions or be subject to heavy fines imposed by the EU. If a facility reduces its emissions beyond the cap, it can keep the excess allowances to cover its future emissions or it can sell them to another facility that is short of allowances. An allowance gives the facility owner permission to emit one metric ton of carbon dioxide.
The EU’s carbon market is the largest mandatory emissions trading system in the world.
Natural Gas Prices
Natural gas shortages in Europe result from a combination of low imports of liquefied natural gas (LNG) due to Asian natural gas demand pressures and a low volume of natural gas flowing in Russian pipelines. The result has pushed natural gas prices up by 1000 percent in the last year.
Europe will have significantly lower natural gas reserves than usual going into this winter. European natural gas reserves are currently at 60 percent of their capacity, more than 20 points lower than a year ago and well below their average at this time of year. A cold start to this year resulted in European countries dipping into their gas reserves, which would normally be replenished in the summer months when demand tends to be weaker. However, the economic rebound from opening up from Covid-19 lockdowns, meant higher-than-expected demand that led to a shortage of gas. If the winter is cold in Europe or Asia, natural gas prices could rise even higher than last year when Europe had ample reserves.
Electricity Markets
Last year, the cost of a combined cycle plant was €40 ($47) per megawatt hour. Now it is around €100 ($118) per megawatt hour. Most of the increase (85 percent) is due to the increase in the price of natural gas. Combined cycle power plants (CCGT) set the marginal price in European electricity markets. Spanish households are paying about 40 percent more than what they paid for electricity a year ago as the wholesale price has more than doubled. Britain’s energy regulatory agency recently allowed utilities to increase the ceiling on energy bills for millions of households paying standard rates by about 12 percent, to 1,277 pounds, or $1,763, a year.
Natural gas prices have increased so much that coal-fired plants are now competitive, despite their higher carbon dioxide emissions, which are subject to the emissions trading scheme. In recent months, Germany has reduced its gas-fired power generation by 36 percent while doubling its coal-fired generation. Similar developments have occurred in the UK and the Netherlands. This increase in coal demand has increased the price of coal by 100 percent in the last year. Further, carbon emission prices have increased by 60 percent mainly due to Europe’s ‘decarbonization” policy.
In the UK, wind farms have not generated as much power as normal due to warm, still weather, and soaring natural gas prices have made it too costly to rely on natural gas. As a result, an old coal plant that had been on standby was fired up. Despite a three-day coal-free run in mid-August, the country had to rely on some coal power every day since then. National Grid ESO, which is responsible for balancing the UK’s electricity supply, confirmed coal had provided 3 percent of the nation’s power, which was later lowered to 2.2 percent. Last year, coal contributed 1.6 percent of the country’s electricity mix—down from 25 percent five years ago. The UK government has committed to phasing out coal power by 2024 and the fuel is currently used only when it is a better value than natural gas.
China’s Emissions Trading System
In contrast to the EU system, China’s system is designed differently. China’s Emission Trading System was launched in July 2021 and encompasses 2,200 companies that operate coal- and natural-gas-fired power plants—facilities responsible for 40 percent of China’s greenhouse gas emissions. On the opening trading day, July 16, 2021, allowances to emit one metric ton of carbon dioxide exchanged for between 50 and 53 yuan ($7.72 to $8.18). By August 20, prices had fallen to 49 yuan, or $7.57. The $7.57 permit trading price is 84 percent lower than the International Monetary Fund estimates would be required to efficiently lower China’s emissions.
China’s trading system allocates tradable permits free of charge to existing power entities as a function of their operations’ emissions intensity (the ratio of emissions to power generation) and historical power output. The system does not place an upper bound on the sector’s emissions as the EU trading system does, nor does it set a timetable for doing so. According to the International Carbon Action Partnership, the nominal cap is to be adjusted ex post facto based on actual power-production levels. The system design essentially guarantees that the power sector’s cumulative emissions will continue to increase. Whereas the European Union ETS has firm emissions limits for the sectors they cover and offer fewer permits over time, China’s system takes the “cap” out of “cap-and trade.” In so doing, China’s power sector will continue to increase emissions.
Conclusion
Europe is heading into winter with an insufficient supply of natural gas, which has increased gas prices and resulted in European countries reactivating coal units to generate electricity. The resulting increase in electricity prices is due to the 1000 percent annual increase in world gas prices and the high price of carbon dioxide emissions, which continues to increase mainly due to EU’s decarbonization policies. EU carbon prices are now over €60 ($71) a metric ton. EU’s emissions trading system requires larger producers of carbon dioxide emissions including power plants to purchase enough allowances to cover their emissions.
Because EU’s carbon market is the largest mandatory emissions trading scheme in the world, countries may use it as an example for global carbon pricing to meet their commitments to greenhouse gas reductions. In the United States, Congress is looking at various tax proposals in its reconciliation bill to reduce greenhouse gas emissions, meet its carbon goals and pay for the initiatives in the bill. Americans may be falling into the EU trap of much higher prices for energy as a result.
