The price of EU emission credits were in touching distance of hitting record highs this week; the third time in as many months that the price has skirted with the €30 per tonne level. It’s been a long wait. The previous high of €31 per tonne was reached back in April 2006. Since then prices have languished around €5 per tonne.
But things started to change three years ago. The Market Stability Reserve (MSR) was introduced at the start of 2019 in order to reduce the supply of carbon credits or EUA’s has been instrumental in supporting the price surge.
Perhaps surprisingly, the EU carbon market is financialised just like any other commodity market. Banks, hedge funds and even private individuals can take positions in the European carbon futures market.
Many investors are betting that the price could go much higher in order to have the carbon impact that the EU intends, perhaps even as high as €50 per tonne. If prices break decisively through the €31 per tonne barrier then prices could quickly break up to €40-45 per tonne.
But what the EU giveth, the EU can also take away. Remember that the EU introduced the MSR as a lever to restrict supply, pushing carbon credit prices higher. The MSR also enables these credits to be re-released if the emissions market becomes too tight, much like a central bank controlling the money supply.
Banks and other institutions betting on higher carbon credit prices are likely to continue to push prices higher until the EU blinks. If Europe falls into a deep recession the political will to constrain emissions may evaporate, and so the EU’s grip on the levers of supply may start to loosen causing carbon prices to fall back to Earth.