Choppy carbon prices

European carbon prices have rebounded from two-year lows in February to trade around EUR 70/t. One of the main drivers for the CO2 market has so far been gas. Listen to a discussion with Ingvild Sorhus from Veytabout the other drivers influencing prices and why a return to EUR 100/t is possible as a shortage looms from 2026.

Host: Snjólfur Richard Sverrisson, Editor-in-Chief, Montel
Guest: Ingvild Sørhus, Lead Carbon Analyst, Veyt 

Transcript

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 0:06

Hello listeners and welcome to the Montel Weekly podcast, bring You Energy Matters in an informal setting. In today's pod, we'll discuss carbon markets current developments, and the outlook for prices which remain very volatile. I think it's fair to say that the market's been very choppy with prices hitting two year lows in February before returning to levels between 65 and 70 Euros. In fact about the same as when we last had this week's guest on the pod. Could prices rise to a hundred or sink to 50 euros, or perhaps somewhere in between? Helping me, Richard Sverrisson to discuss the key issues in Europe's carbon market is our old friend and regular guest on the pod Ingvild Sørhus now of Veyt.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 0:49

Thank you, Richard. It's a pleasure to be here.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 0:51

Perfect. You're very welcome as always Ingvild.. Now let's start, I think the sort of big picture about emissions in Europe, they fell quite dramatically last year, didn't they? What, how much did they fall by and what were the main reasons for that form?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 1:06

And we don't have the final number. But it looks like the emissions were down 15 point a half percent year on year for 2023. I guess it was a bit of a twofold. We saw the biggest decrease in the power sector. That was both more. Renewables coming in but also a lower demand picture across our lower electricity demand. And most of the year as well. We saw that, coming out the winter in 2023 we had a quite healthy gas situation and then gas prices were dropping and then we saw, gas being in the money or rather than coal. So that kind of amplified kind of the decrease in emissions in the power sector. And then of course, we saw a big drop or kind of a rather kind of drop in industry emissions as well. And that was mainly due to, lower activity. Starting the year was bit more optimistic though it was at least going to be a small increase in industry activ activity. So that was those two two sectors that was responsible for the big drop. The sector where we did some in increase was aviation. Like flying activity across Europe increased compared to where we were at the years, like pandemic and post pandemic.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 2:13

So people are flying again. That's the essence there. And has having emissions ever dropped to that scale before on a year on year basis?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 2:21

No. So that was the steepest drop. We have seen kind of drop. Drop before, like with COVID. And we have seen after, in 2019, we saw a big decrease in emissions due to fuel switching. But we've never been to these slow levels before. Like the total emissions for the EUTS in history,

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 2:38

no. And do you think this is gonna be a one-off, or could this be repeated again?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 2:43

Might where we'll be that we on the pot to a lower emission future as well. We see just the development for emissions in the power sector this year. We see them or estimate them to be like around 24% lower at this point in time compared to where we were last year. Of course, we started or started the year with like more more, coal to gas, which already from the beginning of the year but also more increase in renewable generation. So like just emissions, were dropping quite significantly in the power sector last year and we see a further decline decline this year. Of course, we need to see also a quite rapid decarbonization in the power sector in the years to come as well. But then I guess it's also the question on what level will industry come back at or the industrial activity.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 3:29

And do you expect some of that to return or now, I mean there's a lot of talk of demand destruction. I see numbers up to 15% demand from, from industry down for energy. Is this something that you think is also reflected in current carbon market dynamics?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 3:45

I think yes I think 'cause of overall we look at quite kind of a bearish year. I would say, that is reflected in the prices as we have seen, we saw big decrease in in emissions last year and then we see a continuation of that this year. And also with more supply coming to the market. So that really reflecting. What kind of levels we have been with with carbon prices, just looking at short term dynamics. And of course there has been uncertainty also, or the European economy as well. When will it pick up? It's 2023 became less optimistic than. When you started 2023. So I think it's a bit wait and see. And of course some of the in, in industrial activity might not return to where they were before the energy crisis and the Russian in nation.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 4:32

And of course some of that industry might, may be becoming more we're increasing energy efficiency as well. And their kind of processes are changing.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 4:39

Of course. So that's kind of part of the picture as well with kind of the energy crisis probably also was speeding up kind of some of the energy efficiency improvement that could be taken by industry as well. And then some might not see a future in Europe that. That might be both power prices demand that has been dropping in our kind of demand for different goods in Europe. So it's quite a bit kind of mixed picture.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 5:05

And, I mentioned in the intro that, and you're talking now about the sort of, bearish momentum in, in the market. What prices dropped to 50 euros, around 50 euros in February. But what, why have they rebounded so, so sharply?'cause now we're what around between 65 and 70 anyway, aren't we?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 5:24

Yeah, I think we, this week we've seen prices testing like 70 again. So of course we have seen big volatility and. Whole, all of this year we've seen it's been really like tightly correlated with gas. And of course with the uncertainty and a bit more nervous gas market carbon has reacted to that as well. And I think it's it's bit because if you only look isolated on. 2024 and 2025 perhaps. And then it's quite kind of oversupplied markets we see drop in emissions and then 26, 27. So it depends on the horizon you're looking at. Because then we're getting into shortage and then we're getting into quite heavy shortage in these years. So it depends on how the market participants are valuing a bit. When do they start factoring this these kind of shortages or future shortages. So that's a bit. Bit mixed, but I would say that it's mainly been driven by kind of the uptick in gas prices, or at least that has been the trigger of prices moving higher. And then it's quite volatile and technical driven. And then of course there are, for instance, investment funds have quite big, had quite big short positions. And when, and talk about this big price movement that there are short covering in the market as well. So yeah, it's it's and then on top of that, in the uncertainty of the Repower eu which is of course when prices are increasing again, there is then we'll be less supply that needs to be added to the market as well. So it's yeah, it's a bit difficult. I think it's a difficult times for the carbon market that moment to pinpoint the real kind of the proper level.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 6:58

I think we've touched on several of those issues during the course of our conversation in Wheel. But explain to the reasons what's the link to gas prices? Why are, why is carbon so closely correlated? We mentioned a little bit before we started, we were talking about the chicken and egg kind of situation, but so what's the, Dr. Why is gas so important for carbon prices?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 7:18

Yeah, good question. Ideally, like in the past and like textbook example, it's like the fuel switching. The fuel switching levels that is setting is a price setting setter for the carbon price. And by fuel switching, what kind of level the EUA price needs to be to switch from coal to gas. So less emission in in the power sector. Of course now fuel switching levels are super low. So carbon price could be so much lower. So even if the gas price is moving, carbon. I by mean, by no means should really be that closely correlated with gas. But I guess the participants are engaged in both market and for now it's been no really other kind of big drivers for carbon. So then it's more kind of a price taker of of gas.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 8:05

Because it may seem odd to some people, are looking at the European carbon markets and thinking, okay, there hasn't been an. Gas prices are moving up in an escalation in the Middle East and the crisis developing there, and, potential of conflict between Iran and Israel. But then why on earth should that drive European carbon prices? That's the question.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 8:23

Yeah. And I guess that has been the case earlier as well. Then it might not be correlated to gas, but after the. Pandemic. And when Europe was closing down suddenly when everything else was going down carbon was going up with macro and whatever was happening on the macro side, on the US perhaps, and sometimes it's follow, has followed oil. So it's a bit kind of schizophrenic, I would say. Sometimes without kind of the lack of real fundamental drivers, it's it's. It's shifting a bit on what's the main drivers of carbon, and for now it's been super correlated with gas.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 8:57

Does that make it harder or easier to analyze in, from your perspective there? Anyone?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 9:03

Yeah, I think it's it's a bit I would say slightly harder. Also because it's I mean we see fuel becoming less and less relevant as a price setting element for carbon. Of course, next two years. You need to have quite a lot of gas or coal switch over the next two years. So in that sense, it is some price setting element to it. But now, if the price should have been the, you or the carbon price should be at the fuel searching level then carbon should be much lower than here. But of course, then you come into this other kind of the. Supply and demand balance for carbon in the future years. Just because of the setup of the EUDS direct.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 9:42

Yeah, exactly. But then, but you also mentioned sort of coal being outta the money. There's very little coal, or There's certainly drastically reduced coal fired electricity gen generation in Europe so that, the coal, the fuel switching from coal to gas isn't really, as you mentioned, not a driver though anymore.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 10:00

Gas could go up quite, quite a bit without more emissions coming into the power sector for the UATS at the moment. So that's why it shouldn't really be that correlated at the moment, but it is.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 10:11

But it is. Yeah. And I think. You see very closely that across Europe people are expanding renewables generation. We're seeing, negative prices in the power sector, huge amounts of solar and also wind coming on stream. How does, do those kinda short term do those short term factors influence the carbon market at all?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 10:31

Yeah, now we're a bit on the shoulder season. So in that sense it does not have too much impact at the moment shoulder season. But we are outta winter. So winter typically when we have heating heating demand. And then in the summer when we have cooling demand and of course then you see the weather forecast having more of an impact okay, more or less wind, or how much emission free. Power generation is available especially in the high demands high demand seasons. So of course we have seen previously that has had an impact. Typically when the weather forecast, new weather forecast is coming in, that is influencing not only kind of gas or gas, coal power market, but also carbon for reasons why. Okay. More or less emissions based on the availability of emission free power generation, so nuclear and renewable power generation.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 11:19

I, and I guess the sort of, a hundred million dollar question is then in England where are we going now in terms of prices? Where do you expect to see prices of now as we maybe leave the shoulder season and go into summer and then in, in towards winter?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 11:32

There are a few factors that is, I think will play in first of all, the weather will of course be important for summer. If we suddenly get into heat waves where we have like high demand or more fossil fuel generation, that will be habit. Polish impact on prices and vice versa. But then it's also this repower eu measure that is this extra sale of allowances to the market to par partially fund the the Repower EU plan. And of course. S, these volumes that is added to this year's auction calendar that is, that's based on a 75 Euro carbon price. Now the average carbon price so far has been just above 60 euros, so that means they're falling short with a monetary target for a repower eu. So that means in the sense that they need to add more volumes to the market to reach this 20 billion target that they have set for as a monetary target for the sale of, eU allowances.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 12:31

So what's the Repower eu? What is that all about? For those listeners who may not be familiar with that that, that. That part of EU policy?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 12:39

Yeah. That was EUs response to the invasion the Russian invasion of Ukraine. When we had the energy crisis, the need to, with the high dependency on Russian gas especially to wean off eu. At a fast pace and increase the energy security for Europe. So increasing the speed of renewable genera, renewable build out increasing infrastructure. And of course that comes with a price as well. Some of. Funding or kinda will come from the recovery and resilience fund that was set aside for COVID and other measures as well. But part of the funding was also earmarked to come from the EUTS on the sale of allowances. I think the big problem was that they set like a monetary target. So 20 billion euros should be reached within August, 2026. And of course that means we don't know exactly what volumes will need to be optioned to reach this target. And then when this start year started with lower carbon price and then we still prices were dropping and we've been down to, as you said, 50, of course, then they bus in the market is okay, how much more volumes will come to a market in a market where we really don't need these extra allowances that will be brought to the market. So it's, it. The EUTS is by default quite complex anyway. And then putting, like adding complexity on top of that with three power eu. And of course, in short term, that's bearish, but also in the long term, that's tightening the market quite considerably Also, 'cause you're borrowing allowances, you're bringing in allowances that was supposed to be auctioned in the future and auctioning them now instead. So I think that's been one of these like a bit tricky thing both for the market to assess and for us as analysts to assess a bit when will potential additional allowances be brought to the market? We as we have a, an assumption that. We think the commission will keep the auction calendar as days for 2024 so that the extra allowances will be added to 2025. But we don't know for sure 'cause we don't have the information in the auction regulation. You say you can update the auction calendar. Throughout the year. So one could be when they update the or adjust the auctions with the auction with the marketability reserve adjustment from September. That could be like one, one event that they can also increase the volumes, but we don't know for sure.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 15:07

So this could increase volumes by what if you're saying if they're measuring a price of, based on a price of 75 euros. It could be anything between 20 and 50% of extra volume coming on top of in, into the market.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 15:21

Yeah. So it's so that's the big ask where, or big 'cause they will use the actual auction price of the six month when they adjust the volumes. So in that sense that's creating quite big of uncertainty for what will the prices be for the rest of the year. How much will the prices be next year? Will you have a full auction until August 20, 26 or will you have quite. Little, depending on the price also in 2025 and 2026. So that's the big unknown and big kind of x for the carbon market. In the short term I would say.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 15:53

A big if then, but but what you're saying then they could, we could be still within this sort of 50 to 75 range then in 2024 and 2025 due to this extra volume coming in.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 16:05

Yeah, so the annual, if you look just at the annual balance we have oversupply this, or it's coming more soup oversupply, this this year and we assume that will be even larger next year. However. Because we are running into quite a big shortage already in 2026. So we expect prices to or that market, need to take this into account already, especially in 2025. So we expect prices to increase then in 2025 compared to where we are where we are now. So that's the, because of course this is like bit kind of resemblance to when we had the start of the market stability reserve where kind of market participants were starting to prepare ahead of the shortage in 2019. So I think talk to quite a lot of market participants and they see this shortage will hit the market. So it is more dependent on when will the price turn or when will that be factored in. More than that, it will stay at these levels forever.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 17:09

So you would say before the market tightens in 2026, the end of the repower EU program. So that would be a good time for many investors potentially, or people come in to enter the market at this time while prices remain fairly low because the expectation is from 2026, they will go up.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 17:30

Yeah.'cause it's I mean we started the fit for 55 framework this year. So that's already tightening quite a bit like year by year. And then in 2026 on and on top of that you have the market spill reserve that is a. Like acting or reacting to both kind of the drop in demand, it will treat the repower EU as a supply shock, so it will work on these volumes. So that will, especially when you talk about kind of repower EU that we see quite strong MSR in the years to come. When you are in the years where you have to pay back the repower EU volume, you're decreasing in the cap quite rapidly. You will have the second rebasing in 2026. You'll have the full inclusion of maritime sector that will come with 40% this year, 70% next year, and then a hundred percent in 2026. So that's of course. And then you have some like bits and pieces with some readjustment of the maritime cap and like all these things are coming at the same. Same time. So 26 and 27, it's like quite a lot of these tightening elements that will hit the market at the same tide. So even if we see emissions are dropping fast, but it needs to drop fast as well to remain within within the cap.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 18:44

And the trajectory for remissions. And so this, if I understand you correct, anyway, you were saying this, we could easily then see prices go to a hundred and beyond post 2026. Interesting. Very interesting. I think so. But you mentioned as well earlier about the so investors and their short positions, so they, so every week we get these sort of figures come out and. You know what's happening here? Why are the, the expectations that prices will fall?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 19:10

Yeah. This week we saw or the latest commitment of traders numbers that came in this week. We saw in investment funds were actually decreasing their net short positions. So we, they were adding both kind of on the short side and on the long side, but. Totally like the net and shortage has decreased by, 1 million or so.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 19:29

What does that mean for the market and what kind of an indication is that Ingvild?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 19:32

It's it's a good question.'cause it's, investment funds are holding like a relatively sh. I guess a relatively small part of the of the market. But it has become increased. One of these increased factors that market participants are watching. Of course, when they were reentering the market, when prices were rallying, they were more on the building up on the long side. Now it's reflecting that they have also a short view on the market as well. And also this kind of, the risk of the short covering, for instance, is some things that people are bringing up as well. But it's I guess it's giving some indication, but not the whole picture.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 20:11

Yeah. Yeah. No, that's fair enough. You also see, does that to some extent explain why prices move so much on, on a daily basis? They can be up or down six euros in the course of a day, which on some days it represents close to 10% of the value of the actual commodity, of the carbon allowance.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 20:28

Yeah. It's I think maybe not only the investment fund, but it's of course there's, it's quite a lot of technical trading on top of things. So sometimes you just need a spark from, for instance, the gas market and then you move across some levels that will increase this increase the or amplitude of the market.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 20:47

And are you seeing any kind of, change in hedging behavior from big utilities?'cause previously they would hedge many years in advance. Now with the onset of much more renewables coming into the system, big utilities are greening their portfolio. What does that mean for, in terms of hedging their carbon emissions?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 21:05

Of course, their hedging needs. It's less, with less less expected emission intensive power generation. And of course, that's also what we've seen a bit the beginning of the year as well. Suddenly you have, even for 2024, you have probably decreased your expected generation for 2024 just by seeing how rapidly the the need for fossil fuel, especially hard coal, has been been for 2024. And we see also it's a decrease because, the cleaning of the power sector is happening regardless so that the hedging needs are getting lower and lower. Yes.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 21:42

And that's also, and then of reflecting and in, in the market in terms of lower demand and potentially less liquidity as well?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 21:49

Yeah, we've seen the open interest has decreased decreased a bit, but of course we have different market dynamics also possibly kicking in as well. We have for instance, industry sectors, which for now has received quite a lot of free location. Now the free allocation is decreasing and then we have the face out. So in what way will, for instance, the industry players be able to hedge their. Carbon price risk for the future. And then we also have like shipping sector. Even if it's like relatively small it's typically a sector where. Where you have like hedging strategies in place already for fuels. So possibly some increase in hedging from shipping. So I think it's like just a different kind of the dynamics that's changing a bit. And that's where we are also going from a more like power centric EUTS to a more industry centric EUTS.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 22:40

Yeah that's very interesting. I think 'cause that there's always been this, the power sector's been the sort of one of the main drivers. But if that's gonna come from industry, that's an interesting change. A final question, Ingvild. We're sitting here in Oslo. It's a bright, sunny day. A very welcome sun sunny day. But we're ahead of the summer. Now summer is traditionally quite sort of low liquidity and quite volatile as you mentioned. Also because of the if we get a heat wave, it has dramatic effects or has big, large effects or large impact on generation from nuclear and coal plants. But you have the new compliance deadline, which is aft right after the summer. That could produce more volatile volatility in prices. What do you think about that? What do you expect for the summer months?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 23:21

Yeah, so it's very interesting because now it's like the first year we were seeing kind of compliance and in September. So that's new. We have seen a bit, a uptick in interest for the August future contract, but not very much. Normally it has been kind of March that has been like the second largest. But of course just like being in the market for quite some while it's. Been this like always like this psychological factor. Even if the buying or the buying needs not necessarily have been like huge, but it's always this thinking that someone needs to go into the market and buy ahead of compliance has always been like this like psychological factor that has often been a kind of a support to prices. What is also changing is that. Normally August is half. Do you have like half volumes or auction volumes? But that has changed now. So now it will be like full auction volumes in August to accommodate for kind of a later a later compliance period. It will definitely be interesting to see both how will demand that auctions be, especially in August when it's normally Hal volumes. Then that we potentially can have some support from from the delayed kind of compliance deadline.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 24:32

We shall see indeed be exciting times ahead, Ingvild, both in the short term and from 2026 onward when the mar market will certainly tighten. Thanks very much for being a guest on the Montel Weekly Podcast.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 24:44

Thank you.