Europe's Carbon Market Passes the Test --- Investors can take comfort in the bloc's cap-and-trade program

"The world's oldest, and largest, carbon market has finally come of age.

After a rocky start in life, the European Union's Emissions Trading Scheme has proved its mettle. EU carbon dioxide emission credits now trade around 80 euros for a metric ton, equivalent to $87. Since the start of 2020, prices have touched a low of 15 euros a metric ton and a high of 96 euros. That is a wide range, but it has been a testing time for energy markets generally with the pandemic, and the European energy crisis. The carbon market, and its regulators, have weathered it all with aplomb.

It took a while for this bold economic experiment to get over its teething pains. The economic contraction after the global financial crisis created a glut of carbon allowances that kept prices in the doldrums until a 2018 reform. Since then carbon credits have been steadily appreciating. That created a range of views as to what the carbon credit prices should be. And so, like all good markets, buyers and sellers took some time to arrive at a new market clearing price. 

EU carbon credits have been getting more expensive because the bloc has raised its decarbonization ambitions and cut the number of free allowances it grants.

Europe's ETS is a regulated market, created to support the bloc's climate action policies. To do that, carbon needs to get more expensive to emit, creating quite a reliable one-way bet for investors. A key investment risk has always been that politicians would interfere when prices started to pinch. It recently faced exactly that test. In the autumn, European carbon prices reached new highs around the same time as local energy bills were skyrocketing. On cue, many politicians demanded that the EU intervene to bring ETS prices down.

They didn't. Power and heating bills were expensive mostly because Russia sent far less gas to the bloc last autumn, forcing it to compete in the tight global market for liquefied natural gas.

There were also accusations of financial speculators manipulating the carbon market, prompting an investigation by the regulator. A final report last month found no evidence to support the claims, concluded the market was working well and focused its recommendations on increased reporting and transparency.

The events create confidence that the EU credits are an investible asset, which isn't to say there will never be intervention or change: The 2018 reforms established mechanisms to adjust the supply of credits in extreme situations, but recent events suggest that intervention will be predictable. Other ETS reforms are coming, but they are published long before they are implemented, giving investors time to adjust.

Europe has led the way on carbon markets and seems to have finally designed a robust, investible one. That is good news for investors as other nations, including China, have used it as a model. While a global carbon market still seems like a pipe dream, the EU ETS offers a model to develop some well-designed national ones." [1]

1. Europe's Carbon Market Passes the Test --- Investors can take comfort in the bloc's cap-and-trade program
Toplensky, Rochelle.
Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 15 Apr 2022: B.10.