Energy BrainBlog

European CO₂ prices have developed very dynamically in 2018. They rose to over 25 EUR/ton in September and then fell sharply again within a few days. Prices however have also fluctuated considerably in recent years. How does this affect the price of electricity? And what can we expect in the future, especially in view of upcoming fourth phase of the ETS (Emissions Trading System)? Guest author: Michael Claußner (Junior Expert at Energy Brainpool)

The European carbon market is currently in its third phase (2012-2020). Several sectors (among others, e.g. aluminium industry, air transport) and greenhouse gases (nitrogen oxides and perfluorocarbons) were included in this phase [1]. In principle, such enhancements lead to increased liquidity on the market, which can counteract price volatility.

As can be seen in Figure 1, however, strong price jumps within short time intervals could still be observed in recent years, as previously. In March 2014, for example, CO₂ certificates lost 25 percent of their value within just three days. An even greater fluctuation occurred in December 2016: Within 15 days, CO₂ prices climbed from 4.30 to 6.07 EUR/ton. This corresponds to an increase of 41 percent. Daily volatilities further intensified the effect. Examples include the leaps from 26 to 27 April 2016 (+12 percent) or from 13 to 14 September 2018 (-18 percent; see also Figure 1).

CO₂ prices fluctuate – in wich ways does this affect the electricity price?

A glance at Figure 1 gives an idea: the CO₂ price has a significant influence on the course of the electricity price. In principle, two types of cause-effect relationships can be observed. On the one hand, a CO₂ price increase is directly associated with a linear increase in the short-term marginal costs of fossil power plants.

Due to the higher marginal costs of the price-setting power plant in the merit order, the electricity price therefore also rises linearly. If we take into account the different emission factors among varying power plant technologies, it is noticeable: their marginal costs increase linearly, but not all to the same extent.

For example, as CO₂ costs rise, the short-run marginal costs of a coal-fired power plant grow faster than those of a combined cycle gas turbine (CCGT) plant. This results in so-called “fuel switches” at certain price thresholds, when one technology can undercut the other in terms of cost. Such an effect is illustrated by the example of hard coal and CCGT in Figure 2 and occurs to varying degrees depending on the CO₂ price level.

The power plant that is now setting the price (here: CCGT instead of hard coal) has a lower emission factor. If the CO₂ price continues to exceed the level of the “fuel switch”, its increase will henceforth lead to a proportionally lower increase in the electricity price.

However, this effect can only be observed to a limited extent in Germany due to the well-mixed power plant structure (in the merit order) with multiple efficiencies.

Outlook for the future: What are the carbon market refoms for 2021 to 2030?

Background: as can be seen in Figure 3, the number of emitted EUAs in recent years has partly been lower than assumed (due to partial or complete closures and capacity reductions).

Nevertheless, there are still large surplus quantities of certificates from the second trading period in circulation. This counteracts the scarcity of certificates on the market and thus the desired price signal.

For this reason, between 2014 and 2017 a total amount of 900 certificate was withdrawn from the market and transferred to the MSR (“Market Stability Reserve”). Since there were still about 800 million surplus EUAs remaining, mechanisms like this need to be strengthen for the next trading period. The MSR is a key criterion for Phase 4 reforms.

In summary, in April this year, the EU adopted the following reforms for the fourth trading phase of the EU ETS from 2021 to 2030³:

• Between 2019 and 2023, the volume of allowances transferred to the MSR will double to 24 percent of the total number of allowances in circulation (“TNAC”). As of 2024, only 12 percent will be transferred, as was previously the case.
• New rules apply for transferring certificates to and from the MSR:
  • If TNAC exceed 833 million: 12 or 24 percent of the annual quantities will be supplied to the MSR instead of being auctioned.
  • If TNAC are less than 400 million: Up to 100 million allowances are withdrawn from the MSR and auctioned additionally. This also applies if, over the course of six months, the CO₂ price is three times as high as the average value of the past two years.
  • From 2023 on, the maximum size of the MSR is limited to the auction quantity of the previous year and allowances above this limit are cancelled.
  • In addition, Figure 4 illustrates the plans to reduce the total number of emission certificates issued annually (the “cap”) by 2.2 percent per year from 2021 onwards, instead of the previous 1.74 percent.
• In addition, Figure 4 illustrates the plans to reduce the total number of emission certificates issued annually (the “cap”) by 2.2 percent per year from 2021 onwards, instead of the previous 1.74 percent.

How could these developments affect CO₂ and electricity prices?

As a result of the EU’s increased level of ambition, experts expect certificates to become increasingly scarce. This would increase CO₂ prices in the long term. It is assumed that the changed expectations about future price developments were already evident on the market when the temporary high occurred in September 2018.

However, the reforms do not rule out the possibility that price uncertainty will remain in the future. As a result, the electricity price will continue to be affected by these volatilities. In order to counteract these uncertainties, fundamental electricity price scenarios are a useful tool to obtain a structured overview of possible future electricity price developments.

As an example, Figure 5 illustrates the influence of different CO₂ price levels on such prices. The forecasts are based on calculations of our fundamental model Power2Sim.

[1] IETA:  https://www.ieta.org/resources/Resources/3_Minute_Briefings/phase%Prozent203%20eu20ets_final.pdf

[2] EU Kommission: http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018L0410&from=EN

[3] EEA: https://www.eea.europa.eu/data-and-maps/data/data-viewers/greenhouse-gases-viewer

 

Guest author: Michael Claußner (Junior Expert at Energy Brainpool)