Commerzbank Commodities Radar April 2021

Source: Bloomberg data

Why are the currently high prices remarkable? At the beginning of April, the EU Commission is set to report that, in the past year, verified emissions recorded the strongest decrease since trading commenced. Although the coronavirus-related lockdown measures did not see industrial production losing as much momentum in 2020 as during the global financial and economic crisis of 2009 (in particular the cement industry, which is covered by the EU ETS, recovered quickly thanks to the continuing construction boom), emissions from covered combustion plants have probably fallen twice as much (measured in percent) as during the economic and financial crisis, the reason being a massive reduction of coal-fired power.

However, the market seems to be focusing less on past facts and more on expectations for the future. The Market Stability Reserve (MSR) addresses the surplus with a delay. When the EU Commission publishes the total number of allowances in circulation (TNACs) for the preceding year at the beginning of May, it should become apparent that the number of allowances to be placed in the MSR as of September will remain high. As a result, the auction volumes will remain significantly reduced until well into next year. Nevertheless, these prospects alone cannot be the reason for prices stepping from record high to record high.

In fact, we think that more ambitious climate targets are a key driver: In December, the EU summit resolved to cut greenhouse gas emissions by at least 55% by 2030 compared to 1990 (previous target: a 40% reduction). This target requires a faster reduction of emissions in the EU ETS, with emissions covered by the scheme accounting for at least 40% of all EU greenhouse gas emissions. In the past, these emissions fell significantly faster than in other sectors. It seems like the EU ETS sectors will (have to) continue to make a disproportionately high contribution – unlike in the past, it is not only the utilities but also the industrial sector which will have to ‘roll up its sleeves and do its bit’.

The prospect of a significantly reduced cap in the EU ETS by 2030 is driving prices upwards, and the EU Commission is planning to present first parts of the ‘Fit for 55’ climate legislation package by mid-year, aiming not only to make the necessary amendments to EU emissions trading but also to present a new carbon border adjustment mechanism (CBAM) and to review whether the MSR provisions require adjusting. It should come as no surprise that these challenges are tickling pricing fantasies on the market, especially in view of additional national climate tools – such as the carbon tax on fuels introduced in Germany this year – also setting the bar high for prices.

Against the background of the rapid increase seen in the past weeks and the currently (still) low demand, we believe that prices are too high in the short term; therefore, we are expecting a consolidation in spring. However, we are also convinced that – in the medium term – the ambitious climate targets will force price increases to new record highs.

Source: Commerzbank Research, as of: 30.03.2021