energy

European gas crunch pushes up price of carbon offsets

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Europe’s escalating gas supply crunch has pushed up the price of allowances linked to carbon emissions as energy producers switch over to cheaper but dirtier coal.

EU carbon allowances last week topped €65 a tonne for the first time. Allowances under the UK’s nascent cap and trade system hit a record £76 (€88) a tonne.

Under both the EU and UK emissions trading systems, polluters buy credits granting them permission to emit one tonne of carbon.

Soaring gas prices driven by supply shortages have made generating energy from coal more profitable in the short term. Since coal is more polluting than gas, demand from power producers for EU and UK allowances has increased, driving up prices, said energy market analysts. Coal accounted for more than 5 per cent of UK power generation in early September, its highest level since March.

The price rises are “being driven, we believe, by increased utility demand, as a result of increased fossil fuel generation”, said Tom Lord, head of trading at consultancy Redshaw Advisors.

Chart showing UK credits are now trading at a premium to EU allowances

Traders had accepted that “for a certain amount of time”, potentially running into 2022, “there will be this fuel switch from gas to coal and therefore higher emissions from the power sector”, said Sebastian Rilling, EU power and carbon markets analyst at ICIS, the market intelligence group.

The EU and UK systems are designed to put a cost on carbon dioxide emissions. Energy producers and industrial groups often buy allowances in advance to hedge their exposure to the carbon price, and to ensure they have enough credits to cover anticipated emissions. Speculators have also shown increasing interest in the market.

The EU ETS broke above €50 in May for the first time, and has broadly stayed above that level since. The UK launched its own post-Brexit system in May. Allowances in the two markets traded roughly at parity until September, but UK credits have been trading at a widening premium for about two weeks.

Redshaw’s Lord said that in addition to gas market issues, the UK system was suffering from an insufficient supply of credits. The newly established UK ETS has fortnightly auctions and few industrial sellers, and “doesn’t have a surplus like the EU market has”, he said.

UK utilities are having to hedge both as a result of switching over to coal and because they used EU allowances to hedge their exposure before the UK system was established, he added.

Looking ahead, the price of allowances under both systems will in part depend on gas prices, said analysts. Falling gas prices could prompt a switch back to the fuel and away from coal, and drive down the price of allowances.

But a harsh winter that drives up fuel demand could mean sustained demand for coal.

“I don’t think there’s much room for further price surges for [EU allowances] right now in the absence of an even tighter gas market,” said ICIS’s Rilling. But “it seems unlikely that [they] are going to come down from their all-time high levels any time soon”.

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