The cost of polluting today remains close to what it was a year ago. The CO2 emission rights started 2024 with a downward trend that has turned this European instrument, meant to incentivize major industries to cut emissions by paying more, into a barometer hovering around 50 euros per ton, roughly half of what was seen twelve months earlier. This decline accompanies the recent drop in gas prices, which sit near 25 euros per megawatt hour, resembling pre-crisis levels and close to the reference quotes on the Dutch TTF market.
Since 2005, Europe has operated a system named the Emissions Trading System (ETS) that caps emissions from about 10,000 energy-intensive facilities, including power plants and heavy industries, plus airlines. Each company receives an annual allocation of CO2 rights it can emit without cost within its productive activity. If it exceeds that allowance, it must participate in a market auction to buy additional rights.
In this way, CO2 becomes an extra production cost for the higher-polluting plants, helping explain its impact on the electricity bill. Thermal power stations, such as combined-cycle plants and coal plants, are the largest buyers of these rights because they often lack free allocations. Consequently, a shift in emission rights directly affects wholesale electricity prices, which follow a marginalist system where the most expensive technology sets the final price.
From 2018 to 2019, these rights rose from 4 to 23 euros per ton; by 2021 they reached 48 euros, and last year they hit a peak near 100 euros. The prevailing belief is that increasing the cost of pollution pushes industries to lower their emissions, even as the year begins with a price retreat to roughly half. The question is whether this decline truly lowers emissions.
Global CO2 emissions rose by about 1.1% in 2023, adding roughly 410 million tons, according to a recent report from the International Energy Agency. Yet in the European Union, emissions fell by nearly 9%, reducing emissions by around 220 million tons. This downturn is linked to more renewable energy in the electricity sector, a weaker economy, and greater industrial efficiency.
Lower demand
The three factors mentioned above, which have cut emissions in Europe, also reduce demand for emission rights. Electric sector sources point to an industrial slowdown, especially in Germany, a major European consumer, and note that investors sell rights to cover losses in other assets and improve liquidity. Meanwhile, a knock-on effect appears: as the market declines, positions are dumped.
“High renewable generation is limiting gas and coal use in European electricity markets, particularly in Spain and Germany. Industrial demand is not growing rapidly, which helps contain CO2 prices,” explains an analyst at Ignis Energía, Pedro Cantuel, via email. He adds that bearish fundamentals exist and a stable climate scenario is not pushing prices higher.
Attention should also be kept on speculative investment, which has pushed prices up in recent years. Investment funds and banks account for about 30% of purchases, according to Ismael Romeo, director of SendeCO2, a rights trading platform. “They are the key factor that lifted prices beyond reason, yet they also explain the recent decline. Some funds are playing the downside,” Romeo notes.
More supply
Other dynamics may have alleviated price pressure, such as greater liquidity in auctions tied to Repower EU to finance clean investments, or this year, for the first time, the annual delivery of emission rights will occur on September 30 instead of April. “Industries no longer feel the same urgency to acquire units, and rights deliveries have been delayed. It would not be surprising if prices begin to recover after summer,” Romeo suggests.
The big question remains whether high levels will return. A senior executive at Endesa said he was “absolutely sure” prices would rebound to 100 euros per ton, pointing to mechanisms that can drive prices higher and to the European Commission’s stance that elevated prices are needed to spur technological innovation.
Among these mechanisms is the Market Stability Reserve, described by the Endesa executive as a “central bank of rights” that regulates liquidity: it drains rights when prices are low and injects them when prices are high to prevent drastic price spikes. This system operates via an algorithm. It did not intervene when prices rose, and so far it has not intervened to curb them either.