The EU carbon allowance market is back in the investor spotlight as the European Environment Committee voted for an early start for the market stability reserve (MSR) – a ‘central bank’ for carbon. Meanwhile, the UK’s domestic carbon tax will be under scrutiny this year as it starts to push a switch from coal to gas generation. What will be the next government’s policy on putting a price on carbon?
Two years ago, the EU Emissions Trading Scheme seemed beyond redemption, with a proposal to delay the issuance of allowances rejected and the carbon price collapsing to €2/tonne. However, progress on tackling the surplus since then has allowed the price to recover to €7/tonne, and some are hoping it could go much higher.
Even the proposed reforms could take until 2030 to put enough allowances into the stability reserve to create a tight market. Nevertheless, given that it would cost more than €30/tonne to save carbon from switching from coal to gas generation, even the distant prospect of a carbon allowance shortfall could drive up today’s price.
While a higher carbon price would raise the cost of generation, it is seen as positive for generators as a whole in Europe, because clean generation (nuclear, hydro, market-exposed renewables) would see higher power prices without suffering from higher costs. In a world of falling coal, oil and gas prices, rising carbon prices offer hope of a positive driver for revenues.
What does this mean for the UK? The UK-specific carbon price support is a tax on generation fuel on top of the EU carbon price. It is due to increase once again to more than £18/tonne from April this year, which would already be sufficient to make gas cheaper than some coal stations in the summer.
A rising traded EU price could accelerate this fuel switch and pose an interesting question to an incoming government this May: is the UK carbon price a green instrument or a revenue-raising tax? A green government might celebrate the fact that the combined EU and UK carbon price was reducing domestic emissions. On the other hand, the Treasury might miss the lost revenue if a shift to gas generation cuts the tax take. Perhaps the true colour of the UK carbon tax is about to be revealed.
Martin Brough, utilities equity analyst, Deutsche Bank