Reform of the EU ETS creates challenges for corporate clients
With reforms to the EU Emissions Trading System pushing up the cost of CO2 emissions certificates and lowering the future number of allowances, companies with high emissions could benefit from leveraging Commerzbank’s expertise in emissions trading.
Head of corporate & investor solutions at Commerzbank
Prices of European carbon allowances increased by more than 200% in 2018 on the back of the political reform of the EU Emissions Trading System (ETS). An increase in pricing, reduced auction supply and lower free allocation to industry mean carbon risk management will play a more important role for companies in Europe.
The EU ETS is the largest carbon pricing scheme in the world, covering more than 12,000 energy and industrial facilities in the EU as well as in Norway, Iceland and Liechtenstein, and accounting for more than three quarters of international carbon trading. The legislative framework of the ETS for its next trading period was revised in early 2018 to align the scheme to the EU’s 2030 emission reduction targets and its contribution to the 2015 Paris Agreement. Key changes of the reform include an increase of the linear reduction factor and the strengthening of the Market Stability Reserve (MSR). The MSR will start operating in 2019 and was established to address the current surplus of allowances and improve the resilience of the EU ETS in case of major shocks by adjusting the auction supply of allowances.
The impact of the reform of the EU ETS, especially the strengthening of the MSR, has already been felt. The price of CO2 emissions certificates rose more than five-fold between summer 2017 and autumn 2018 and some analysts expect a further increase in price. This would create a considerable financial burden for companies required to cover a compliance deficit. Experts from our commodity research department forecast the price per tonne of CO2 will rise to €25 by the end of next year – an increase of almost 50% on the price of €14.40 recorded as recently as the second quarter of 2018.
Ingo Ramming, head of corporate & investor solutions at Commerzbank and co-chair of the International Emissions Trading Association’s EU ETS working group, says companies will need to adjust their procurement strategies and carbon risk management. “The significant increase of prices and particularly the volatility of prices makes an active risk management much more important.”
How does Commerzbank support companies with risk management and emissions trading?
It is key to identify the business impact – both the risks and the opportunities. These need to be quantified and prioritized. How large are they in absolute terms? What is the potential volume and price risk? How pivotal are they in terms of the success of individual transactions, parts of the company as well as the entire company and the group?
The annual cycle begins with allocating the free certificates in February and concludes with settlement in April of the following year. On the basis of disclosures made by the company, we can calculate possible surpluses or deficits in emissions allowances and present concrete action options.
The following strategies are frequently used:
Passive strategies: CO2 certificates are acquired shortly before the compliance reporting date, with sales made at the end of the year or quarter.
Tactical/active trading approach: companies use the opportunities in the market and buy or sell emissions allowances as soon as a previously defined price target is reached.
Hedging/purchasing strategies: in this approach, companies define strategies that set how certificates will be acquired or disposed of on a regular basis.
Integrated risk management approach: commodity, exchange rate and interest rate risks are managed simultaneously.
More strategically, it is about “make or buy”. Is it possible to reduce CO2 emissions? What is the cost of abatement? Is it cheaper to invest in low-carbon technologies than to purchase allowances?
Refinancing: How EU emissions certificates that are allocated free of charge can be used in order to optimise financing costs.
Commerzbank is a pioneer in the area of emissions trading. We participated in the first auction of carbon certificates in Germany in 2001, concluded the first ISDA-documented EU allowance transaction in 2004 and the first EU aviation allowances transaction in 2011. With this experience, we are an ideal partner to support companies in carbon procurement and risk management.
Find out more about Commerzbank:www.corporates.commerzbank.com
Get in touch:Ingo.Ramming@commerzbank.com