Shipping: EU Carbon Market Could Trend Downwards

The EU carbon market could be set for further correction moving forward, with could impact the EU Emissions Scheme, which shipping is now a part of. In its latest weekly report, shipbroker Intermodal said that “the European carbon market has witnessed significant volatility in recent months, with EUA prices gaining momentum and surpassing the €70/ton mark since early May. On May 10th, the benchmark December 2024 EUA contract hit an intraday peak of €75.50/ton, the loftiest level since early January. This upward momentum appears driven by a combination of technical factors like short-covering by speculative investors and periods of thinner auction supply due to public holidays across Europe. However, the current bullish sentiment may be difficult to sustain given the lack of a clear fundamental catalyst, with EU emissions data continuing to show a downward trajectory amid strong renewable energy output. Specifically, in Q1 2024, hard coal generation plummeted by 34% y-o-y, lignite output decreased by 14%, and natural gas generation declined by 18%”.

According to Ms. Chara Georgousi, Research Analyst with Intermodal, “looking ahead, market participants should pay close attention to the potential shift in the historically positive correlation between EUA prices and European natural gas prices. Traditionally, this correlation stemmed from fuel-switching dynamics, where higher carbon prices incentivized a switch from emissions-intensive coal to cleaner natural gas for power generation. The underlying logic follows that if gas prices rise, coal becomes comparatively more competitive, potentially increasing coal generation and thus boosting demand for EUAs. Conversely, a drop in gas prices enhances natural gas’ position at the top of the merit order, reducing additional demand for carbon permits”.

She added that “however, as the EU progresses further with its decarbonization agenda and renewable capacity expands, this fuel-switching mechanism could diminish from 2026 onwards. At that point, with coal power plants being progressively phased out, the EUA price is projected to trade significantly above the technical levels that facilitate coal-to-gas switching. In this future scenario, an increase in natural gas prices may no longer translate to higher EUA prices. Instead, elevated gas costs could dampen overall energy demand, spur greater efficiency measures and accelerate the adoption of non-fossil fuel alternatives – ultimately putting downward pressure on emissions and EUA prices. Conversely, cheaper natural gas could incentivize higher consumption and emissions, driving EUA prices higher”.

“This potential inversion of the current positive carbon-gas correlation coincides with expectations of a tightening EU carbon market from 2026 onwards. More specifically, the bloc’s RePowerEU policy response, aimed at reducing reliance on Russian fossil fuels, emerges as a key bullish catalyst. By bringing forward the sale of emissions allowances originally scheduled for later in the decade, this policy is expected to create a shortage of permits that could push EUA prices back towards the record highs above €100/ton witnessed in early 2023. Yet, in the near term, the market faces bearish pressures as the EU aims to achieve its RePowerEU funding targets, potentially necessitating additional allowance sales and increasing supply. Uncertainty around the timeline of these policy adjustments has also contributed to volatility. Against this backdrop, we anticipate further EUA price weakness through 2024 before the projected market tightening takes hold from 2026”, Intermodal’s analyst concluded.
Nikos Roussanoglou, Hellenic Shipping News Worldwide