Can COP28 spur EU carbon market?

World climate negotiators will meet for UN-led talks in Dubai next week in attempt to slow warming that is exacerbating extreme weather from flooding to heatwaves to drought. Could COP28 provide impetus to Europe’s carbon market, where prices have dropped from a record high above EUR 101/t to a one year-low below EUR 75/t amid weak fundamentals and rising geopolitical risks. Listen to a discussion on the outlook for the EU’s key climate policy tool.

Host: Snjólfur Richard Sverrisson, Editor-in-Chief, Montel

Guests: Ingvild Sørhus, Lead Carbon Analyst, Veyt 

Transcript

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 0:19

Hello listeners and welcome to the Montel Weekly podcast. Bring Your Energy Matters in an informal setting. In today's pod, we discuss carbon markets and the upcoming COP 28 Climate Conference ahead of UN Climate talks. Next week, there are questions whether the conference can deliver results in phasing out fossil fuels and accelerating the transition to a decarbonized world, and what could it mean for carbon markets and the renewables rollout in Europe. Meanwhile, CO2 prices have been on a downward trend and have hit fresh one year lows this week. Could the cop provide impetus to the EU emissions trading scheme, or will bearish factors continue to weigh on the market in the coming weeks and months? Helping me, Richard Sverrisson to address the key issues in Europe's carbon market is our old friend and regular guest, Ingvild Sørhus now Oslo based Veyt. A warm welcome to you in England.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 1:08

Thank you, Richard.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 1:10

Let's start by talking about the COP. What can't we expect there and can it have any bearing on Europe in a sense and the carbon market.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 1:20

I think that's probably dragging a bit too far that it will have an immediate effect, but I think it is an important cop because it's like the first review of the first global stock take. So really going into all the ambitions, see. How much is missing to get us to keeping us below 1.5 degrees? Of course, it's no surprise that the policies and the indices or national determined contribution plans, what's in there now is not sufficient to bring us there, so it's more than. That will form a bit of discussions of where do we need to tighten the measures. And of course, as every cop, it's also important piece will be a lot about financing. So this year will be about operationalizing the climate loss and damage fund, which is of course how to support these countries that is not responsible for the big share of the emissions that has happened in the past, but is suffering quite a lot from the. Climate change that we currently experience and will experience going forward. But it's also the part where financing to move away from fossil fuels move away, implementing the right decisions also in the least developed countries or develop developing world. So of course it's lots about money and of course that's going always to be the big issue, to channel enough money into the different measures. There is coalitions where you ask also to increase the amount of renewables. Worldwide also to reduce fossil fuels and to phase out fossil fuels, or at least to have abated, fossil fuels in the mix. So of course, these issues will be quite key in all cups, for the carbon market. This also discussing article six, which is this missing piece on the, or. How you can do exchange of credits or either between countries, between companies, so bit the old Kyoto mechanism and that is of course, to get those things right is important because of course climate change is a global problem and you can do. As much as you can in your own country, but always comes at the cost. And if you can do these abatement options in other countries at the lower cost, that means you also can increase your own ambition if you can then get funding and get a contribution for that kind of effort. The Article six is important to get Right for countries or eu. It is a mechanism that you can actually use in the future, but then it needs to be foolproof.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 3:48

These sort of carbon credits that you talk about potentially under Article six, they've received quite a bad press. They're still quite controversial. Is that something that will hold them back, do you think? The development of using these for country to country basis,

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 4:01

that's why it's important to get it right, to get it to be a mechanism that country. Can rely on and they can use. So it's getting all these rules, right?'cause I think that was a bit of the problem that we had in the CDM era and also a bit on some of the voluntary, the credits. Is that at least for CDM, then it was, you thought you had a good. A good system and then you discover these loopholes. You were trying to minimize the loopholes as you went through history. And I guess for fair reasons, it was a criticized method in the end as well. There were quite, quite a lot of credits that came to the market that wasn't really emission reductions, or at least that was questionable if there were additional, and of course, this is important if you say that. I fund these abatement options that it is counted in some way and also it's important that it's not double counted. So for instance, that one host country is not iud, the emission reductions in their NDC if the buyer country is doing the same. So of course these issues are quite important to get sold in a good manner because if you have the good mechanism in place, then it's easier for countries to say, okay, we are opening up for. Article six, either country to country or for companies within a specific country.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 5:19

So for those listeners who run, it is a long time ago, but there was the CDM is the clean development mechanism, isn't it? So under, basically under Kyoto protocol. So England, literally the earth is burning. We can see climate change before very eyes. It's hurricanes, it's floods, it's extreme temperatures, and that must surely increase the urgency. At the conference next week for policy makers at the global level to be seen, to be doing something. What's your view here? If we've had so many disappointments over previous conferences, could this be different?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 5:50

I don't know if there will be massive. Could be like on the funding part. We could see. Fast and firm countries are bringing money to the table, but when it comes to targets, we don't expect to see any surprises now, but this is more review of the targets that has already been put in place by the national determined contribution, the target of each country. The whole idea under the Paris Agreement is that you bring to the table what you think your country can do, and then to constantly improve that target until you come to. That you have all the policies in place and all kind of measures in place to hopefully stay below 1.5 degrees.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 6:30

Although we've seen warnings that we're gonna hit three, three degrees soon and stuff, it's all very worrying. But fingers crossed that the cop 28 won't be a cop out. I think that's the big hope here. But let's turn to. Car markets, your specialist subject eng and and especially the EU emissions trading scheme. Now, prices have retreated this year from a record high of just above 101 to a one year low of just before 75 euros a ton. So what, what's going on? What's happening here?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 6:59

Yeah. I think it's why we hit 101 in the first place. I think we were all shocked, like by the crisis last year. Europe was with the energy crisis and the war in Ukraine. And we saw a lot of industry reducing their activities. So emissions in the UTS went down and then after coming out of of the winter, and then you saw the. Energy prices were retracting quite, and gas market was sta coming down from really high levels. And there were some optimism that, like on the economy side of things that were done with the worst. Now it's looking forward, expected to see us increase in, in activity through, across, across Europe. And also just before Christmas, you had the agreement on the FIT for 55. So you knew that the implementation of the FIT for 55 framework, so adjusting the whole ETS directive for the new 2030 target was going to be implemented then from January in 2024. So it was a bit of a optimism around those things. And then. It has been a struggle in Europe this year from industry production numbers, economic indicators, that it's got getting worse and worse and worse. And also we see that's reflected also on the power sector, like demand for power or electricity. So of course we are looking at the year where we see emissions dropping quite, quite a bit. And I would say that prices have been holding up. Quite like surprisingly high throughout summer and then when it first fell below 80, it was quite a lot of these bearish factor that struggle to recover. So now I guess we, lately we've been trading around like 75 to 80, but it's like struggling to, to recover again.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 8:37

You say emissions, you expect them to fall quite strongly this year? To from what to what?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 8:43

Yeah. So for power sector emissions, we see emissions dropping around 20%. For industry sector, we are seeing quite, quite some, a decrease as well. We saw quite, quite a decrease last year. Then especially we saw last year that the chemical sector was hit quite hard. It's declining any further, but it's other sectors that it's taking more the hit. This year, like cement sector decline also in steel, last year we saw an increase in oil and gas, for instance. Now we see a bit of a decrease there as well. So across the board we see a decrease, in industry productivity.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 9:19

But these numbers are huge really in a historic perspective and. If I'm not wrong, there are greater fraud emissions than in the year when we had COVID.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 9:29

Yeah. So that is massive and of course when we got all out of the winter as well, I mean in addition to the biggest impact on power sector emissions is the decrease and in demand. But of course. We, when we went into last winter, we expected gas to be priced out of the power sector mix for most of 2020 three of course coming out of winter. Then gas prices softened quite fast already. Like in end of end of February, beginning of March, we saw that we were in the fuel switching range again. So also less need for soil fuel. Generation, but also switch from more polluting fossil generation to less emission intensive. So that came on top of everything. And then of course, it has been an improved situation. When you talk about France and the nuclear situation last year, it was much focus on the lack of non non emission sources, which, especially with the French nukes and the hydro situation which have been improved throughout this year.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 10:28

Absolutely. These are, but it's generally quite a bearish cocktail at the moment. If we look maybe into the medium and longer term, so by the end of this decade, the end of next, some analysts have said that climate policies should indicate you're tightening the linear reduction factor you are making, putting in place very stringent policies to reduce emissions. Yet they're still struggling to, to get above that a hundred. And some have said we can get to 160 by 2030, maybe 400 by 2040. What's your view in the medium and longer term? Ingvild?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 11:01

Yeah, so I think it's right now it seems like the carbon market is struggling a bit. To look a bit further ahead. It is still about above or around like 75, 80 euros. And of course, without these long term targets, longer term tightness going forward we could probably have seen carbon prices at much lower level. And it's interesting 'cause it has been quite a lot of focus on Repower eu. They're injecting more volumes to the market next year, but it's also that next year will be the first fit for 55 year, which we see quite a lot of the tightening elements implemented already from next year. So maybe like on the balance, we don't see too tight year next year, and maybe not in 20. 20 10, 25, but then it's really tightening up. So starting in 26, but 27 it's going to be a massively tight year. So of course it depends when the market participants are starting to factor that in, because of course then it's no longer repower volumes that will hit the market in 2027. Then it's you used some of the volumes that were supposed to come in member status auction or innovation fund. In 27, 28, 29, and 30, then you start feel the effect of that repower was rejected in 23, 24, 25, and bit of 26. And at the same time, you have this linear reduction factor, which is quite strong. Now year by year it's tightening. And it's going to be much tighter the years ahead. So it's yeah.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 12:32

Sorry to interrupt, but could I just, if you could clarify what those repower Europe, what the, what that is for those who are maybe unfamiliar and what the fit 4 55 measures that that you mentioned there.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 12:42

Yeah. First of all, the Repower EU was the answer from the European Union as a response to the invasion, the Russian invasion in Ukraine. So to how they made a plan on how to win itself. Off Russian gas and quicker or speed up the transition, the green transition, to avoid being that dependent on Russia, especially gas. So that was the big plan. And then of course the funding was some was unused COVID money, the recovery, resilience and recovery fund funding and some. Like it was set the a monetary measure for that the EUTS should contr contribute with. So then 20 billion euros of the funding should come from the sale of allowances. And how they did it was. You said, okay, we'll take part of this volume. That will come from what was supposed to come from member states, auction volumes, and also from the innovation fund. But we're not taking this year's volume or next year's volume. We're borrowing from the future. So then you take these allowances that should have been auctioned at the later, towards the end of this phase, and you will offer them to the market now. To raise this capital.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 13:56

And it's, and at the same time, making the years further out, even tighter, as you mentioned.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 14:00

Yeah. Even tighter. So of course that's, it's not felt as hard now, but looking a bit further ahead. That's also, it would've been difficult anyway. It would've been tight anyway, but that's making it even tighter.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 14:12

But that, that could explain that there's gonna be increased supply in the coming months and certainly next year. Yeah.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 14:19

Yeah. So it's 86.7 million tons that will be added to the auction calendar for repower purposes. It sounds like a big number and it is a big number. But looking at the daily auctions, it's not going to. The German auctions and the Polish auctions will be without, these volumes are going to be considerably lower than what we see currently at the moment. For the common auctions, that's offered in the to the market three times a week. It's only going to be like slightly higher. Than what we currently see. A bit bearish, but it's not I wouldn't say that it's like massively bearish because Yeah, you asked me about the fit for 55 as well. So next year we will see the increase in the linear reduction factor, which is quite big. Big as well. And then we will see also,'cause historically the emissions have been quite much. Below the cap, and now they're trying to adjust the cap to be more in line with actual emissions. And they will do it over two, like two times. So they will do like a first two of rebasing. And so then you will reduce the cap with 90 million tons next year as like the first two off, and then in 2027 you will reduce it. A bit further 27 million tons. So it's these elements as well that is. Yeah.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 15:36

That are, these are significant as well in terms of supply and demand balance, but it's clear that in recent weeks, investment funds have built sort of record net short positions on carbon. In other words, they're heavily biased towards bets that the carbon market will fall further. What do you think this tells us?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 15:55

Yeah, good question. I think I think the whole story for this year has been like. Massively bearish, right. But then also holding up, but now you see it. Yeah. It's testing levels, it's testing new lows breaking below this year's earlier low. So of course the, it's quite bearish momentum. And then every week we see like the commitment of traders are coming out and it's yeah, everyone is looking at the investment fund positions are, they're built even shorter positions. It's more mirroring what we see in the market, I would say. And of course, I. Think this economic outlook as well. For Euro, it's, we're optimistic in the beginning of the year and we know that's going a bit further down the lane. It will be like quite tight for the UTS, so you need to have a carbon price to reflect the abatement cost that is needed. But of course, now we saw recently that the European commissions were downgrading their economic outlook. For, also for next year. So of course it's this uncertainty. Have we hit the bottom and or how low will European industry go before we hit the bottom? So I think there's a bit uncertainty over where we headed into 2024. Are we talking about a similar lower levels? Are we seeing even lower levels for industrials or do we see any recovery? And I think this kind of uncertainty is also a bit playing out in the carbon market.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 17:16

Absolutely. And, major economies are struggling, as you mentioned, industry and certainly German industrial production is falling. And the key question is, can that get back to, to pre COVID levels? Those are the crucial questions here, not just for carbon market, for the bigger macro economic picture as well. But Ingrid what does this mean for your forecasts and your outlook for this year and for next? What, where do you think prices are headed?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 17:41

Yeah. Now currently it seems to stop a bit, at least finding some support around the levels that we saw in last last November. A bit lower. We saw were in October last year, so that, so then we were like 67, bit over 67, around 70. Was staying there for a while before it bounce up again, but I wouldn't expect that we go any further below that. Because of these tightening elements, as you, we have talked about, that will already start being implemented next year. And also we have to remember that we have the market stability reserve that will respond to this year's lower emissions. A bit like we had in, in the COVID year when everything was like plunging and carbon was holding up and that was because, okay, COVID has bearish impact on emissions in the EUTS, but. That will be soaked up eventually by the market stability reserve. So this year's low emissions will be reflected in the total number of allocation in circulations or the official oversupply number that is going to be published by European Commissions and beginning of June and May, beginning of June next year. And of course that will be reflected on the auctions from September, but at least this certainty that. This will be addressed also, the dip in demand will be addressed by the market stability reserve should be a supportive factor.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 19:01

So if I continue on some numbers or a range, Ingvild, do you think?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 19:05

Yeah, you always ask about the tricky questions. I, I think we might be surprised a bit to the upside as well, but that we will go much above 80. I'm not completely certain, but I think round eight-ish,

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 19:24

There's a lot of uncertain factors, of course. And if I could continue to ask about some of the, maybe the fuel drivers here. We've seen, we've had a mild autumn, there's been strong gas supply to Europe coming from Norway and from LNG, the Europe's gas inventories above 99%. We have even had days of net injections beyond 15th and November, something we haven't seen in the past. Decade, but eventually we'll be in the middle of winter. But are we on track to see a lot less coal fire gen generation this winter than previously priced in? And if so, could we see a further slump in demand for an ounces at some point?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 20:02

So the prices currently suggests that it's coal in the money for December and also most of next year. So that's a bit similar picture as we went into winter last year. So looking at the fuel prices and the carbon prices on the forward curb that suggests that it's coal in the mix. Of course there is probably some risk premium for, is it going to be a cold spell? Pricing. So of course if we have another mild winter and we are coming out of winter with healthy gas storages, then of course we could see a switch again and have more gas or gas being in the money over coal. So in that sense, it's, yeah, that could reduce the power sector emissions for next year.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 20:44

And linked to that is do you think we've seen a lot of an increase in geopolitical risk? Of course there's the war in Ukraine, there's also the Middle East crisis. Do you think these have put something of a flaw under fuel prices despite the gloomy macro economic picture that we've talked about?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 21:00

Yeah, definitely. You saw, for instance, how gas prices were jumping on. It has been on news. News, for instance, if we have an outage in the Norwegian productions, you see prices spike when you had like the incident in the between Estonia and Finland. So I think this is the nervousness that we have in the gas market. The geopolitical risk is a big factor that it, I think is factored in for the fuel fuels market. And of course. We are quite reliant on LNG at the moment. They will depend on the whole world, right? Where the demand is at the moment. So yeah, I think definitely like the geopolitical picture is also, yeah, it's risk or priced in.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 21:42

Adds to a massive level of uncertainty in a very already very jittery market, doesn't it? But I think just a final question there, England and coming back to the cop, but talking geopolitics, do you think geopolitics will play a role here? You have, China, us Russia, different parts of the globe. Do you think that could play a role in potentially not reaching or lowering ambition in terms of a deal or agreement if whether it's voluntary or mandatory?

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 22:12

Of course, that's a worry, right? The deal is there already, right? With the Paris agreement. So it's more these upping and increasing ambition. I the pressure is to increase the ambitions year by year, or at least for every global stock date, that it should increase your ambition. You are reliant on corporation to get as deep as you can. Also with also this corporation between. Between countries as well is going to be like crucial to get us there. The less corporation there is, then it's every man for himself and that what can you solve solve by yourself, of course, hopefully. Yeah, there will be a focus also on, on big economies. That is for the good of the economy and the country itself to increase ambition. We wish everyone was speeding up in a much faster pace than they are today.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 23:03

Absolutely. Let's hope that sort of bottom up pressure where people are struggling in this very warm climate that we're getting into, it will make a difference. But Ingvild thank you very much for being a guest on the Montel Weekly podcast as ever.

Ingvild Sørhus, Lead Carbon Analyst, Veyt: 23:16

Thank you for having me.