Rising prices for CO2 emission rights

Rising prices for CO2 emission rights

26 October 2021Reading time: 6 minutes

Climate change, caused in particular by greenhouse gases, is a major concern. One of the most important levers for halting global warming is CO2 emission rights and the trading of related CO2 emission certificates. These grant companies the right to emit one metric ton of CO2 or an equivalent greenhouse gas for each emission certificate. Tighter climate targets and limited quotas for emission allowances have recently been a major price driver for the development of CO2 futures traded on the futures market. There could still be potential here, which could also open up interesting investment opportunities for investors.

Climate change is taking its toll on our world. Weather extremes, drinking water shortages, hunger and the extinction of flora and fauna are just some of the devastating consequences of global warming. Rapid action is needed to halt this trend. Among other things, the Paris Climate Agreement of 2015 agreed to keep global warming below 2 degrees Celsius.
The main cause of climate change is greenhouse gas emissions. To be able to achieve the climate target defined in Paris at all, it is imperative that greenhouse gases are reduced as quickly and as strongly as possible. The goal should be to reduce emissions worldwide to zero by the years between 2045 and 2060.

CO2 emission allowances: what is it?

One means that can help reduce CO2 or similar greenhouse gases is CO2 emission rights or emission certificates - also known as EUAs (European Union Allowances) in Europe. These grant companies the right to emit one metric ton of CO2 or an equivalent greenhouse gas for each emission certificate. In Europe, around half of greenhouse gas emissions are to be regulated by means of such certificates. Companies that belong to particularly energy-intensive sectors, such as energy companies, industrial metal, cement and paper producers - and those that are of a certain size - are included in particular. These companies are not allowed to emit CO2 or other greenhouse gases without the necessary number of CO2 emission certificates.

Cap and trade: emissions trading

Companies that have a greater impact on the environment by emitting or causing more CO2 than they are entitled to through their emission allowances can buy additional emission allowances. More climate-friendly companies that do not use up their quota need fewer emission rights can sell these remaining rights. This is through this mechanism that CO2 emissions get a price. In the EU, the European Commission limits the total amount of emission rights with a cap. The plan is to further reduce this cap from year to year.

The system is known as "cap and trade" and is intended to make a significant contribution to achieving the goals of the Paris climate agreement. This is because the trading of emissions certificates is intended to motivate companies to invest in more climate-friendly production. The more expensive the emission certificates, the greater the incentive to make climate-friendly investments. However, if emission allowances become too expensive, affected EU companies would no longer be competitive compared to their global, unaffected competitors. It would then be feared that these companies would migrate to unregulated foreign countries. Therefore, a certain number of emission allowances are allocated free of charge for precisely this reason. All other allowances are then traded. In addition, the goods of non-affected companies are to be subject to a tariff on imports in the future to ensure greater equality. Other compensatory measures are also conceivable, so it cannot be assumed with certainty that the planned annual limitation of quotas will also lead to a price increase in the trading of emission allowances.

Development of CO2 emission certificates

Just a few years ago, the prices for CO2 emission certificates were considerably lower than today - at around 5 euros per certificate or per ton of CO2. For large corporations, who had to pay this, it was very cheap. As a result, their efforts to keep emissions low were relatively small.
This has changed considerably in the meantime. Climate policy has been tightened considerably and quotas have been reduced more and more. As a result, the prices of emission certificates have risen considerably. This was also necessary in order to be able to achieve the climate target that had been set. In December of last year, for example, the European Union set much more ambitious climate targets: greenhouse gas emissions are to be reduced by 55% by 2030, instead of the previous 40%, compared with 1990. In addition, the annual reductions are likely to be increased even further.

CO2 emission allowances have become considerably more expensive, not least due to political intervention, reaching record levels of over 60 euros in September this year.

With the higher prices, the emission certificates could finally bring about what was expected years ago: energy production from fossil fuels would hardly be worthwhile anymore due to the higher price. As a result, energy production from such energy sources is being cut back more and more, so that alternative energy sources are increasingly being used.

Emissions trading in the EU and Switzerland

Emissions trading in Switzerland and the EU is therefore having some effect, but the potential remains great. It was only last year that Swiss and European emissions trading were linked. Advocates hope that more countries and world regions will join.

How to invest in CO2 emission certificates?

The price development of CO2 emission certificates could also result in interesting investment opportunities for investors. In principle, it is possible to invest in emission rights by means of futures contracts traded on futures exchanges. To enable investors to participate in this price development, Vontobel has issued a range of products on the ICE ECX EUA Future, which tracks the price development of CO2 emission certificates.

The Underlying: ICE ECX EUA Future

The ICE ECX EUA Future is a futures contract on the CO2 emission right traded on the ICE Endex futures exchange, which is part of the Intercontinental Exchange (ICE) and is based in the Netherlands. Futures contracts are agreements to buy or sell an asset (in this case, the CO2 emission right) at a specified price on a specified date in the future. This agreement allows buyers to lock in the price of emitting a specific amount of greenhouse gases (CO2) on a specific date in the future. Due to the expiration dates of the contracts being fixed in advance on a monthly basis, if the position is to be maintained in the market, the position in the expiring futures contract must be regularly switched to a contract with a later expiration date.

Since a future is a forward transaction, the price of the future may differ from the price of the CO2 emission rights to which the future relates. This is the case, for example, if the future is traded on the futures exchange at a premium or discount compared with the CO2 emission rights due to certain market factors which are valued differently in the futures market than in the spot market for the CO2 emission rights.

The future price of an underlying is subject to several political, industrial and sector specific as well as economic factors. Investors should consider these risks when making their investment decisions. Developments can be different at any time than investors anticipated on, which could result in capital losses.

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Vontobel products on ICE ECX EUA Future are tradable at DEGIRO.

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Important legal information:
This information does not constitute a financial analysis, but product advertisement. Thus it does not meet the legal requirements to ensure the impartiality of financial analysis and is not subject to trade prohibition before the publication of a financial analysis.
Fordetailed information, particularly regarding the structure and the risks associated with an investment in the derivative financial instruments, prospective investors should read the Base Prospectus, which is available together with the Final Terms and any supplement to the Base Prospectus in electronic form on the issuer’s website: http://beursproducten.vontobel.com. Additionally, the Base Prospectus, anysupplements to the Base Prospectus and the Final Terms are available inprinted form, free of charge, at the registered office of the issuer: Vontobel Europe AG, Bockenheimer Landstrasse 24, 60323
Frankfurt am Main, Germany.

Investors should consider the applicable selling restrictions.
Companies of the Vontobel group may directly or indirectly pay commissions in varying amounts to third parties (e.g. brokers) in connection with the public offer and the distribution of the derivative financial instruments. Further information is available upon request from your distribution partner. 

18/01/2022 18:11:24