From 30 euro cents to 25 euros: the price of a ton of CO₂

From 30 euro cents to 25 euros: the price of a ton of CO₂

Blog
16 May 2019

One of the best performing commodities at the moment is CO₂. At the beginning of 2018, the price of European emission allowances, the right to emit one ton of CO₂, was approximately 8 euros. A year later the price is already 25 euros. Carbon credits, which can be exchanged for emission allowances under certain conditions, have long been traded for less than 30 euro cents. And companies that voluntarily offset their carbon footprint with carbon credits pay prices ranging from less than 1 euro to more than 20 euros per tonne. What is the difference between these tradable tons of CO₂ and why the large differences in price? In this article we try to provide more clarity.

Different types of CO₂ rights

For a better understanding, it is important to first make a distinction between rights to emit CO₂ (emission rights) and rights to claim already reduced CO₂ (carbon credits). In addition, there is a difference between purchasing these rights on a voluntary basis or due to an obligation. It is also good to place this in the context of the international climate agreements that have ultimately laid the foundation for the vibrant trade in greenhouse gases.

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Emission allowances
Following the reports of the Intergovernmental Panel on Climate Change (IPCC), the United Nations Framework Convention on Climate Change (UNFCCC) was established in 1992. The aim of this climate treaty: “to stabilize the concentration of greenhouse gases in the atmosphere to such a level that a dangerous human influence on the climate is prevented”. This treaty has now been signed by 197 countries. Every year, all countries meet at the Conference of the Parties (COP) to discuss progress and ambition on climate change.

The Kyoto Treaty was concluded at the third COP in 1997. The content of this treaty, the Kyoto Protocol, regulates the greenhouse gas emissions of Western industrialized countries, the so-called “Annex I countries”. The treaty ultimately only entered into force in 2005 after a sufficient number of countries had signed and ratified the treaty. All Annex I countries in the treaty have been given emission targets for a first period (2008-2012) and a second period (2013-2020). For the second period, 37 parties have committed themselves: the EU and its 28 member states, Australia, Belarus, Iceland, Kazakhstan, Liechtenstein, Norway, Switzerland and Ukraine. The United States, Canada, Japan, Russia and New Zealand have not made a commitment for the second period and China and India also have no obligation under the Kyoto protocol.

Enforcement of the treaty takes place by allocating emission allowances, Assigned Amount Units (AAUs), for each period. One AAU represents the right to emit 1 tonne of CO₂e (CO₂ or equivalent greenhouse gas) during that period. Part of the protocol is that these rights may be traded, one of the so-called flexible mechanisms. Countries that need fewer AAUs than allocated can sell AAUs to countries that need more to avoid falling short of their Kyoto commitments. Since the start of the second period, this international emissions trading has only been used to a very limited extent. Instead, we see that emissions trading mainly takes place at regional, national or local level.

By far the largest emissions trading system in the world is the European Union Emission Trading System (EU ETS), which has existed since 2005. The EU ETS must ensure that the European Kyoto targets are achieved: a 20% reduction of greenhouse gases in 2020 compared to 1990 levels. The EU ETS regulates the emissions of approximately 11,000 companies in the energy, industry and aviation sectors (45% of total emissions in the EU). For the other sectors, each European country is individually responsible for achieving the climate goals.

Emission allowances within the EU ETS, European Union Allowances (EUAs), are partly allocated to companies. EUAs must be purchased for the part that is emitted more. The total number of allowances will be reduced in phases, which will reduce total emissions. Rights are traded through an auction system and sold to the highest bidder. If a company cannot provide enough rights, a fine will follow.

The idea behind this system is that, through market forces, reduction measures take place where they are most cost-efficient. Because there is supply and demand in emission allowances, CO₂ emissions come at a price. Companies decide for themselves which is cheapest: purchasing allowances or taking emission-reducing measures. We see other such ‘cap and trade’ systems in South Korea, California and Canada, but China and Colombia are also working on the implementation of an ETS and more countries are expected to follow suit.

Fluctuating prices of emission allowances
In the early years of the EU ETS (2005-2008), the price of the EUA was between 20 and 30 euros. Since 2008, when the economic crisis set in, prices have plummeted to below 10 euros. Reduced economic activity created a surplus of emission allowances. Because these rights can be saved, this also had an effect in the years after the crisis. The ETS faced considerable criticism, as the low price of the EUA would not motivate companies enough to emit less CO₂.

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However, in 2018 there has been a reversal in the price of the EUA. The improved economic climate, but especially the removal of a surplus of allowances from the market (market stability reserve) by the EU, has caused a change. Due to the increasing demand for emission allowances and limited supply, we saw a strong increase in the price of the EUA in 2018. In 2019, the price of the EUA even increased to 25 euros and it is expected that it may go towards 40 euros. Factors that will play an important role in this are developments regarding Brexit and specific policy measures with regard to the market stability reserve of the EU ETS.

Carbon credits
Mandatory CO₂ market
In addition to emissions trading, there is another flexible mechanism within the Kyoto Protocol, the Clean Development Mechanism (CDM). Within the CDM, countries with a reduction obligation may achieve part of their target in non-Annex I countries. The idea behind this is that it is often more cost-efficient to achieve reductions in poorer non-industrialized countries. This includes projects in the field of sustainable energy, reforestation, waste processing or energy saving. Every ton of CO₂ emissions avoided within a CDM project results in a Certified Emission Reduction (CER). Within the Kyoto framework, a CER gives the right to claim a realized tonne of CO₂e reduction in a non-Annex I country, as it were, to ‘get the credits for it’.

These carbon credits can be traded just like emission allowances. CERs may be used up to a certain maximum, 2% for most countries, to meet the Kyoto obligations. These credits may also be used instead of EUAs within the EU ETS until 2020, under a number of strict conditions and up to a maximum. When a CER is used, it is canceled in the CDM register (retirement) and can then no longer be traded.

In addition to the CDM, there is also the lesser-known Joint Implementation (JI), this mechanism regulates CO₂ reduction projects in Annex I countries and produces Emission Reduction Units (ERUs). The third type of carbon credits within the Kyoto protocol are Removal Units (RMUs). RMUs arise from CO₂ sequestration in Annex I countries through forest growth or land use change.

Voluntary CO₂ market
CERs are not only used to meet the reduction obligation within the Kyoto protocol, but also for voluntary CO₂ compensation. Buyers are usually companies or other organizations that want to voluntarily mitigate their climate impact, we also call this CO₂ compensation. In addition to Certified Emission Reductions (CERs), which arise from CDM projects, Verified Emission Reductions (VERs) are mainly used in this market. VERs are carbon credits generated by CO₂ compensation projects that are specifically aimed at the voluntary compensation market, also known as ‘voluntary emission reductions’.

Commonly used standards for this are Gold Standard and VCS (Verified Carbon Standard). Commonly used standards for this are Gold Standard and VCS (Verified Carbon Standard). The VCS standard is the most widely used standard and was developed by the World Economic Forum (WEF) and the World Business Council for Sustainable Development (WBCSD) on the basis of an effective standard with limited administrative burdens and criteria, which are comparable to CDM.

Carbon credits prices
Mandatory CO₂ market

CERs have for a long time experienced the same price development as European emission allowances. CERs, like the EUA, went into freefall after the crisis. While the EUA has recovered, it became clear in 2011 that CERs could only be used to a limited extent in phase 3 (2013-2020) of the EU ETS. Because the EU ETS has always been the largest customer of CERs, this created a large surplus, causing prices to plummet further to below 1 euro. Today, CERs are traded in the mandatory market for less than 30 euro cents.

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Voluntary CO₂ market

However, in the voluntary market, very different prices apply for carbon credits, both for VERs and CERs. The reason for this is that VERs are seen to a lesser extent as a commodity. In addition to price, qualitative aspects of a project also play an important role. For example, in addition to CO₂ reduction, a project can also focus on social impact or nature protection. An example of this are clean cooking projects, which, in addition to CO₂ reduction, also have a positive impact on health and poverty reduction. The extent to which buyers are willing to pay for these qualitative aspects plays an important role in determining the price of these credits.

Prices vary from less than 1 euro for large-scale sustainable energy projects, for example, to prices that can go up to 20 euros for small-scale cookstove projects or reforestation. The average price in 2017 was approximately 3 euros, which is more than ten times higher than the market price for CERs.

However, even in the voluntary market, the supply of credits is so high that the price is under pressure. The price of a carbon credit generally does not reflect the true cost of reducing that ton of CO₂. In addition to income from carbon credits, projects are often dependent on other sources of income, such as subsidies or donation money from NGOs or governments. This not only undermines the sustainability of projects, but also the claim that the buyer of the carbon credit is 100% responsible for reducing that ton of CO₂.

Fairtrade International, in collaboration with Gold Standard, has developed the Fairtrade Climate Standard, an add-on to the Gold Standard. Deze vrijwillige standaard stelt een minimumprijs voor carbon credits, gebaseerd op de werkelijke kostprijs van het reduceren van een ton CO₂ binnen een project. The minimum price must guarantee sufficient carbon income for the project to cover the total costs of the project. On top of that, a Fairtrade premium is paid, which is used for social purposes within the local community, such as training in the field of climate adaptation.

Further price development of carbon credits
Not much is expected from the market price of CERs, which is now 23 euro cents. The main reason for this is the enormous supply compared to the demand for CERs. In addition, it appears that CERs may no longer be used in the EU ETS after 2020. Specific types of CERs that meet certain criteria, for example those that are permitted within the Korean ETS, are expected to be traded at higher prices. Contracts are currently being concluded that vary between 4 and 8 euros.

Within the international aviation sector, climate-neutral growth from 2021 is currently being discussed, the ‘Carbon Offsetting and Reduction Scheme for International Aviation’ (CORSIA). If the sector is dependent on carbon credits for this, this would mean a significant increase in demand for both CERs and VERs. However, if all types of carbon credits are allowed, the expected impact on the price is still limited. But the more specific the criteria are for these credits, the higher the impact on the price will be for the credits that meet those criteria.

Another determining factor for carbon credits are the National Determined Contributions (NDCs). The Paris climate agreement stipulates that from 2020 all countries must contribute to reducing greenhouse gases, thus bringing the Kyoto era to an end. The NDC sets out a country’s goals for reducing greenhouse gas emissions and how these reductions will be achieved. If it turns out that emission reductions from compensation projects are counted within the NDC of the country where the project is located, it is no longer possible to sell the emission reductions as carbon credits to foreign buyers. After all, the reductions have already been claimed by the host country, so selling credits would mean double counting of emission reductions. Determining policy decisions include which sectors will be classified as NDC sectors and the options for not counting the reductions from specific projects within the NDC.

Introduction of a possible CO₂ tax could also influence the demand for and price of carbon credits, especially in the voluntary compensation market. The question is whether companies subject to the CO₂ tax will also voluntarily compensate and whether carbon credits may be used up to a certain level as an alternative to a CO₂ tax.

Finally, for the voluntary market, much depends on the awareness of organizations and companies of the impact they have on the climate and the space and willingness there is to do something about it. We see an emergence of more and more companies that strive for climate-neutral or even climate-positive business operations, products and services and the need to contribute to the Sustainable Development Goals (SDGs). For this reason, we expect a continued need for high-quality climate projects that also contribute broadly to sustainable development in the long term.