Rising Carbon Costs Poised to Accelerate Europe's Energy Transition

Sharply higher EU allowance (EUA) carbon prices are bound to accelerate Europe’s energy transition, according to speakers at a webinar hosted by the Intercontinental Exchange (ICE). The Jun. 14 event dealt with the inclusion of shipping in the EU emissions trading system (ETS) for the first time next year — 20 years after the ETS debuted. It also covered the increased climate liabilities of aviation. Airlines have been included in the EU ETS since 2012, but free EUA allocations for airlines are due to be phased out by 2027. The number of available allowances will also be reduced under the EU’s new Fit for 55 legislation. That package of measures to cut EU-wide emissions by 55% from 1990 levels by 2030 finally passed into law Jun. 5.

Much of the focus was on shipping, which enters a fully-formed ETS next year with no experience in trading EUAs and without free allocations to help ease its entry. Crucially for shipowners, international voyages are covered by the scheme, not just intra-EU journeys. Climate finance expert Peter Zaman, a partner at HFW, suggested Brussels had refused to offer the same derogation to international shipping as it had for international aviation because the International Maritime Organization (IMO) has failed to come up with a global equivalent to the International Civil Aviation Organization’s (ICAO) carbon offsetting and reduction scheme for international aviation (Corsia).

Setting the Standard

Aviation stands out as the only global industry to commit to net zero by 2050 and is way ahead of shipping on climate action. That is despite the fact that ICAO and IMO are sister UN organizations with similar industry remits. On Corsia, Zaman warned that the EU could still choose to scrap the exemption for international flights after 2026 if ICAO fails to ramp up its ambition. The derogation had been due to expire at the end of this year but was extended for two more years. Corsia is still voluntary, with mandatory participation not due to start until 2027. The scheme has adopted a watered down 2019-only emissions baseline after Covid-19 grounded global air travel in 2020.

The EU has already scrapped the airline industry’s special EU aviation allocations (EUAAs) for intra-European flights. That means airlines have to compete with other polluting industries for more expensive general EUAs. The ICE exchange has delisted its EUAA contract but is allowing EUAAs to be delivered against its regular EUA instruments. The number of free EUAs available to airlines has already been cut by 25% this year. Half will be available in 2025 and a quarter in 2026, before free allocations are scrapped from 2027. Other greenhouse gases may also be included in the ETS from 2026.
 
As for shipping, any vessel over 5,000 gross tons will be covered by the ETS from Jan. 1, 2024. EUAs will be needed to balance 100% of emissions from intra-EU voyages and 50% of emissions from international voyages. Shippers will have until Mar. 31, 2025 to declare their calendar 2024 emissions and until Sep. 30, 2025 to surrender the equivalent number of EUAs. Non-compliance incurs a fine of €100 per ton plus inflation on top of the cost of the EUA, which would still need to be procured. Maritime compliance is complicated by the fact that vessel charterers are often the polluters, rather than shipowners.

ICE has a keen interest in ETS market developments. More than 95% of all globally traded environmental futures and options, including secondary EUAs and their derivatives, traded on the exchange last year. That involves more than 6 billion tons of carbon credits worth over $1 trillion. ICE also organizes bi-weekly auctions on behalf of the UK government for its post-Brexit equivalent of the ETS. ICE director of utility markets at ICE, George von Waldburg highlighted the UK’s phase out of coal-fired power generation as a major success story for cap and trade carbon pricing. For shipping and aviation, he was keen to promote the exchange as a one-stop shop for hedging ETS liabilities alongside fuel price exposure.

Buying from the secondary EUA market, including ICE EUA futures and options, means shipowners or charterers only need to pay an initial 10% margin and can adjust their positions going forward. That is much cheaper and less risky than paying the full fixed price up front for a primary EUA at auction. Price volatility has also boosted the appeal of trading EUA futures on ICE. But von Waldburg conceded that high EUA costs were making the alternative — cutting emissions in order to reduce EUA exposure — even more attractive. He reckoned most airlines already do their EUA business via financial institutions rather than directly on the exchange.

EUAs are nothing like the cheap nature-based offsets currently getting a bad press in the voluntary carbon market. Under the EU’s cap and trade system, industries essentially pay for the right to pollute: one EUA gives the bearer the right to emit 1 metric ton of CO2. Brussels can set a limit on emissions by controlling the number of EUAs available at auctions. It has been cutting the number of EUAs by 2.2% per year, but under Fit for 55 has accelerated that market tightening to 4.2%/yr. Artificial scarcity and the continued expansion of the scheme are driving up carbon prices. EUAs have risen from as little as €5/ton between 2013-17 to more than €100/ton in February this year. The EU’s Fit for 55 program dictates that 61% fewer allowances will be available by 2030 than in 2005. Without enough EUAs to go around, industries will have no choice but to decarbonize.