The Factors Influencing Carbon Prices on the European Market

‍The price of a tonne of carbon on the European market (EU ETS) has increased by an average of 32.4% per year over the last ten years. This asset, now considered a central lever for sustainable finance, is characterized by high short-term volatility. Its value depends on numerous factors such as energy prices, weather conditions, and implemented policies.‍The evolution of carbon prices since the creation of the European Union Emissions Trading System (EU ETS) reveals that initially, CO2 prices were extremely low due to an excess supply of carbon allowances. Added to this was a significant reduction in economic activity with the subprime financial crisis. On the European market, CO2 prices were then close to zero. But with the economic recovery, regulators introduced market stabilization mechanisms, and allowance prices began to grow gradually starting in 2018.‍But why is a certain stability in carbon prices observed, with a downward trend, particularly in 2024? What have been the main evolutions of the price of a tonne of carbon on the European market so far? What are the price forecasts for 2025?‍Homaio answers all your questions concerning the carbon price in 2024, as 2025 approaches.

Key Determining Factors for the Price of a Tonne of CO2 in Europe

The price of carbon in the European Union (EU) depends on several key factors, notably energy markets, demand for carbon allowances, weather conditions, decarbonization policies, and macroeconomic developments.

Energy Markets and the EU ETS

‍Greenhouse gas (GHG) emissions from the energy sectors are regulated by the EU ETS, which encourages companies to seek less polluting energy solutions.‍Companies' energy choices directly influence the demand for allowances and, therefore, prices.

Demand for Carbon Allowances and Fossil Fuel Consumption Levels

‍Companies are increasingly looking to reduce their carbon emissions to comply with regulations and meet growing demands for impact investment or ecological investment.‍A significant portion of carbon allowance purchases therefore meets compliance needs: industries in France and Europe have the legal obligation to acquire allowances in a quantity equivalent to their carbon emissions. The greater the consumption of coal, gas, or oil for a company, the higher the volumes of CO2 emitted, and the greater the quantity of allowances needed.‍Carbon emission levels depend on the type of energy used for industrial production or electricity. For example, using coal generates more carbon than using gas. Therefore, a larger quantity of allowances will be required due to coal's higher carbon footprint.

Carbon and Energy Prices

‍The price levels of carbon allowances depend on demand, which results from industrial players' choices regarding primary energy sources. These choices are made based on price levels and the most advantageous sources. This is how carbon allowance prices end up being strongly influenced by price levels in these energy markets.‍For example, if gas prices decrease relative to coal prices, power plants will prioritize gas, which has a lower carbon intensity for production, and will have a lower need to purchase carbon permits. Thus, when gas prices fall, EUA (European Union Allowances) prices also decrease.

Industry Influence on Carbon Prices in the EU ETS

‍Today, European industries face challenges related to adapting to climate change, which encourages them to invest in low-carbon technologies. Industrial decisions in France, in response to EU regulations, heavily influence the demand for allowances on the market.‍Industrial activities generally emit CO2. An increase in CO2 levels translates into an increased demand for carbon allowances.‍Logically, this increase contributes to rising prices on the CO2 market in Europe. Consequently, during periods of economic boom and increased industrial activity, an upward trend in CO2 allowance prices is observed.‍Some companies do not hesitate to implement an internal carbon price to anticipate future regulations and integrate environment-related costs into their investment decisions.

The Cost of Decarbonization Technologies

‍Industrial players concerned about meeting ESG criteria face the following choice: invest in decarbonization technologies or continue to produce CO2 and purchase carbon allowances to offset emissions.‍If effective and relatively cheaper decarbonization technologies become available, industries adopt them, thus reducing their need for EUAs (emission allowances). Demand for allowances then decreases and impacts the price of CO2 on European markets downwards.

Weather Conditions and Carbon Price Fluctuations

‍With the arrival of cold weather in winter, energy and heating consumption increases significantly. This leads to a rise in Greenhouse Gases (GHG) and, consequently, a peak in demand for CO2 emission allowances. Therefore, during cold periods, increased EUA purchases can drive up their price.‍Conversely, warmer weather tends to reduce CO2 emissions and allowance demand, which can lead to a drop in CO2 prices on the market. In summer, the opposite effect is observed: during heatwaves, building air conditioning consumes more, pushing prices higher.

EU Climate Ambitions and Impacts

‍The European Union's climate objectives influence the price of allowances to protect the environment. On the other hand, decarbonization policies led by European regulators determine the quantity of carbon allowances issued and the pace of their reduction.

Necessity of High Carbon Prices to Meet EU Climate Targets

‍Carbon markets (EU ETS) constitute the main political instrument for combating climate change: they are designed to achieve the climate goals set by the European Commission.‍The implementation of a carbon pricing mechanism aims to achieve these objectives: each company is thus encouraged to adopt practices that respect the environment and climate as part of its development.‍Authorities would fail in their decarbonization mission if the price of EUAs was not able to incentivize industrial players to change their behavior. In some countries, a carbon tax is used to encourage companies to reduce their GHG emissions.

European Regulators Reduce EUA Supply to Increase Prices

‍Since carbon allowances are exclusively issued by the European Commission, the European political climate ambition plays a crucial role. By having the capacity to decide the volumes of EUAs injected into the markets, authorities can impact the speed at which emitted quantities decrease.‍The faster the EU wants the economy to decarbonize, the more it accelerates the decrease in allowance supply, thereby increasing prices in the interest of the climate. According to the simplest macroeconomic concepts, price levels increase as supply decreases.

Implementation of CBAM

‍The Carbon Border Adjustment Mechanism (CBAM), which entered into force in its transitional phase in 2023, is a European measure designed to combat carbon leakage. This phenomenon occurs when companies relocate to countries with less strict environmental regulations to avoid the high costs associated with carbon emissions in the EU.‍CBAM aims to remedy this problem by imposing a charge on certain imports from non-EU countries. Particularly affected sectors include steel, cement, aluminum, fertilizers, and electricity. By integrating these imports into the EU ETS, CBAM ensures that imported products are subject to the same carbon pricing rules as those produced within the EU.‍The implementation of CBAM, mandatory from 2026, could lead to an increase in carbon prices as companies will have to integrate environmental costs into their supply chains. In the long term, this will strengthen the transition to a decarbonized economy by encouraging external countries to improve their environmental standards.

Price of a Tonne of Carbon on the European Market: What Evolutions So Far?

‍The evolution of the price of a tonne of carbon since the creation of the EU ETS has been marked by significant fluctuations, initially being low. Discover the main stages that have influenced the carbon market until today, in 2024.

Initially Low Carbon Prices

‍At the beginning of the EU ETS, carbon prices were extremely low due to a surplus of allowances, aggravated by the financial crisis. Let's look in more detail at the causes of this oversupply, particularly the excess supply and low demand, as well as the consequences for the European carbon market.

Structural Surplus of Allowances and Its Effects

‍During the first three phases of the EU ETS (from 2005 to 2020), the focus was primarily on regulatory aspects. Political authorities injected volumes of EUAs corresponding to the quantities of GHG emitted in the past by the economy.‍However, a problem of excessive supply arose, as the commission issued more allowances than the market ultimately needed.‍The resulting excess of supply over demand led to a drop in prices on the carbon market. Prices remained below €30 at that time.

A Problem Accentuated by the Financial Crisis

‍In addition to the excess supply of allowances, macroeconomic conditions played a significant role in the drop in allowance prices during the early phases of the EU ETS.‍The financial crisis of 2007-2008 reduced economic activity, which resulted in a decrease in industrial production, energy use, and CO2 emission levels. This drop in demand for EUAs contributed to a consequent price fall, which remained close to zero for a long time.

Revisions and Improvements to the European Emissions Trading System

‍The EU ETS has been revised several times to better regulate the carbon market and correct imbalances between supply and demand. Key reforms, such as the introduction of the Market Stability Reserve, have helped stabilize carbon prices and strengthen the resilience of the EU ETS.

A More Balanced EU ETS Market

‍Regulators implemented carbon market control mechanisms to address the imbalance between supply and demand. These mechanisms helped reduce the excess supply and initiate a recovery in European market CO2 prices.‍The introduction of the Market Stability Reserve (MSR) allowed them to withdraw allowances from the market when needed, thereby providing a mechanism to tighten supply a posteriori (after initial issuance) and stabilize carbon prices.‍Stabilization mechanisms aim to strengthen market resilience while having a positive impact on the environment.

A More Sophisticated EU ETS Market

‍After 2018, emission allowances were designated as financial instruments under the MiFID 2 regulation.‍This led to increased market participation by various financial representatives, including hedge and investment funds, resulting in improved liquidity in the EU ETS.‍The diversity of investment objectives of these participants contributed to greater carbon market stability from a financial perspective.

Rising Price of a Tonne of Carbon

‍After 2020, the prices of emission allowances (EUA) experienced a constant upward trend worldwide, due to the factors mentioned above.‍They remained at levels close to €80 between 2021 and 2023, before experiencing a slight drop at the end of the year.

Carbon Prices on the European Market in 2024

EU ETS: A Downward Start to 2024

‍In 2024, the carbon price in the European EU ETS market was marked by several determining factors. At the beginning of the year, prices stagnated around €65 per tonne, mainly due to a drop in industrial demand following a mild winter. Furthermore, the reduction in GHG emissions in certain industrial sectors helped maintain downward pressure on carbon allowance prices.‍Moreover, gas price fluctuations have a direct impact on EUA demand, because when the price of gas decreases, industries turn to less emitting alternatives, which reduces the demand for EUAs.‍However, as the year progresses, the situation seems to be reversing. Indeed, the integration of the shipping sector into the EU ETS from 2024 contributes to increasing the demand for carbon allowances, which should push prices towards €80 per tonne by the end of the year.‍It should be noted that fluctuations in carbon allowance prices in France depend on energy policies and industrial demand.

What are the EU ETS Price Forecasts for 2025?

‍For 2025, carbon price forecasts indicate an upward trend. Analysts predict an increase of 7 to 9%, with prices ranging between €93 and €109 per tonne.‍All of this is explained by the acceleration of decarbonization in sectors such as industry and transport, as well as the progressive reduction in the supply of allowances issued by the European Commission, which aims to achieve the climate neutrality objectives set for 2050.‍Furthermore, in the event of an energy crisis, it is not impossible for EUA prices to increase to more than €150 by 2030.

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