The “trade” part of the cap and trade scheme makes the European Carbon Allowance’s price the result of demand and supply. The cost is not determined by policymakers. Less supply creates scarcity and makes the permit price increase. More demand creates competition and also pushes the prices up.
The first years of the EU ETS were an experimental phase. Regulators decide on the total EUA supply. At the beginning of the existence of the scheme, they have issued more allowances than needed by the market. There has been less CO2 produced (demand) than carbon permits in the economy (supply). This phenomenon has been keeping EUA prices down pretty much until 2019. There was an availability surplus of more than 2bn units by 2013. This is of the same order of magnitude as the yearly allowance cap. On top of the structural oversupply, the financial crisis and promptly reduced activity in 2007-2008 made prices collapse. Industrial output had declined and there was a way lower demand for EUAs as well.
A very powerful market design tool was introduced in 2019. Until then, prices had been broadly oscillating between €0 and €25. After the start of its operation, a gradual increase has brought the cost to swing around €75 and €80 in the past few years. First, this tool allowed for the balancing out of the supply and demand gap. If there were too many EUAs issued, this mechanism would take some back. And vice versa, should there be not enough (and should this undersupply de-stabilize the market), more permits could be re-introduced. On top of this, it provoked a larger interest in the market and more participants. It reassured investors that it is getting more sophisticated and mature.
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9. The price drivers
Multiple factors such as the weather, energy prices, or industrial activity can affect EUA prices.
8. The Legislative Frameworks
The EU ETS is rooted in a legislative framework dating back to the early 1990s.