Initially, the EU ETS faced low carbon allowance prices due to oversupply from overestimated emissions caps, the 2008 financial crisis, and the use of cheaper international credits. This structural oversupply kept prices low for a long period, but adjustments have since tightened the market for carbon allowances/carbon exchange.
Before 2018, European Union Allowances (EUA) prices remained low, rarely exceeding €20 and often staying in single digits territory. Initially, the way of issuing allowances, combined with the macroeconomic environment, led to an oversupplied European Union Emissions Trading Scheme (EU ETS) market.
The initial setting of the cap
In the first phases of the EU ETS, the emissions cap was set based on individual estimates provided by each member state about their expected “carbon needs”. These estimates were summed to set the total cap for the EU. However, this method led to an over-allocation of allowances, meaning that installations were offered a higher EUA budget than they actually needed. As a result, the market was flooded with excess allowances from the very beginning.
Impact of the Financial Crisis
The 2008 Global Financial Crisis further exacerbated the oversupply problem. Economic activity slowed significantly, leading to reduced industrial production and, consequently, lower emissions. With emissions falling, the demand for EUAs plummeted. A carbon budget that was already higher than the demand levels faced an even greater decrease in demand for allowances. This drop drove the price of EUAs to levels around €5, where it stagnated for nearly a decade.
The regulatory - voluntary carbon markets mix
Another factor of the initially low prices was allowing for international voluntary credits (such as Certified Emissions Reductions (CERs) issued by the UN) to be used for EU ETS compliance. These credits could be used in place of EUAs, in fact increasing the supply of compliance allowances further. CERs were often cheaper than EUAs, trading well below €5 and sometimes as low as €0.20. The availability of these inexpensive alternatives reduced the demand for EUAs, compounding the problem of oversupply and keeping prices low.
Structural oversupply and accumulation
The combination of those factors made the EU ETS experience a long period of structural oversupply, with a large number of EUAs building up in the market. Even during Phase II (2008-2012) and Phase III (2013-2020), when regulatory changes were made to better match the cap with actual emissions, the surplus continued. By the end of Phase II, there were about 2 billion unused EUAs. Despite efforts to reduce the cap and improve market operations, the large excess of allowances kept prices low.
The EU ETS is a pioneering mechanism, and the initial phases were a learning period for both regulators and installations - they were adapting to the new reality of carbon becoming the tradable commodity of tomorrow. The early years of the scheme were characterized by a structural oversupply, but this issue has since been addressed, leading to the increasingly tighter market we have today.
Do you like this article?
Share it with your network and introduce Homaio to those interested in impact investing!
By clicking “Accept”, you agree to the storing of cookies on your device to enhance site navigation, analyze site usage, and assist in our marketing efforts. View our Privacy Policy for more information.
.avif)
.avif)
.avif)
.avif)
