The European Union’s flagship climate policy instrument, the Emissions Trading Scheme (ETS), needs more oversight and transparency to prevent ‘speculation on speculation’ and restore political confidence in the market, analysts said.

Carbon prices rose sharply last year, hitting €50 a tonne for the first time in May after remaining below €20 for more than a decade.

A record high of nearly €100 was reached in February this year thanks to new EU targets to halve emissions by 2030 and a war-fuelled gas supply crisis. Russia in Ukraine.

This has set off alarm bells in EU capitals, with Madrid calling for trade limits to be put in place on the ETS to prevent CO2 prices from driving up the cost of energy.

These calls were later amplified by Polish Prime Minister Mateusz Morawiecki, who warned that carbon prices were ‘out of control’ and needed to be contained in order to avoid ‘a drastic increase in energy bills’ for ordinary households. .

“We need to break the speculative bubble that has formed around ETS trading,” Morawiecki wrote in an opinion piece published on EURACTIV in January.

ESMA calls for more transparency and control

The European Commission has so far rejected suggestions that speculation is driving up the price of CO2 and referred to a March report by the European Securities and Markets Authority (ESMA) which concluded that the European carbon market was working normally.

“Price movement and volatility are driven primarily by supply and demand dynamics, structural quota declines and rising energy prices,” said Fabrizio Planta, Head of Markets and Reporting. of data to ESMA.

And although investment funds have increased their presence in the European carbon market, “the volumes traded are still relatively small compared to other market players”, he told a recent EURACTIV event, rejecting the idea that speculators had become dominant players on the ETS.

The official, however, acknowledged that “transparency and oversight” could be improved and pointed to suggestions from the ESMA report on how this could be done.

This includes, for example, the extension of controls to derivatives on emission allowances, the modification of position statements on emission allowances, the improvement of the information content of the weekly position reports and the improvement of the transparency and reporting of over-the-counter (OTC) transactions, Planta said.

“So a lot of work in terms of transparency and control is needed,” he said.

Increase confidence

Calls for increased transparency on the EU ETS are backed by Michael Pahle, a leading academic at the Potsdam Institute for Climate Research in Germany.

“The main problem, I believe, is actually ‘speculation on speculation,'” Pahle told EURACTIV in an interview, saying there is currently “no evidence” of speculation leading to an increase in the price. carbon on the ETS.

That said, he agreed with Planta that tighter controls are needed to measure investment flows and quota holdings, and set a point above which they can be considered excessive.

“One of the indicators consists in measuring the quantity of liquidities consumed, ie the number of allowances withdrawn from the market which are no longer available for the regulated entities. If it is only a very small part of the overall market liquidity – currently a few million allowances – no one will have to worry about it. But if at some point it becomes a broader phenomenon, it risks distorting the market. »

“So we need a proper indicator and a threshold to determine when it becomes critical,” he said, adding that this requires new methods to measure the impact of trading as well as improvement in trading. data in the sense suggested by ESMA in its report.

“Monopoly” of information

More fundamentally, Pahle also pointed to an “information monopoly” held by a handful of traders who have disproportionate influence in the market. For example, he pointed to a situation last year where prices rose sharply after an influential London-based hedge fund made vocal statements about future ETS prices.

“It certainly got a lot of attention from other, probably less knowledgeable marketers who may have followed suit,” Pahle explained, saying it underscores that information can play an important role in the driving prices in the market.

To solve this problem, Pahle recommends improving information sharing and transparency between all market participants. “We need a better explanation of what really drives prices,” he said. “And I think that’s really the fundamental problem with the current debate” on price stability, he told the EURACTIV event.

“In a politically created market, we want a clear answer to this question” because everyone must be able to trust the market to achieve the political goals for which it was created, he said. “So trust has to come into the equation. And I think that’s really what we should make a centerpiece of new proposals.

Some European politicians are receptive to calls for greater transparency.

Peter Liese, a German MEP leading ETS reform in the European Parliament, mentioned a recent example where carbon prices rose by 10% following an article published by the financial news agency Bloomberg.

For Liese, “this means that there is speculation” about the ETS. That “nothing should happen is not a satisfying answer for me,” he said.

Complains about volatility

PGE, Poland’s largest energy supplier, has complained loudly about the volatility of the European carbon market.

“The situation is absolutely unpredictable from our perspective,” said Wanda Buk, vice president of regulatory affairs at PGE. “One day the EU ETS allowances cost €90 a tonne, the next day it’s €60,” she told the EURACTIV event, recalling that the cost of CO2 had previously remained around €5 per ton for many years.

“We are in a very, very difficult situation,” she said, complaining that the current high price of carbon credits “affects our daily liquidity” as a business. “For the year 2021 alone, we paid 2 billion euros” of EU ETS allowances, an amount equal to PGE’s revenues (EBITDA) for that year, she underlined.

To study the impact of financial players on the EU carbon market, PGE commissioned a study from a consultancy, Compass Lexecon, which published its report in April.

Fabien Roques, the consultant who oversaw the study, came to the same conclusion as ESMA and found “no hard evidence” that carbon price volatility could be attributed to financial players like investment funds. ‘investment.

However, he said, “certain features of the market itself can potentially foster speculation and have adverse consequences for price stability.”

For example, even though a Market Stability Reserve (MSR) has been introduced to prevent wild swings in carbon prices, “there is inelastic supply in the short term, and that obviously can increase price volatility.”

Roques also flagged “concerns” about volume-based thresholds in the MSR, saying that “this mechanism could in fact, under certain circumstances, have a destabilizing effect on the market and encourage speculation.”

More fundamentally, Roques said the ETS was “politically driven” and based on the “credibility” of EU climate policies and emission reduction commitments. This long-term political uncertainty “can in itself reinforce speculation in the market”, he pointed out.

According to him, it is essential to review the market design of the ETS and to consider “some additional measures to improve the predictability and price stability” of carbon prices. These include better monitoring and market surveillance, as highlighted by ESMA in a recent report.

“And we think it’s a no-regrets option.”

[Edited by Zoran Radosavljevic]