Perfect storm in the energy and carbon markets
Energy and carbon market: Temporary shift or structural change?
This year was different in the energy and carbon markets. A host of factors has driven wild price swings: The reopening of the economy after lockdowns triggered a surge in demand which was followed by chaos in numerous supply chains. The last winter was long and cold, and then an extended lull affected wind energy.
Additional factors are at play. A number of extreme weather events, from fires at the US West Coast to floodings in the Ahr valley in Germany, have further increased awareness of climate change as has the UN conference in Glasgow, COP26. With “Fit for 55” the European Commission published new legislation to set the framework for accelerated decarbonisation in the years ahead and get the continent ready for net zero by 2050. Meanwhile financial investors are increasingly focusing on sustainability.
It was against this backdrop that Commerzbank hosted its ninth “Energy & Carbon seminar” on 18 November 2021 – a virtual event due to ongoing COVID-19 restrictions – to offer corporate clients and other interested parties additional insights into market developments as well as drivers of change.
Oil prices are close to multi-year records
The oil price crash of the early days of the pandemic has been more than reversed. Supply remains tight because of restrictions by OPEC. At the same time, shale oil production in the US is only slowly recovering. Producers are under growing pressure to reduce debt as well as emissions. Hence, the market remains undersupplied, but the drawdown of inventories seems to come to an end. This could be an early sign for a relaxation of prices over the course of 2022.
Gas prices are skyrocketing around the world
By contrast, no such relief is noticeable in the gas market. Price swings of up to 500 percent have marked 2021 as a truly unprecedented year for gas. Reduced production volumes in Europe and flat Russian supplies have led to a growing importance of LNG in Europe. Supply disruptions and increased global demand on the back of less wind and hydro (e.g. in Brazil) have exacerbated the situation. As strong demand from East Asia siphoned off LNG supplies and European storage levels were significantly below average, concerns about a cold winter increased and prices reacted.
The new pipeline Nord Stream 2 should bring some relief via additional Russian supply. But with certification in Germany suspended for now, this is unlikely to happen in the short term. Meanwhile, the debate whether Russia is not able to increase deliveries as demand is strong at home or if the country is intentionally restricting supplies to keep up the price is ongoing.
"We are in the very beginning of a transformation from an old, conventional, fossil world into a ‘Paris world’, a low-carbon economy where renewables have to dominate. A significant increase in transition-related investing is required” , said Ingo Ramming, Head of Corporate and Investor Solutions at Commerzbank.
UN Climate Change Conference 2021: New coalitions of the willing
The Glasgow Climate Pact has been agreed. It has kept the 1.5 degrees alive, but it will only survive if promises are kept, and commitments translate into rapid action. If all pledges were to be implemented, the global temperature increase should be capped at 1.8°C, rather than the earlier 2.7°C.
New coalitions of the willing have stepped forward, the pacts to end deforestation and the leakage of methane being just two examples. These initiatives should be just as important drivers of change as the decision of individual countries, South Africa being one of them, to do whatever they can to phase out coal within their borders.
Another one of the significant changes is the growing importance of the private sector. “ESG and sustainability have moved from niche to mainstream and are becoming key factors of corporate strategies. One of the big differences over the last years is that the private sector is no longer waiting for governments to define the rules but is actively driving change”, said Ramming
EU Emissions Trading System: Evolution or revolution?
As an intermediate step towards climate neutrality by 2050, the EU has raised its 2030 climate ambition, committing to cutting greenhouse gas emissions by at least 55 percent until then. In July the European Commission published the legislative proposal for the “fit for 55-package” to revise its climate legislation and align it with ambitions for 2030 and 2050 respectively.
With a tighter cap, free allocation of emission allowances to industry within the Emissions Trading System (ETS) will be reduced. Reduced free allocation and high carbon prices impact the competitiveness of industry as long as there is no global carbon price.
The Carbon Border Adjustment Mechanism (CBAM) is designed to tackle this issue as it puts a price on carbon for goods imported into the EU. Challenges in the discussion with the EU’s key trading partners are clear and diplomatic skills will be key to avoid major disruptions. Still, done well, the CBAM could be a catalyst for global carbon pricing.
Beside concerns about cost and competitiveness, strategic investments in low-carbon technologies are required to cut industrial emissions and avoid carbon-lock in.
Because of the long-term nature of sites and facilities in many industries like steel, cement or chemicals , technological development is needed urgently. Any reinvestment in production capacity in the coming years will determine emissions for years ahead, all the way to 2050.
Contracts for difference (CFD) could be one tool to support the financial needs of a switch to new, greener technologies. CFDs can incentivise investments by providing developers of projects with high upfront costs direct protection from volatile wholesale prices.
Besides strengthening the EU ETS, policy makers aim to extend the carbon price signal into other sectors like transport. Here, the European Commission suggested establishing a separate ETS for transport and buildings.
Such new initiatives, the impact of renewed growth plus factors not yet foreseen will surely bring new surprises in 2022. One thing seems certain: It’s interesting times ahead for energy and carbon.
As of November 2021