Feeling bullish: Carbon market tipped for continued growth, but challenges remain

Confidence remains high across the global carbon market, but investors want to see governments act to make carbon pricing fairer and more predictable

At least one market is feeling bullish in the face of the myriad economic headwinds that have defined 2022 to date.

According to the latest annual Market Sentiment Survey from the International Emissions Trading Association (IETA), participants in the global carbon market remain confident that the sector will continue growing rapidly as countries double down on climate ambition and corporates step up efforts to deliver on their net zero emission goals.

The survey, which was conducted by PwC UK’s Sustainability and Climate Change team and is based on responses from over 200 IETA members, found that growth is anticipated in both mandatory carbon markets, such as the EU Emissions Trading Scheme (ETS), and the global Voluntary Carbon Market, where developers are striving to meet accelerating corporate demand.

The report details how prices in the EU ETS have more than doubled since the beginning of March 2021 and are now widely expected to reach €100 a tonne by 2030, while prices in other markets have similarly tracked upwards over the past year.

“Europe’s market has shown that carbon markets can be resilient to energy price shocks,” said IETA’s CEO and President Dirk Forrister. “The continued strength of the EU ETS throughout the Ukraine crisis demonstrates that climate ambition can be advanced in a way that reinforces energy security.”

His comments were echoed by Ian Milborrow, a partner at PwC, who said the survey reveals “a bullish sentiment for carbon pricing globally, as price expectations hit record highs across all emission trading schemes surveyed.”

“Carbon pricing initiatives – which already cover over one-fifth of global GHG emissions – represent a critical lever to deliver the emissions reductions required to keep warming to below 1.5C,” he added.

The survey confirmed that market participants are broadly confident that the war in Ukraine will lead to more ambitious decarbonisation policies across Europe, as the EU looks to reduce its reliance on fossil fuels – a trend that is expected to drive EU carbon prices to an average price of almost €100 in the period 2026-30.

However, a majority of sufficient respondents said that the actions being taken by governments and the finalisation of the Glasgow Climate Pact last year are not to put the global economy on track for achieving net zero emissions.

“At COP26, consensus was reached to finalise the Paris Rulebook,” said Milborrow. “However, as the survey shows, stronger, more ambitious national commitments will be required to achieve the goals of the Paris Agreement.”

The survey also revealed that market participants expect to see significant changes to the voluntary carbon markets over the course of the next decade.

Nearly three-quarters of respondents – up from two-thirds in 2021 – expect the market to partition between credits for carbon avoidance or reduction on one side, and carbon removals on the other by 2030.

Respondents were also said to be “cautiously optimism” that recent initiatives to streamline the voluntary carbon markets and enhance quality – such as through the Voluntary Carbon Markets Integrity (VCMI) initiative – will bring greater transparency and standardization to the sector.

“The voluntary carbon market has a critical role to play in directing private finance towards climate mitigation and nature-based projects,” said Milborrow. “Improving the integrity and transparency of the market will be critical to guarantee its credibility and enable action at scale from the private sector.”

Meanwhile, a majority of respondents expressed confidence the Article 6.4 mechanism to better integrate international carbon market schemes would become operational between 2024 and 2025, with another 31 per cent predicting it will start operating between 2026 and 2028.

However, despite the confidence across the market, there is also an awareness that significant policy and economic challenges remain.

The results of the survey come in the same week as the Net Zero Asset Owner Alliance of leading financial firms published a new position pricing paper arguing that carbon must be made “predictable” for businesses and fairer mechanisms for consumers if they are to deliver on their goals without unleashing unintended consequences that could fuel opposition to the net zero transition.

Published ahead of the G7 Leaders’ Summit in Berlin next week, the paper urges policymakers to take steps to ensure a just and equitable net zero transition for consumers, as carbon pricing systems such as ‘climate clubs’ and Carbon Border Adjustment Mechanisms (CBAMs) are implemented.

It warns that blunt or poorly-designed policies could have regressive impacts, such as ‘carbon leakage’ across borders whereby carbon intensive businesses relocate to regions with lower carbon prices, leading to job losses and higher overall emissions, or disproportionately higher costs for lower income earners as carbon tariffs lead to higher prices for some consumer goods.

“The sharp rise in energy prices is putting enormous stress on households and the business sector,” said Günther Thallinger, board member for Allianz SE and chair of the Net-Zero Asset Owner Alliance. “Continued government support and relief is needed to bridge these difficult times. Yet, in addition to better managing the near term, we also need to better position ourselves to avoid this happening again in the future. Accelerating the shift to net zero is essential in This regard. Structural change will need policy incentive, such as carbon pricing. These take time to implement and should not be delayed.”

As such, the report sets out five design principles for carbon pricing schemes, which together can “build momentum for effective carbon pricing.” [and] ratchet up the share of global greenhouse gas emissions that are covered by pricing mechanisms.”

Specifically, the paper argues that best practices for carbon pricing design should include greater international cooperation in the form of ‘climate clubs’ that adopt similar carbon prices or integrated market schemes; effective CBAMs to limit so-called freeriding where countries or businesses ‘offshore’ their emissions to regions with lower carbon prices; pricing systems that have appropriate coverage and ambition; complementary policies such as higher investment in carbon abatement research; and the removal of fossil fuel subsides that counteract carbon prices.

“Carbon pricing is a cost-effective way to incentivise mitigation,” the report argues. “By targeting several sectors at once, carbon pricing provides a broad-based incentive for decarbonisation. This allows firms within the sectors to decide where and when emissions reductions would be the cheapest and easiest, resulting in cost effective decarbonisation when compared to direct regulation.”

But the authors also emphasize the need for continued innovation. “The reduction in emissions resulting from carbon pricing will depend on the availability of alternatives to emission-intensive production inputs and processes and consumption goods and services,” they stress.

Carbon pricing remains a highly effective policy tool for governments looking to decarbonise and it is clear why market participants are feeling bullish, given the continued expansion of regulated carbon markets and the growing corporate demand for offset credits.

But as this week’s reports also highlight, tackling carbon leakage risks without pushing up costs for hard-pressed consumers and businesses remains a major challenge that could yet fuel a backlash against carbon pricing schemes.

There are good reasons why the UK, EU, and US are all now looking at how to introduce CBAMs and broader policies to tackle unfair competition, as their various carbon markets see prices ratchet upwards. But equally, there are good reasons why IETA reckons the US remains not to implement a federal carbon price, despite the expectation that carbon markets will continue to expand and other jurisdictions will launch CBAMs.

Carbon markets could yet help turbocharge decarbonisation efforts over the next decade, as prices continue to rise, or they could serve to trigger a series of trade spats between industrialized and emerging emerging. Or, more likely still, they could deliver a combination of both.

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