COMMODITIES 5 minutes to read

European carbon emissions retrace with gas and coal

Ole Hansen

Head of Commodity Strategy, Saxo Bank Group

Summary:  European power prices and the cost of carbon emissions have been pushed sharply lower by a blend of mild weather, abundant gas supply and a weaker economic growth outlook. But a project to create a properly-functioning EU emissions trading market is continuing apace.


The combination of a weaker growth outlook for Europe together with increased availability of natural gas and a short-term outlook for milder weather, has helped send European power prices sharply lower, and with them the cost of carbon emissions. Last week’s 10% declines in the Dutch and UK front month gas contracts were the biggest since March. Lower gas and stable-to-lower coal prices have both helped drive down the price of the ICE ECX carbon emissions futures. Since hitting a peak above €25/tonne on September 14 – following a five-fold increase in the previous 14 months  – it has since corrected by one-third and trades today around €17.5/tonne.

Carbon prices have rallied this year in response to the finalisation of the Market Stability Reserve (MSR) measures. The MSR sets out a mechanism to reduce the surplus of carbon credits that has built up in the EU emissions trading system (ETS) since the financial crisis. The MSR will start on January 1 and during several phases over the coming years allowances will gradually be adjusted to create a proper market which ensures a continued drive towards cleaner sources of energy while the use of coal decreases. 

Speculation about how high the price could go helped create the strong speculative momentum which resulted in a five-fold increase up until September 14. Once the bubble burst the speculative interest began to fade and the price has now returned to the middle of the €15 to €20/tonne range, which seems to be the unofficial target during the first phase of the MSR. The longer-term outlook, however, still points towards higher prices with Goldman Sachs in a recent update lifting their FY 2021 forecast to €35/t from €20/t previously.

Another reason behind the surge and subsequent drop in European gas prices this year has been due to strong competition from Asian buyers. Gas providers from China to Japan and South Korea have all been looking to build stocks ahead of the peak winter demand period. This in order to avoid the tightness and a repeat of what happened last winter when China’s drive to switch users from coal to gas led to a shortfall and surging gas prices. China National Petroleum Corp., the country’s top gas supplier, has injected its storage tanks with record amounts of gas and this has led to some buyers being left with more gas than they can handle, depressing spot prices. 

These developments among others have create a shift in global trade flows with strong volumes of Seaborne Liquified Natural Gas (LNG) flowing into Europe, thereby pushing  stock levels comfortably above the five-year average and the price of gas lower. 

Fundamental relationship between gas and carbon prices


The relationship between coal and gas-powered power production is often expressed through the "clean dark spread" and the "clean spark spread". The dark spread refers to the profit realised by a coal power generator after paying the cost of coal fuel and carbon allowances. Similarly the spark spreads refers to the profits of a gas generator. A weaker dark spread makes coal relatively less attractive than cleaner sources such as natural gas and vice versa. In the current situation where the cost of carbon allowances has dropped by one-third the clean dark spread has nevertheless been falling due to the above-mentioned decline in natural gas prices. The result is that even with these lower carbon prices the expected emissions from the power sector are declining.
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