Hi, I'm Dana Perkins and you're listening to Switched on the b n e F podcast. Today Mark Taylor and I speak with Jan Olsen, who's the head of European Carbon Research. We talked to Jan about the EU Emissions Trading System or EU e t S and his most recent market outlook, where he tells us how and when carbon prices are likely to go over one hundred euros per metric ton from the under fifty euro price they
are today. We've not done a podcast about the EU e t S or the u K e t S for that matter, so this is going to serve as a bit of a primer. We're going to define a few things, explain how these markets work, and in other words, if you are a carbon trader, you likely already know this stuff, but for the rest of us, it's important we understand this unique mechanism for driving decarbonization. For those who want to know more, check out the one EU e t S market outlook or our primer on the
UK Emissions Trading System. These can be found on the Bloomberg terminal at b NF Go or on BNF dot com or a mobile app. As a reminder, b and F does not provide investment of strategy advit. So we've got the full benef disclaimer at the end of the show. And now let's get started by speaking with Johan Olsen about the EU e t S. Jan thanks for joining
us today. We are here to talk about the EU Emissions Trading scheme and what looks like will be a rocket ship sort of price increases over the next couple of years. So let's start. Will you first explain to all of us what the EU e t S is. Absolutely first, just let me say thank you for inviting me here. It's a pleasure to be here. Now, the EU e t S is a cup and trade emission market and us a name might suggest, coup and trate
us two parts to it. The first part is is the cup in this case the use of the cap on the maximum amount of emissions that can be omitted by European industry dot cup will decline every year. The EU done distribute allowances either by auctions or they hand them out for free. Too hard to upbate industries. And you need one allowance for each ton of CEO to you emit, So an allowance is an European emissions allowance. The capticizes how many emissions allowances are supplied every year
to the market. And the second part of the system is trade. Now companies, after they've got their initial allocation and auctions have taken place, companies can freely trade allowances between each other. And the idea is that companies with the expensive options to reduce emissions can buy allowances from companies with cheaper form of emission reductions available to them, and that way you have a market based mechanisms that hopefully will drive the cheapest form of emission reductions in
the system as a hope. So these EU ways, which is what the cool kids call them, are looking to drive down emissions. Now how much are they looking to reduce emissions by and what year kind of what's the objective here? So that's a little bit unclear right now. The system is set up for the EU emissions target by which is a thought for target by twenty thirty and the U T S sectors will then have to reduce emissions by forty three percent compared to two thousand
and five levels. Now we know the European Green Deal is taking place and that the updated emissions target for for the EU as a whole will be fifty by twenty thirty instead of the four percent that it currently is. It is not yet clear how that will impact EU d S sectors. Because the S sectors only covers about, let's say, just under half of emissions in the EU, we expect U d S sectors to have to carry
more of the burden of this additional ambition. So when we run our models, we say that the cup for e U D U d S or the emissions targets will be a sixty three reduction in emissions compared to two thousand and five levels, and then the rest of the burden will have to carded by non e T S sectors such as transport or agriculture. Who's covered right now? Can you describe some of the EU E T S sectors? So it's essentially all heavy manufacturing industry, so things like cement, steel, aluminium,
petrochemicals and that kind of thing. And in addition, power generations and intra regional aviation is covered, you know, and I understand how the policymakers fit into this. You know, they're trying to reduce carbon emissions in the EU and understand how the covered sectors play in as well. You know, they're on the hook for reducing their emissions or you know, buying credits or excuse me, eu A S to cover those emissions. But how does the financial sector work under
the eu T S. It's different. Well, different financial actors act differently in the market for obvious reasons. First, I would say that most trading within the cover market happens within derivatives, so that these futures or options. Financial institutions like how UCH funds, banks, day traders, whatever it may be, have can trade these derivatives on exchanges like ICE or e X. And there are a lot of smart people within the financial sectors, particularly if you think about energy trading.
Tusks are really active within the carbon market, and what they will do depends on what kind of time horizon they operate in. So you have anything from day traders who just look at their little latility that might even just look at technicals rather than the technical analysis rather than fundamental analysis in an attempt to you know, buy
the dip and sell the top, as it were. You don't have institutions with longer horizon maybe a year, maybe two years, who have a fundamental view and where they think the price will move in general over the next year or so. And finally you might have institutional investors who will buy some EUA s or futures and look them, put them in a cupboard. They put them in a cupboard for four to five years and then see where the prices and when that time comes. Traders are much
maligned in the market. So lately we've heard that there's been a lot of traders entering the market, particularly investment funds, and that has brought a lot of extra demand, which has driven the price up, maybe higher than some people have predicted. So it drives the price up but also potentially makes it harder for companies that are you know, the coverage sectors to get their hands on euays. Is
that right, Yeah, that's's exactly correct. It is a fair point in a way that these financial investors are pushing the price up, but you have to remember that they also play a really important role as market makers and
enhancing liquidity on the market. So so price formation becomes becomes better, and we have a let's say, a live market rather than a market with trades you know, every thirty minutes or so, so you know, they they're all that they play you could criticize it for or distorting the market, but at the same time it is important
to have them there. It would seem that the policymakers would love it that they would drive up the price and make it harder to get the EU A S and therefore force well at least in encourage emitters to find other ways to reduce emissions. Well, if your end goal is emissions, but of course you could just put the cap down. Policy makers do support financial activity within
the market. That being said, there are talks around holding limits for financial institutions as we have more and more funds joining and it could actually look like financials will become the dominant actor within the market. So there's a balance there and and you also have to think about the political side. But in the EU it is clear to to people in the European Commission and the European Parliament that we will need a much higher carbon price by the end of the de kid for you to
reach its ambitious emission reduction targets. That being said, it's not just about you know, knowing that we have to get to a certain level. It is also about how fast we get. If you say a hundred and ten europer ton carbon price in thirties politically acceptable. That might not be the case for a hundred and ten euros
per ton this year. So yes, the Eupean Commissioners or the the EU is happy for the financials to play in this market and to provide this extra liquidity, but there's also a limit to how how the price can go before we'll get a lot of lobbying from industrial interest groups or EU member states that might not necessarily support the carbon market as much as Western countries do. So let's talk about that price and what is it as of recording today? What is the price right now?
The last time I checked it was something along the lines of fifty one euros per ton. We've had an all time high earlier fifty six euros per ton, So that is quite a dramatic increase from the twenty to thirty weeks so last year and certainly the five euros in tw seventeen. And you know that's yeah, that that's been driven by reform within the Euse of the EUTS has been reformed several times over the last few years,
and that's striving the price of well. And you do this market outlook periodically where you look at what the price could be in the future, and you have a pretty good view on when you think we could reach a hundred euros per time? So when is that? And you know why has that timeline looked like it's gotten so much shorter. The main reason why the timeline has got so much shorter is this updated emission reduction target
for twenty thirties. That will mean a a reformed that would have to literal reform of the U T S that will tighten the cap going into we can generally split our forecast down in into three periods at the moment, so the next few years, we still think fuel switching will be the dominant so of emission reductions, and to have sufficient field switching take place, we'll need a current price around where we are now, so anywhere between the fourties and sixties really, Then as we moved to the
mid twenties, field switching will no longer be enough, and also there won't be as much field switching available as called plants close down, and that will lead to a period where renewables will dominate the emission reduction sort of picture. If you will renewables, I mean renewables that are on top of national targets, so we know there's going to be a lot of renewable auctions taking place in different
EU member states. Well, we think also think that we're going to need some much and renewable so that is renewables that are only supported by a power purchase agreement or just placed on the spot market itself. And then as we get pasted towards the end of the decade, we're going to need to see industrial decorbanization and that's think we've never really seen in the e U t S or really any industrial sectors. So it is unclear
how that will play out. But the two most likely technologies that will be used as we see it now is either hydrogen or CCS or a mixture of the two.
And to make those technologies competitive against the more traditional methodologies of manufacturing steel, cement and that kind of thing, you're going to need a price around a hundred years per ton, and that is how we get to our forecast of above eight euros per ton by and it's just going to be gradual or do you think we're going to see a lot of volatility between now and then? We are going to see volatility. The ut is is
a volatile market by its very nature. If you look at other energy commodities and compared volatility to carbon, then then carbon is is always higher. And and that is because it's it's an entirely political market. And say, you know, it's not a let's say, real commodity market. There's no storage of carbon per se, like you have a gas storage and and that kind of thing. So that closet
we put them in, it's it's a metaphorical closet. Yes, exactly, exactly, So so yeah, I mean it is going to be volatile. It's not going to be an easy right, and the e U ty has cannot do it in a vacuum. It needs supporting policies like support for hydrogen projects that we are now seeing being announced in different EU member states.
We know that there are large commercial scale hydrogen projects within the EU plan to go operational in in around and then gradually ramp up the full capacity by twenty thirty. So it is happening, and of course it will be if you look at the general trajectory, it will be gradual. But if you look at you know, whatever could happen within a year, it would I wouldn't be surprised to see spikes of twenty euros or or or of twenty euros.
Now for a very short break, stay with us. So as we talk about price, one of the options while dealing with the carbon prices is something called fuel switching. Before we get into the you know how the price plays out, can you explain fuel switching and how companies go about it. Fuel switching has been the dominant form of emission reductions within the e U t S in the past couple of years. What that means is some
markets have an over capacity within their power market. Coal is generally the cheapest fuel you can use to or call or lignite is generally the cheapest form of fuel you can use to to generate power, but they are really emissions intensive. Gas is more expensive but only have
around half of the emissions intensity of coal. So in those markets where we have excess capacity within the power market and we have both coal and gas plants, what will happen is for the carbon market to balance, there will be a a need for some of those gas plants to take over a lot of the generation from some of those cold plants. No, as the carbon price goes up, it will become more expensive to produce power both by coal and by gas, but because coal's emissions
intensity is higher, that will be affected more. And at some point, when the carbon price gets high enough, it becomes economically cheaper to produce power with gas than cold. So you get this dynamic where gas used to be a more expensive option, but because of the carbon price, it becomes a cheaper option than cold. Dana, I don't know about you, but I'm just really encouraged by this. It just seems like, you know, maybe I'm naive, but
it seems like e U e t S works. It's pulling carbon out of the air, right, I think he's In the report it said something like a hundred and fifty eight million tons so far. I want to say, um, and honest way to I think it's a two. I'm not sure, but anyway, it seems that as the price goes up, you know, when it's low, you just pay
for it. When it goes a bit higher, you do fuel switching, then you do renewables, and then it makes sense to suck the CEO two right out of your process, your industrial process, and then add more sectors to it. And that is why later in the show, we're also going to talk about the UK emissions Trading scheme because even though they brexited the European Union, they want to
keep the emissions trading part. It works, it works, or at least it's it's working until now, and it's important to keep keep in mind that the U t has can't work alone. It needs supporting policy around it to to drive the price of nascent Decomganization technologies don't, particularly in the R and D phase or the pilot phase
of a new technology. So it does work in the sense that it can drive fuel switching, and it can also to to some degree, will drive renewable spuild We haven't seen industriallycomganization yet, so we don't exactly know if it will function when we get to that stage, but we believe it will because we're already seeing these hydrogen projects coming online, and then we talk to companies, they say it is because they expect the carbon price to
go up. The really important thing to keep in mind is that the fifty euros or sixty euros price we have now, it's an important signal two industrial companies that the market is a has to be taken seriously now. So it's an investment signal now to prepare for the future. If the price was twenty years per twn this year, that signal wouldn't be as strong. And if we think about the investment cycle for these big industrial companies, we
are typically talking anywhere between five and fifteen years. So if we want to decarbonize heavy manufacturing industry within the EU by thirty that investment decision has to happen today, and that is why the high price today is such an important signal for industrial lead companization in the future.
Time to get cracking, exactly, we're already too late. They should really have started yesterday, but we are where we are, and the best place to you know what, to say that, the best place to start this is yesterday, and failing that, let's start today. So you mentioned reducing the cost of nascent carbon reduction technologies. I remember, you know, I used to be a CCS analyst about a decade ago, and one of the ideas back then at least, was that they would use the proceeds for EU A s that
were just you know, purchased to fund demonstration plants. Is that still the idea or what are the proceeds being used for that is still the idea. So we have this innovation fund that will support CCS projects and hydrogen projects and the like and so um. One of the advantages with the CCS is that you will get support from the innovation fund and from other sources, but you will also help a company avoid the high cost of
emitting seal two. So you have essentially two income streams where if you are a company focusing purely on CCS, you could charge your customers, as it were, a price that is slightly lower than the eu A price, and then they can then sell their own eu A s to other companies and make a profit. So you have a not recharge opportunity there. But that is only possible with support, as CCS is quite expensive still, so you
just need a price that supports it. You need a price that that supports it, and you need, like I said, support for pilot projects and underlike the encouraging thing that we're seeing. Now let's talk about industrial clusters. So the idea is that rather than having so a few megaprojects supporting the whole of EU, we start with some smaller projects, putting large industrial clusters, for example in the south of Germany.
That way, you don't have to build a massive amount of infrastructure to put these projects into place, whether that be CCS or high rogen. So, since I think we have probably a few people listening today who aren't super knowledgeable on the emissions trading schemes, both in the UK and the EU, where else in the world are these if this is an effective mechanism, have any other countries or I'm going to lead on this one states that
have U S states who have looked at doing something similar. Absolutely, so there are, like you said, in the United States, we have the California Quebec emissions trading systems and the and Reggie the Regional Greenhouse Gas Initiative. So we also know that Washington State will start a emissions trading system. I think by twenty twenty three we have an emission trading system in China for the power sector and several
regional systems for industrial sectors in China as well. Then we have trading systems in Korea, Kazakhstan, New Zealand, and I'm sure I forgot some on the horizon. We also have these. Kenya has recently announced an emission trading system, and so has Ukraine. So it is popping up several places that there are already several, but there are more. Comic do you expect them to link? No, I don't expect them to link. We know that the one linkage we've had within the EU is the EU and the
Swiss eas linking. They were really close and designed to each other, so all of the designed parameters were broadly similar, and it still took ten years to link those two markets. So it's it's it's a it's a difficult one, but but the other one, the u K e T S will likely link with the e U t S. But other than that, these broad international or a cross continental links are far away in the future. Hopefully we'll see them, but I wouldn't expect to see them within the next
five years. I love how Jan said no when you asked him if they're going to link. He's like, no, are you crazy? You could hear in his voice like obviously not. I just I just remember the what California and Quebec capitrats linked, right, Yes, I mean it is a lot easier to link regional markets within the same continent than it is to to do cross continental linkage.
It is also politically difficult because you need to you need countries that are not necessarily on the best terms to get to an agreement of fungibility, and you know the different parameters of linking not not not least conflict resolution. So yeah, and we've we've talked about regional expansion of current markets. But going back to the EU e t S just for just a second, let's talk about sector expansion. In the report, you mentioned that it's likely that maritime
will be included soon and aviation is looking possible. My question here is, looking at fuel switching, it seems hard for these sectors to do fuel switching and reduce emissions. Are they just going to be on the hook for just buying us to some degree, yes, but there are ways to reduce emissions in maritime and there are ways to reduce emissions in in aviation, although it's not straightforward
at all. First, what we're talking about is intra e A maritime, so that is only maritime transport that starts and enced within the European Economic Area. We already have intra aviation within the EU it t S, and what they might want to do is expanded to international aviation, although that might be in doubt because of this new Corsia offset scheme for international aviation when it comes to reducing emissions. Yes, they are. These are sectors that don't
have an easy access to decorganization technologies. Let's say, but we know there are electric ferries running in in Norway and elsewhere, so you know it, it's not an impossible feed. The idea of expanding is that when you have a larger market, you have more effective price formation and these markets will probably be protected by free allocation in in the beginning. To other sectors that are of interest is hitting and transport. So Franz Timmermans, who is the Vice
President of European Commission. In April he said that they would start a separate e t S for hitting and transport within the EU. Now the goal is to link that e t S with the e U t S at some point in the future, and that way you have an indirect expansion of the scope of the of the e U t S. So yeah, and just to kind of bring it all home here on this you're seeing some increasing prices on the EU e t S side.
What is it that you want to watch? As the UK has well completes now their first year with their
own emissions trading scheme. For me, the most interesting part to see how closely the price of the u k it t s will be linked to the EU t s. It is quite possible that we will see a link between the UK and EU t s in the future, so for me that that suggests um possible price convergence between the two more markets, and another reason for price convergence is that we have a lot of UK power companies who have hedged EU a s and they will likely unwind those hedges and buy into into the UK
has when the price is right for them, and the price would be right if there are similar prices between the two markets, or if there is a premium on EU A s. So you might have a situation where you have a more expensive EU allowance than a UK allowance. Then you will have power companies taken advantage of that by selling off an EU allowance and buying a UK allowance. That way, the price of the EU allowance will go down and the price of the UK allowance will go
up and we will have some convergence. So for me, that is the number one thing to look out for. The second thing to look out for is news on linking the two systems. It is unlikely that they will be linked by twenty two, so probably twenty twenty three is the earliest possible year. Now of both the EU and the u K agree that linking is advantageous for
both sides. The problem is that carbon markets are not on the top of the agenda of the prime ministers of the world or the the the highest level of government, so it might fall victim to two larger negotiations between the two parties. But hopefully we will see a link in the in the next couple of years. Yeah, do you have any final thoughts for us? It's really encouraging to see the market had recovered from the doldrums of twenty seventeen when the reform for one to thirty was
taking place. It really was the last chance saloon for the market. A lot of political capital had been spent on it and it was seemingly going nowhere. This is really an example of effective policymaking and how the European Commission has learned from previous mistakes, and they should be lauded for that. We are now in a situation where e U t S is no longer a compliance is you for large corporate entities, but it is a real strategic risk going into the future, and that is where
it needs to be to drive these investment decisions. So I would say that the development of the of the uv T S is again is a It's a really great example of effective policy making. People within the European Commission and in the EU as a whole really compat themselves on the back for what's happened in the last few years. This week's show was produced by Ava gonzaleze Isla and edited by Rex Warner of gray Stoke Media. Bloomberginny app is a service provided by Bloomberg Finance LP
and its affiliates. This recording does not constitute, nor should it be construed as investment advice, investment recommendations, or a recommendation as to an investment or other strategy. Bloomberguinnia should not be considered as information sufficient upon which to base
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