How the CO2 market influence electricity and gas prices?

Electricity and gas prices traditionally reflect the cost of building and operating power plants. In a context of fight against climate change, policies to reduce Greenhouse gas (GHG) emissions are becoming equally important to understand the variations of electricity and gas prices.   

The European Union Emission Trading Scheme incentives actors to invest in low-carbon energies

The EU ETS, implemented in 2005, defines a maximum amount of GHG emissions to be emitted. Each actor is allocated a fixed number of quotas. If they issue more pollution than they are allocated quotas, they pay financial penalties, or they buy additional quotas to businesses than have not used all theirs. 

The energy industry is one of the main sectors subject to the system, with 56% of the allowances in 2012. It should be noted that the electricity sector is the largest GHG emitter: in 2016, it is responsible for 23% of emissions in France and 50% in Europe.

For that reason, the electricity and gas markets are influenced by the price of CO2 quotas. Until 2017, carbon price being low, the impact was negligible. European carbon price has escalated since the beginning of 2018, up from €8 per ton in January to peak at €25 per ton in September with big price volatilities.

Evolution of the price of CO2 quotas on the European market
Source: Ellipse, 2019

Less quotas issued in the coming years

To ensure compliance with the Paris Agreement, the European Union must reduce its GHG emissions of 43% compared to 2005 emissions by 2030. This is the reason why the European commission has decided to reduce the ceiling of quota. By lowering the number of allowances, the supply becomes rarer and raises the price on the market. 

Not all businesses are subject to the EU ETS, but they will be all affected

The EU ETS systems involves roughly 16 000 facilities in the energy and industry sectors, regarded as “big emitters”. Even though small and medium size companies are not subject to the system, they are also impacted by carbon price variations as the energy suppliers transfers the increase of carbon price to the electricity and gas bills.  

Price of electricity is believed to increase more in France than in Germany

In Europe, France occupies a unique position due to nuclear and hydroelectricity compared to its neighbors which rely more on fossil fuels. For instance, absolute energy price in France is more competitive but electricity prices in Germany are less volatile regarding carbon price. A rise of 1% in the price of emitting permits would lead to an increase of 0,20 €/Mwh in prices of electricity in France with only 0,13 €/Mwh in Germany.

Gas is becoming more competitive and expensive

Since gas is less emitting than coal, twice less allowances used to produce energy than for coal, it becomes also more attractive in the production of electricity. This implies higher demand and therefore higher prices in the gas market.