Interest in Europe’s carbon market is surging as trading desks, utilities, and factories closely watch the political developments surrounding Brexit. European lawmakers, who have long grappled with an oversupply of emission permits, now face the challenge of minimizing market turmoil in the event of the UK’s withdrawal from the program. If they fail to do so, the motivation to reduce emissions could diminish.
A European Union proposal to address the risks posed by Brexit, which includes placing restrictions on the use of UK-issued EU carbon allowances, caused the market’s five-day rising streak to come to an end on Monday. As the fourth-largest CO2 emitter within the regime, Britain’s potential exit presents significant concerns. “There’s a material risk the entire market grinds to a halt,” warned Louis Redshaw, founder of carbon trading company Redshaw Advisors Ltd. The uncertainty arises from traders’ inability to determine the validity of the allowances they purchase for future use. Exchanges would also struggle to guarantee the authenticity of the allowances they deliver.
Redshaw criticized the EU plan as “fundamentally flawed,” suggesting that UK emitters might be able to use their 2018 allowances for 2017 compliance, retain their more flexible 2017-and-earlier allowances, and sell them anyway. The European Commission has yet to finalize the details of the plan. Last week, the cost of a European Union allowance to release one ton of carbon dioxide surged by 21%, the highest increase this year. Futures trading on ICE nearly doubled and approached a six-month high, while options volumes reached their highest level in over two years.
This surge coincided with the EU’s decision to discuss changes to an emissions-trading overhaul aimed at strengthening the market. However, these changes would be separate from the Brexit-related fix. The draft law for the proposed solution to the Brexit issue must be approved by the European Parliament and member states to come into effect. While approximately 12,000 factories, utilities, and other emitters require carbon permits, the market for trading these permits remains relatively small. Last week, permit futures with a value of €750 million ($900 million) were exchanged on ICE, still less than the trading volume of a single stock, Banco Sant
