Episode 4
Winter Is Coming

Mark Lewis, Head of Climate Research, Andurand Capital

“When you have a crisis like this, it brings home how shortsighted energy policy is in most countries. “
Mark Lewis

This week, we welcome Mark Lewis back into the SmarterMarkets™ studio. Host David Greely sits down with Mark to discuss the energy crisis in Europe and what it means for the European carbon market.

Hosted By

David Greely

Episode Q&A

The following Q&A is created using slightly edited excerpts from the episode transcript, optimized for readability. Download full transcript.

ML: It has been a rollercoaster ride for the last 12 months. If we go back to August 2021, we were all talking about what would happen with the Nordstream 2 pipeline. It began to look as if there were going to be problems with the approval of Nordstream 2 by the new German government in September. Sure enough, in October, because of the escalation in the rhetoric between Russia and the West, the German government declined to approve the Nordstream 2 pipeline, which led to a step change in gas prices going into the winter.

ML: Last year, we were in the disadvantageous position of having very low gas stocks going into winter. So that’s where we were this year ago, prices much lower. To give you an order of magnitude this time, last year, we would’ve had the gas contract for the one year ahead priced at €50 to €60, which already was a very high price by historical standards. If you go back two years, European prices were €15 per megawatt hour which would be around $4, $5 per BTU. We’ve gone from €15 per megawatt-hour to absolutely astronomical prices this August with the new year ahead contract for €250 to €260; it went down now at €180, but still, this is too high price for the power.

ML: It’s been the same story. We’ve gone from €60 megawatt-hour for the year ahead contract to an incredible €1,000 per megawatt hour. Last month we came back down to €500, but again, that is still spectacularly high. On average, two years ago, €50 a megawatt hour was a standard number, and carbon had been going up for structural reasons of its own because of the climate policy and the tightening of the cap. So there was a more normal narrative around the carbon price, but of course, it’s been exacerbated, and it’s been having to deal with the backwash from these very high power prices and gas market. So it’s been a more volatile ride for carbon. So that’s the background.

ML: If you think about why this has happened and what’s happened, then clearly, Russia’s invasion of Ukraine, the war of aggression on Ukraine, has led to the weaponization of gas by Putin and the Russian government. That has been driving power prices and, to some extent, carbon prices. Carbon has its logic and its narrative. There is a link between gas prices and power prices. For the last 12 months, gas prices have been at the margin in Europe. In other words, they’ve been the fuel setting the marginal price for electricity.

ML: As the cost of gas has gone up, the price of gas has gone up too. The price of electricity has gone up as well, and of course, when Putin invaded Ukraine in February, we were still coming out of winter with low stocks because we’d gone into winter with low stocks. We were fortunate that we had a mild winter because if it had been a hard winter, we might well have run to zero storage gas levels, but we came out with at least some gas in the tank. Then following the invasion of Ukraine and the need very quickly to adjust Europe’s energy policy, to find a way to get off all energy imports from Russia. For the last seven months, the European Union has been gradually refining and accelerating its plans for the energy transition. The main priority over the summer was to stock up on storage levels ahead of the winter because that is crucial.

ML: You’ve also had this saga of Russia, sequentially cutting more and more of the flows into Europe, for example, through the Yamal-Europe pipeline, which runs through Poland. It’s already cut some of the supplies coming through Ukraine. And most recently, with this rather absurd saga over the turbines for Nordstream 1, flows coming directly to Germany are now at zero. I don’t think anybody expects them to restart whatever the Kremlin says. In European circles, the calculation for the winter ahead the remaining flows that are currently coming through Ukraine, which are about 36 million cubic meters per day, will also fall to zero, and that’s why it’s been imperative to bring storage levels back up.

ML: With the news that we are already ahead of target in Germany and Europe for the storage levels ahead of winter, that’s received positively. So that’s why gas prices over the last two or three weeks have started to come back down a bit, but be under no illusion this winter is going to be very tough. Although that’s the immediate priority getting through this winter the next winter is already in many people’s thoughts. We benefited from the flows from Russia over the whole of the first half of the year that filling up our storage tanks for this coming winter, but that will not apply next year. We will not have Russian flows to help us through the first six months of next year and the summer of next year. So filling up storage levels for next winter, i.e., winter 2023/24 is already starting to worry people.

ML: What we’re looking at here in Europe now is a protracted period of very high gas prices, probably through to 2025, by which time, number one, there will have been demand substitution in Europe and more energy efficiency measures taken and more deployment of renewable energy technologies. Then on the supply side, Europe will have ramped up its import capacity for LNG, and the United States, and other jurisdictions with LNG to export will have ramped up their exports. But over the next 18 months, as those import and export capacity constraints are still in place, we will have to live with very high gas prices for the foreseeable future. And that means high electricity prices as well.

ML: Crucial question and energy professionals, those of us who follow energy markets very closely, we have been seeing these very high prices on screens for many months now, but consumers and end users haven’t even seen the full brunt of them yet. I think in the UK and Germany, it’s in October when you will see a sharp rise in prices for residential households. This is a major political crisis on top of major energy, economic, and financial crisis. Residential tariffs are more tightly controlled than business tariffs, which are free market and so on. So free market for residential customers for the most part across Europe.

ML: But government likes to control the sequencing of those price increases. Now, one example of an order of magnitude is the new UK government, which just came into office last week with the new Prime Minister Liz Truss; within two days of coming into office, Liz Truss said we will freeze energy bills for residential consumers at a price of £2,500. And to put that into context, up until January of this year, UK residential consumers were only paying £900 for their gas and power bills, and to put it into further context, if the government had not stepped to freeze that tariffs, the price would’ve gone up to £3,600 and in January would go up further to £5,000. So the government had to step in because it faced wholesale social disintegration and disturbances.

ML: The cost of this is that taxpayers will ultimately have to pay for this is £130 billion. That’s more than the UK government stepped in for to deal with the impact of the pandemic. It’s certainly the largest-ever intervention by a British government in the energy market, and it’s an indication of the real panic amongst governments across Europe about the scale of social disintegration that this could cause if they hadn’t stepped in. So, one of the levers they can pull is direct intervention, freezing prices, and finding a way of paying for it. This is where it gets interesting because the UK government has decided to put it on the taxpayer. Ultimately there will not be windfall taxes in the UK on energy producers.

ML: Whereas in Europe, and we will get more details on this tomorrow when the president of the European Commission, Ursula von der Leyen, sets out the plans. We know there will be a so-called solidarity tax on fossil fuel producers and upstream fossil fuel producers. So oil, gas, and coal companies will have to contribute to help pay for the price freezes that will almost certainly come across the whole of the EU. Different countries will do it at different levels. And for different periods of time, the UK has frozen UK energy bills for residential consumers for two years. That’s why the bill is so high, £130 billion, so there will be taxes on at least some of the industries and companies in Europe to help pay for this. Still, the reality is the economic and financial cost of this is necessary because if the governments were not willing to step in, I think you’d be looking at a very disturbing political context across Europe here.

ML: So I think there’s a recognition we have a war on our doorstep. This is the biggest military conflict on European soil since the Second World War; it’s an exceptional situation. We need to support Ukraine, and as a result, we need to maintain the sanctions in place. We need to take some pain because, ultimately, that’s a price worth paying for a freer Europe and resisting the threat of aggression on our doorstep. So that’s the political logic, and one can totally understand that it has to be the right call. But overall it’s going to lead to a mixture of higher taxes ultimately and whether it be the companies that are making windfall profits at the moment, or ultimately on general taxpayers as income tax rates. One way or another, this debt will have to be paid off at some point.

ML: So that’s how European governments are looking at the financing. In terms of some of the other policy levers, what’s crucial, of course, is reducing demand. We talked earlier about the need to bring in more LNG on the supply side, but a very important policy response is also required on the demand side. Just to put something into context, that £130 billion that the British government is going to spend to freeze bills at £2,500 for two years. Imagine what you could have done over the last 10 years if you’d invested £130 billion in energy efficiency measures. This is when you have a crisis like this, bringing home how shortsighted energy policy is in most countries. We are not investing the way we need to either for climate change or the energy security of supply.

ML: One silver lining from this whole desperate situation in Ukraine is that the dawning realization on many policymakers in Europe that investing to align our economies with the imperative of reducing emissions and net zero by the middle of this century goes hand in hand with providing security of energy supply over the long term. I don’t think that’s been obvious to many people; a lot of people have made the argument that we’re not investing enough on the supply side. Well, it may be true, but we should be investing in renewable energy resources, which benefit from being environmentally friendly, providing local jobs, and providing an energy security supply. Energy efficiency is going to be the unsung hero in all of this.

ML: That would be for an annual bill. So those numbers that I gave, it’s always the annualized number for a given quarter, which is why it was £970 at the beginning of the year. That was the annualized rate for that quarter. But because, normally, energy prices are not moving the way they’ve been moving over the last year, and that’s why people were getting terrified, as we were going from £900 to £1,970 at the beginning of April, and then should have been £3,600 from the 1st October, but the government said we cap it at £2,500, and then it would’ve been £5,500 by January and no government can live with the social consequences of staggering of that.

ML: Absolutely; there are a number of actions being considered. To quickly recap, the European Union’s policy-making trifecta, that is the European Commission, the European Council, which are the member state governments, and the European Parliament are now entering the final crucial period to finalize the revision to the European carbon market. That will take it to 2030, which means aligning it with the ultimate net zero targets by 2030. Now the commission laid out its plans, its original proposal in July of last year, the parliament and council arrived at their respective negotiating positions for this forthcoming trial between the three parties in June, and then, and the council is slightly tougher in what they want to see in the final shape that the EUETS reform takes vis-à-vis the original proposal from the commission.
ML: But then, with these sky-high prices that we’ve seen in the intervening convening period in July and particularly in August, policymakers have come back from their summer break thinking what we are going to do about the whole energy crisis now. This is interesting because, as we emphasize at the beginning, the rise in energy prices in Europe is overwhelmingly a gas story. Gas prices have gone up for people who use gas, but electricity prices have gone up because of the gas that we use in the market. In fact, if you look at the constituent elements in the increase in the wholesale power price across Europe, over the last 12 months, 90% of that increase is because of the increase in gas prices. Carbon is only 5% to 10% of the increase in power prices.

ML: But the big difference between carbon and gas, of course, is that carbon is a variable that is within the control of policymakers, whereas gas prices, unfortunately, are not, or at least not in the short term. Even though the carbon prices only respond to the increase in carbon over the last 12 months is responsible for between 5% and 10% of the rise in wholesale power prices. That’s for good reasons because we have seen a number of energy-intensive industries in Europe, shuttering facilities over the summer; I’m thinking of the aluminum industry, the zinc melting industry, the fertilizer industry, even the steel industry, these very energy-intensive industries, more than anything else they’ve been hit by high gas and power prices. There is a lot of focus now from European policymakers on what they can do to keep prices in the European carbon market more under control, at least as we get through this winter.

ML: The carbon element is in there, and the industry also lobbies Brussels, knowing that they can make more headway complaining about carbon prices than they can about power or gas prices. The long and the short of it, good news first, there will not be any change to the fundamental points proposed by the European Commission. The cap will fall to the level, at least to the level that the commission proposed last year; we will see a 61% cut in the cap by 2030 compared with the level of emissions in 2005. That’s a dramatic tightening of the cap, compared with the 43% reduction versus 2005 levels that the previous legislation had. So there’s a very significant tightening of emissions. To put it into better context for your listeners, tightening the cap means that over the 10-year period from 2021 to 2030, industrial companies in the European Union will have to make further carbon savings of about 1.5 billion tons of CO2.

ML: That’s equivalent to about one and a half years, almost one year’s emissions. Effectively that’s a very significant tightening of the cap, and that’s why we’ve had carbon prices going to record levels over the last 12 months. That’s the good news. They weren’t tampering with that fundamental point because if they did that, they would be undermining the sanctity of the legally binding target of net zero by 2050. So they don’t want to do that. However, what they can do and what I am convinced they will do is confront load some of the supply that would ordinarily come to market in the second half of the current trading period; that is to say, between 2026 and 2030, they confront load some of that supply bring it to the market. Now, sell more, and inject more volume into the market today to bring prices down so political heat is taken out of the discussion in the short term.

ML: And there is political heat. There is always political heat, particularly from the countries, the member states of the European Union that have a lot of coal fire generation in their power mix because they’re the ones that are disproportionately impacted by high carbon prices, obviously because the carbon intensity of the coal in their power generation mix. So Poland has been saying for the last two months we should just have a flat price for the foreseeable future of €30 a ton. Now that has been rejected out of hand by the European Commission. I don’t think there would be many if any, other member states that would be in favor of that. Still, it’s nonetheless an indication of the political heat that is out there on this issue, and as a result, you’ve had a couple of very senior experienced policymakers.

ML: You’ve had Peter Liese in the European Parliament, a member of parliament charged with leading the reform of the EUETS through the parliament. He’s a very significant figure. He’s going to be negotiating on behalf of the parliament in these discussions with the commission and the Council, who has said, we need to bring more supply to the market sooner rather than later and then in the second half of the current period from 2026 to 2030 supply will be tighter. So all you are doing in front loading, the supply like that is making it tighter at the back, but again, it’s an indication of how urgent the problem is today that they will say, we’re worried about that later, for now, the absolute priority is to bring prices down in the near term.

ML: Peter Liese is retired from the Brussels bureaucracy, but another well-known figure in European carbon circles is Jos Delbeke. He was the Senior Civil Servant at the European Commission in charge of Climate Change, and he is the architect of the EUETS. And now, he is a professor at a university, and he is retired from the commission, but he made a public statement two weeks ago that any, anywhere above €70 a ton in the current climate is politically dangerous, and it would be expedient to see prices below €70. Right now, we’re trading €69-€70 today. So, I think prices probably have further to fall through the winter, both because you will have pressure to front-load some of the volumes and the impact on industrial demand. Unfortunately, I think we’re likely to see further temporary shutdowns of some parts of European industry in response to these very high energy prices.

ML: These are crucial questions. If you look at the power sector, we have had, for a long time, for at least 9 – 12 months, carbon prices that are too low to encourage gas fire generation to run ahead of coal fire generation. On a short-run perspective, in the power sector, the carbon price is doing nothing to reduce emissions, which is another reason there is political pressure. I mentioned Jos Delbeke a few moments ago; Jos has made the point publicly. Even though carbon prices have been highest levels in August, we got up to €99 a ton, but even at €99 a ton, gas is so much more expensive than coal that you would’ve needed a carbon price.

ML: In August, in particular, when gas prices were at their peak, you would’ve needed a carbon price of €900 a ton on the front month and front year contracts to incentivize gas-fired power plants to run ahead of coal. Now, of course, in those circumstances, very difficult to persuade anybody that the carbon price is serving any purpose when coal is running flat out and is much more profitable than gas. For the past 12 months, the carbon price has been doing nothing, and for the foreseeable future, if you looked at the gas, the forward curve for gas, and the forward curve for coal, it won’t have changed that much.

ML: It’s not until you get to the middle of 2025, so three years from now on the forward curves, that gas is in the money compared with coal because it takes that long for the gas price on the forward curve to come down to a level where today’s carbon price or the forward carbon price in 2025 is consistent with fuel switching in the power sector. So to all in terms and purposes, the carbon price, the carbon market is broken at the moment in terms of encouraging fuel switching from coal to gas on the industrial side. And this is where it gets interesting. I made the argument last time I was on the show with you that we’d reached a point where the carbon price was in the 90s, and there seemed to be momentum in February before Russia’s invasion of Ukraine for carbon prices to go through a €100 and reach a level €121 – €130 that would’ve been a level consistent with green hydrogen being more competitive than gray hydrogen.

ML: So there’s a very strong long-term argument there. The structural decarbonization angle, as I used to call it, whereby the carbon price was reaching a level that would lead to structural decarbonization of European industry. Now what’s happened again, a silver lining in terms of high gas prices, is that green hydrogen becomes competitive with gray hydrogen without the need for any carbon price at all. Just to put some numbers on this, the cost of production of green hydrogen, using wind or solar and electrolysis to generate hydrogen, so there are no emissions associated with the hydrogen. The cost of production of that in Europe today is around €6, so $6 we’re parity between the Euro and the Dollar; €6, $6 per kilogram, and for gray hydrogen now the cost of production, which would ordinarily be when you have normal gas prices, it would be around €1.5 per kilogram.

ML: Today, it’s more like €7, €8, €9 per kilogram. So green hydrogen is cheaper to produce today than gray hydrogen, given where natural gas prices are. If you look at the forward curve, you’d be looking at 2526 before you need a carbon price to incentivize green hydrogen versus gray hydrogen. But by 2526, the cost of producing green hydrogen will have fallen. The problem today in Europe is that we don’t have green production capacity at scale; if we did, you’d be running and producing all your hydrogen from electrolysis. Unfortunately, we haven’t built out the infrastructure yet, but the incentive is very clearly there now. So I think that’s, to my point about the silver lining, the one silver lining from this dreadful situation, this dreadful war of aggression in Ukraine being waged by Russia, is that it forces everybody to focus on the need to accelerate the energy transition. And that means more renewable energy. It means more imports of LNG from sources other than Russia. And it means building out the green hydrogen infrastructure.

ML: In my view, I have touched on the key pricing parameters here. The power sector accounts for about 50% of all emissions in the EUETS. Power emissions will be very high, much higher than last year because of the coal running and flat out. One thing we haven’t mentioned has been the very poor availability of France’s nuclear generation fleet over this year, even predating the summer. So on the power side, it’s hard to see gas prices falling to a level before the end of this winter, at least where almost any carbon price would incentivize gas to run ahead of cost.

ML: There are a couple of issues going on in the French nuclear sector that are worth pausing on a minute because this is very important for the carbon pricing outlook and the power pricing outlook. So France’s nuclear fleet has 56 reactors in total, 31 of which are currently offline, partly because some of them found earlier this year to have corrosion problems and so are having to be fixed for that problem. That’s a very serious problem, and it needs fixing. Then you’ve had the catch-up effect from COVID. A number of nuclear power plants that should have had their outages for maintenance did not have those maintenance outages during the COVID period for obvious reasons. So they’ve been having delayed maintenance outages. Finally, because of the very hot summer we’ve had in Europe, high temperatures, a number of plants have not been able to operate and certainly not operate at the usual level of availability because there are problems with the water availability, particularly nuclear power plants that are on rivers have not been able to use river water if it’s above a certain temperature. Often that has been the case.

ML: River levels have been low, and that’s been a problem as well, even for the coal generators, getting the coal in Germany, down the river Rhine because the river level has not been high enough for some of these very big, heavy barges to get down the river Rhine. So there have been all kinds of factors over the summer, which led to this super spike in power prices in August. Now going into the winter, EDF, the French national nuclear company national electricity generator, has said it will bring back 12 of its nuclear reactors this month, another 7 in October, and another 4 in November. So by the time, we get to the end of this year, hopefully, of those 31 reactors that are currently offline, we should have 2021 of those reactors back online, which will go a long way to helping with the power crisis in France and Europe more generally.

ML: But of course, that will have a depressive impact on emissions because to the extent that France has had so much of its nuclear capacity offline, they’ve relied on imports of electricity from other countries, not least Germany, and Germany, therefore has been running its coal plants. So even higher levels than it would be based on the economics of gas versus coal and the price signal from the carbon price simply to be able to export to France. So that will take at least some of the pressure off. So although you won’t see any relief from the carbon price in emissions, in the power sector between colon and gas, you will see some relief from a large segment of those French nukes coming back offline. But generally speaking, emissions in the power sector will be strong.

ML: On the industry side, unfortunately, a much trickier situation. We’ve got a number of industries already shutting down production, and I think there will be more going into the winter. So we’re going to have lower emissions from the industry right through the winter. I think that you can take that pretty much as a given, unfortunately. And then, on top of that, if you net those two off on fundamentals, I would say emissions probably end up still being slightly higher than last year or flat at best. Whereas six months ago, I would’ve assumed emissions would be much stronger this year than last year. On top of that, you’ve then got the political pressure. I mentioned pushing for front-loading of allowances. So when you put all of that together, there’s already been an extraordinarily sharp or steep declining carbon price over the last month. August is a funny month in the European carbon market because of the European holidays.

ML: They cut the supply of allowances from auctions to 50% of the normal supply level, and so you always see carbon prices have a bit of a rally during August. This August, we got to a new all-time high of €99 a ton which was €20 higher than at the end of July, simply from cutting the auction volumes. And then we’ve come back down to €70 a ton today. When you put all of that together, I think we’re probably going down closer to €60. If you think of what happened in the immediate aftermath of the Russian invasion of Ukraine, we got down to €55 from €92, which happened in the blink of an eye in a week back in February and early March.

ML: And this has been quite sharp, as I say, from €99 to €70 already; I would expect prices to fall further heading into the winter and I think around the €60, maybe even the €55 level that’s where you’ll start seeing fundamental support coming back into this market. If you’re taking a long-term view on this market and the industrial companies will take a long-term view on this market, then you have to start worrying about the fact that in the second half of this decade, supply is going to be lower. So I think there comes a point where you will see fundamental demand reassert itself in this market below that kind of €60, €55 level. One of the things to point out is the German government hasn’t legislated for this yet, but it has indicated it would like to see across the whole of the EU or in Germany, at least, legislate for a minimum carbon price for German emitters in the EUETS of €60 a ton, which again is why psychologically that’s an important level for the market.

ML: So putting it all together, I’m bearish heading into the winter, and I think around the €60 level is where it starts to get interesting again, but that doesn’t mean it can’t go a little lower €55 was the lowest in early March and that’s the level that the market will have in mind.

ML: It won’t be on the scale of previous recessions, but we are probably heading into a recession in Europe. The German economy minister made noises to that effect today, earlier this afternoon. But I remember back in 2008, when the global financial crisis was starting to accelerate in October 2008, we saw a real wave of very significant selling of the free allocations that that industry had received. The three reasons why that’s less likely to happen at the same scale, although there will be selling pressure at the margin. The first one is as compared with 2008; we now have a very clear long-term target here. We know the cap will fall to zero within the EUETS by 2040 to achieve the overall EU target of net zero by 2050.
ML: So that comes back to my point that the industry knows the second half of this decade is going to be a lot tougher, so they won’t want to sell too many. There’s a real trade-off between how much I can raise cash today to see me through the winter versus yes, but it’ll be a false economy if I have to buy those allowances back in three or four years’ time at €120, €130. So, that calculation will be in play. Secondly, because of the rule change within the legal change within the EUETS, the clawback mechanism, if you sell free allowances, is much tougher than it was back in 2008. In 2008, you could sell up to 50% of your allocation of free allowances without suffering any clawback in subsequent years.

ML: Now you can only sell 1-5% to up to 15%. If you sell 20% of your free allocation in a given year, there will certainly be industrial facilities across Europe that will be producing this calendar year and probably next calendar year as well at capacity levels of only 80% or less relative to their free allocation, but if they sell more than 15% of their free allocation, then they will be allocated corresponding the fewer allowances in the following year. So they have to be careful about that as well. So behaviorally, that was a smart change to the law, but a necessary one because taxpayers are helping European companies with the free allocation. It’s a form of subsidy. It’s a necessary form of subsidy so long as other countries outside Europe do not face similarly high carbon prices, but still it’s a subsidy. So I think there will be some industrial selling at the margin, but not significant amounts.

ML: The single most important feature here is going to be the market’s expectation of intervention on the part of the authorities in the form of front loading and the sale of UAS, either from future auction volumes or from a couple of the funds that have been set up. So there are two funds, the innovation so-called innovation fund, and the so-called modernization fund. These are funds that were set up at the beginning of the current trading period in 2021; they have several hundred million allowances in them that were taken out of the overall cap for an entire 10-year period, and normally, they are auctioned off all freely allocated in equal installments over the 10 years, and obviously what they probably will do is take some of that and front load it. The other element they’ve indicated they will look at is taking a limited number of allowances from the stability reserve itself and putting those into the market.

ML: I think that’s what’s going to weigh on a market sentiment most greatly. In May, the European Commission came up with raising €20 billion from the sale of allowances. Some allowances are currently held in the market stability reserve, but that would’ve been done over a four-year period. There are now certain moves to accelerate that to potentially one or two years, and if you front load that kind of volume, it would be to raise €20 billion at current prices, you would need about €300 million tons. If you do all that in one year, that’s a significant increase in the volume of allowances being auctioned. So I think the market will get nervous about that.

ML: Two thoughts on that. The first one, to the Doomberg point and the redefining of the energy space in Europe and indeed globally, because Russia is in a sense excluding itself from the global energy market, or at least from a very large part of the global energy market in terms of Europe, the United States and sort of Western aligned countries. So there are real global ramifications to that, but as far as Europe is concerned, I think the key point that will come out is that we have a winter ahead and it will be very difficult. In fact, two winters ahead. It will be very difficult, but if we can see through that, the prize at the end of it is very great because the prize is an accelerated energy transition away from fossil fuels to a cleaner energy system and a secure energy system in terms of security of supply.

ML: There is going to be a redefining. Obviously, it won’t be as simple as that. There are going to be some, some very sharp corrections that need to happen across some places, and it’s not going to be pleasant. We shouldn’t be under any illusion there, but the ultimate prize is worth the sacrifice in the short term. I think that’s the key point. How do we see the European compliance market playing out with the expansion of voluntary carbon markets, and in particular, what’s the impact of Article 6 on all of this? I’ll begin with the voluntary market and how it might impact compliance markets after that.

ML: Because I think there will be a very strong link between the two. I think within three years; we won’t any longer be talking about a voluntary carbon market as such, or at least not in the terms that we have traditionally talked about voluntary market. I say that for this reason, under the Paris agreement and Article 6, Paragraphs 6.2 and 6.4, you are going to have incentives for private sector players to establish emissions reductions projects in jurisdictions that will then give those private sector companies the right to take emissions reductions credits from those countries, with this all-important stamp of a corresponding adjustment, which means those credits now have been accounted for under a global emissions accounting system that is consistent with achieving the Paris Agreement and so what you’re getting in effect is a scientific seal of approval to the extent that the Paris agreement itself rests on the science as developed by the IPCC.

ML: And that will be worth a lot more, I believe, in the future to any corporate than a voluntary credit that does not have a corresponding adjustment attached to it. I think you can see the reputational advantages of having offsetting your carbon footprint with a credit that has a corresponding adjustment and therefore is effectively helping countries to align with the Paris agreement versus a credit that does not have that. So there’s a reputational argument, but equally important, I believe, and perhaps you have to think a bit more imaginatively about this, but I genuinely think this is likely to happen. Probably takes 5, maybe 10 years, but there’s an option value to any credit, which has a corresponding adjustment going forward as well because of what you have, and this is why I said the terminology is going to have to change. We won’t be discussing the voluntary market in the same way in the future. If you have an emissions reduction credit with a corresponding adjustment attached – what you have effectively is a quasi-compliance credit. Because if you think about the EUETS cap is going to fall to zero already by 2040. What that mean? It means that European industry will not be able to emit a single ton of CO2 beyond 2040. Now, 2040 is still a long way away, and nobody is freaking out about that too much. But I would imagine that by the time we get to 2026/27 and certainly 2030 industry is probably going to be saying, hang on a minute, can we fully decarbonize by 2040, or shouldn’t we be able to use offset credits that come with a seal of approval that ensures that they are consistent with the Paris agreement.

ML: So if the EU were to say, after 2030, a certain number of emissions reductions credits that come with a corresponding adjustment could be used within the EUETS. I think that would be very advantageous for everybody. Number one, there would be no dilution to the purity of the EU own climate targets, because this would be consistent with the whole point of a corresponding adjustment is that you’re not double counting. So if the EU uses it, somebody else, whether it be Brazil, Mexico, whichever country, whichever jurisdiction that credit came from, has to reduce its own emissions on top of the value of that corresponding adjustment to reach its. So it’s entirely consistent with the Paris agreement, which was not the case with Kyoto, that was very different, and that’s why Europe stopped the importing of CDM credits CRs. There wasn’t this equivalence, and there wasn’t this capturing of all emissions under the same accounting system that we will have through Article 6. So I think it opens up enormously productive and suggestive possibilities for the future. That compliance jurisdictions that have very tough emissions targets, may well come to consider using Article 6 credits with a corresponding adjustment for compliance purposes, So I think they’re going to be very valuable in the future.

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Ranting on the inadequacies of our systems and riffing on ideas for how to solve them …

SmarterMarkets™ brings together the icons and entrepreneurs of technology, commodities and finance to examine how market systems can be redesigned and improved to address the most important challenges of our time.