Electricity pylons can be seen on January 26, 2021 in front of the cooling towers of the coal-fired power station of the German energy giant RWE in Weisweiler.

INA FASSBENDER | AFP | Getty Images

LONDON – The cost of pollution in Europe is rising like never before since its inception in 2005, thanks to the region’s ambitious climate policies and increased financial investment in the market.

The European Union has the world’s largest emissions trading program. Carbon emissions are limited for many companies, and excess allowances can be bought and sold.

The EU reference price for carbon closed on Monday at 56.34 euros per ton, almost the highest level since market launch. The carbon contract of December 2021 topped € 50 for the first time earlier this month, after having been around € 20 before the coronavirus pandemic.

Analysts and traders believe this record breaking rally still has plenty of room to run.

The emissions trading system is a cornerstone of the bloc’s climate and energy policy and the EU’s main tool for reducing the greenhouse gas emissions that cause climate change. The ETS is designed to cost carbon dioxide for the region’s most polluting industries, from aerospace to mining. It currently covers around 40% of the EU’s greenhouse gas emissions.

The European trading system is expected to play a key role in the bloc’s efforts to cut CO2 emissions by 55% (compared to 1990 levels) by 2030 and to achieve net-zero emissions by 2050. The target was briefly criticized by environmental activists for falling, which is necessary to prevent a catastrophic collapse of the climate.

An annual carbon market survey by Refinitiv published on May 11th found that the cost of pollution in Europe is increasingly influencing investment decisions. The survey of 303 respondents – mostly traders or regulated emitters in the global carbon market – also found that the majority believe that EU carbon prices will continue to rise in the coming months.

Average prices of around 40 euros were expected for 2021, before rising to 80 euros by the end of the decade. According to analysts from Refinitiv, CO2 prices in the EU will be trading at 89 euros by 2030, although some forecasters are forecasting a level “far beyond”.

Carbon prices must be “much higher”

Lawson Steele, joint head of carbon and utilities research at Berenberg, told CNBC’s Squawk Box Europe that he had a year-end price target of 110 euros – roughly twice what it is now.

“I know I’ll be wrong. It won’t be exactly right, but it could happen a little earlier, it could happen a little later. It could be a little lower, but it could be much, much higher than that” Steele said earlier this month.

Of the sectors expected to benefit from this trend, utilities could be a big winner from rising carbon prices, Steele said. He identified the aerospace, chemical, steel and mining industries as one of the most vulnerable in the months to come.

A view of open freight cars full of coal under smog on a day when the PM2.5 dust concentration was 198 ug / m3 on February 22, 2021 in Czechowice Dziedzice, Poland. According to a report published by the European Environment Agency (EEA), the Central and Eastern European country has the worst air quality in the EU.

Omar Marques | Getty Images News | Getty Images

Some vulnerable industries have claimed that escalating carbon prices could ultimately hurt their efforts to invest in new technologies, delaying a much-needed industry shift away from fossil fuels.

But Berenbergs Steele disagrees: “I would say that in the 16 years since the carbon system went live in 2005, industry has done little or nothing to reduce carbon emissions, by and large.”

Steele said there was only one exception during that time. Only the energy sector “has actually done something lately,” and that’s because higher carbon prices helped speed the switch from coal to gas-powered electricity – “and coal produces twice as much carbon as gas, so half of which the emissions were saved, if you want. “

“The price of carbon actually has to be higher now, much higher than there – and EU politicians know that – for this behavioral change to happen,” he continued. “Remember, companies can help. They can pass some of those prices on to customers. We ask for elasticity, but they can. So it’s not the shock and horror one might think.”

Analysts said carbon prices would need to be at least twice what they are now for renewable technologies like so-called “green” hydrogen to compete with environmentally harmful alternatives.

Meanwhile, EU climate chief Frans Timmermans said earlier this month that carbon prices would have to be significantly higher for the bloc to meet its emissions targets. He also urged policymakers not to intervene in the carbon market and warned that doing so would undermine the credibility of the system.

Border adjustment tax

One problem currently affecting the system is what is known as “carbon leakage”, where companies relocate production (and emissions) due to the relative cost of pollution in Europe.

The EU is expected to propose reforms in the coming months to solve this problem and possibly implement the so-called carbon limit adjustment mechanism from 2023. The policy is an attempt to improve the playing field for carbon emissions by applying domestic carbon prices to imports.

The European Commission, the EU’s executive branch, believes that this adjustment could generate additional revenues of between EUR 5 and 14 billion.

John Kerry (L), US President’s Special Envoy for Climate, and Frans Timmermans (R), European Commission Vice President for the European Green Deal, will hold a joint press conference on March 9, 2021 in Brussels, Belgium.

Dursun Aydemir | Anadolu Agency | Getty Images

Morgan Stanley analysts said that introducing some form of border adjustment could benefit multiple companies in the long run, but warned it could also lead to heightened tensions between EU member states and their trading partners.

This is because, while all countries are under immense pressure to step up their climate change commitments, the proposed pace of EU policy may be too fast for some. Some Member States, especially those heavily dependent on exports, strongly oppose the introduction of the carbon limit adjustment mechanism and cite third-party opposition.

Ministers from Brazil, South Africa, India and China expressed “great concern” about the EU’s proposed climate change policy in a joint statement released on April 8th.

The US government has announced that it will “investigate” a border adjustment tax. However, Morgan Stanley analysts said they do not believe President Joe Biden’s administration will enact such laws in the near future.

Wall Street Bank also said the EU would likely give a grace period to appease those opposed to the possible introduction of the carbon limit adjustment mechanism, but that schedule could slide to 2024, or possibly even 2025.