EU Emissions Trading

Reducing CO2 emissions to become climate-neutral by 2050

Emissions trading is a cornerstone of EU climate policy for reducing CO2 emissions and achieving climate neutrality by 2050. In her State of the Union Address, President of the European Commission Ursula von der Leyen recently presented her vision of a stronger Europe. Climate neutrality by 2050 is a central target of the EU, with the existing climate target raising climate ambition until 2030. The EU summit decided in December 2020 to reduce the EU's CO2 emissions by at least 55% by 2030 compared to 1990, an increase from the 40% targeted so far. A decision by the member states is expected by mid-2021.

A survey at Commerzbank's annual Energy & Carbon Seminar held in November 2020 showed that 74% of participants expected the parties involved to agree on a reduction target of 55%.

Expansion of European emissions trading being reviewed

It is paramount that an agreement be reached quickly since all EU climate and energy policies must be revised by summer 2021 so as to align them with the new targets. Amongst the questions being discussed is whether transportation, buildings and shipping should be integrated into the European Emissions Trading System (EU ETS), or whether a separate mechanism should be established.

Phase 4 of the EU ETS will bring significant challenges

Whether they recently joined or have been participating since day one, all companies in the ETS will face significant challenges in phase 4, running from 2021 to 2030, as targets are increased. The EU emissions trading will have to bear the greatest burden.

According to the Commission's impact assessment of the matter, increasing the EU-wide target of a 55% reduction in greenhouse gas emissions would mean that the sectors covered by the EU ETS would have to reduce their greenhouse gas emissions by between 63% and 64%. At the moment, the reduction target of the EU ETS is 43%.

We believe that this poses two major challenges for companies:

  • Increase in carbon prices: Most market participants expect the new climate targets to trigger a significant rise in prices for European emission allowances (EUA). The Commerzbank survey mentioned above yielded the result that 53% of participants in phase 4 expected an average price between 40 and 50 euros. 42% saw the price between 30 and 40 euros. In mid-March 2021, it exceeded 43 euros per tonne of CO2 for the first time.
  • Less free allocation: More ambitious climate targets will result in a decrease in free allocations to industrial installations. As a consequence, companies will have to buy additional emission allowances if they cannot reduce their needs through avoidance measures.

Reducing emissions or buying allowances?

A sharp analysis of the current situation and current climate plans as well as active management are critical, in our view. "Make or buy?" In other words: is it possible, from a technical and economic point of view, to reduce greenhouse gas emissions, or does the current situation require that EUA be purchased? Which financing options are available, and what can active risk management in this sphere look like?

How Commerzbank supports companies with risk management and emissions trading*

When prices for emission certificates increase, clients should hedge accordingly and cover themselves with EU emission allowances. Benefit from our extensive and proven experience in risk management, and from our know-how as a leading, long-standing player in emissions trading.

The number of companies attaching importance to sustainability and climate neutrality is increasing – also amongst those that do not participate in the EU ETS. We aide companies on their climate strategies, help them cut their emissions as much as possible, and use carbon credits to compensate the emissions that cannot be reduced.

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Active management of commodity price risk is increasingly important …

We can adapt our comprehensive range of services to match our clients’ specific needs. We provide information about relevant developments in the area of emissions trading, as well as legal changes and new trends. Any cooperation always starts with a precise analysis of the specific risks involved.

Whilst the active management of commodity price risk is increasingly important to companies, we also show them opportunities pertaining to the next phase of the ETS. We support our corporate clients from start to finish in the emissions trading process – starting from the assignment of free certificates in February of each year right through to settlement in April of the following year. Based on information provided, we calculate a potential surplus or deficit of emission allowances, presenting potential action strategies. For example, we will look at how EUA allocated for free can be used to optimise financing costs.

… adding to planning certainty

Together with each corporate client, Commerzbank will help to develop a bespoke risk management strategy, setting out the resulting strategies. One advantage: active risk management enhances planning certainty.

Frequently used strategy concepts include:

  • Passive strategies: Carbon credits are acquired shortly before the compliance reporting date; sales are made at the end of the year or quarter.
  • Tactical/active trading approach: Companies use market opportunities to buy or sell emission allowances as soon as a predefined price target has been reached.
  • Hedging/purchasing strategies: With this approach, enterprises regularly define a strategy as to how certificates will be acquired or disposed of.
  • Integrated risk management approach: Commodity, exchange rate, and interest rate risks are managed simultaneously.

Stronger exposure to commodity price risks compared to interest rate and exchange rate risks

Commerzbank has a broad range of instruments to help enterprises manage commodity price risks, with a specialised range available specifically for emissions trading. Given that companies have a much stronger direct exposure to commodity price risks – compared to interest rate and foreign exchange risks – there is a strong case for using these instruments.

Spot purchase or sales:

A company acquires or disposes of EU emissions rights with immediate delivery and pays or receives the corresponding price. This instrument can be used for annual settlement in April, or generate profit through sales.

Forward purchase or sale:

The company sets a price today at which their CO2 certificates will be bought or sold in the future, allowing the customer to hedge against rising or falling prices.

Limit order:

Commerzbank buys or sells emissions rights at a target spot or forward price on behalf of the customer. This strategy can enable companies to be highly flexible.

Purchase at average price:

Emissions rights are acquired or sold at a previously defined average price. In this way, companies avoid having to settle transactions priced at historically high or low levels.

Option:

Using options, or the right to be able to buy and sell CO2 certificates, customer’s hedge against extreme price developments. These can also serve as the basis for generating premiums.

Swap:

In order to manage their compliance positions, companies can exchange a set quantity of certified emissions reductions (CERs) for EU emissions rights (EUA).

Financing:

By simultaneously selling EU emissions allowances on the spot market and repurchasing these on the forward market, companies can receive funds and finance themselves.

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*Commerzbank offers its EU ETS services only to clients in the European Union, or with a European Union Registry account.

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Disclaimer

This publication is treated as customer information within the meaning of the Securities Trading Act. This information provides information only and does not constitute individual investment advice, nor does it represent an other to buy or sell any securities or other financial instruments. This document alone does not replace individual investor and/or investment-oriented advice.

Please read Commerzbank's full important notice / disclaimer here.