This article is part of our special report Energy poverty.
In the face of rising energy prices, Spain and Poland have called for trading limits to be placed on the world’s largest carbon market, the EU Emissions Trading Scheme (EU ETS). Market analysts, however, say speculative positions are currently too small to be statistically significant.
Is a price bubble building up on the EU carbon market, fuelling the ongoing energy price hike? According to Madrid and Warsaw, the answer is yes – at least partially.
“There is a significant correlation between increasing price levels [o the ETS] and the increased presence of non-incumbents in the market, especially after July 2020,” the Spanish government said in a ‘non-paper’ sent to the European Commission on 30 September.
The paper was sent after a rapid surge in electricity prices, which analysts say is caused primarily by a squeeze in gas supplies coming from Russia.
Meanwhile, the cost of CO2 permits on Europe’s carbon market has contributed “about one fifth” to the energy price increase, according to Frans Timmermans, the EU’s climate chief.
Still, Spain called for measures to restrict trading on the EU carbon market, saying speculation has driven up electricity prices.
“EU ETS trading should not be available to all agents, especially not to speculators with market power,” it said in the non-paper.
For Madrid, the EU carbon market should act as a signal for industry to decarbonise, not as a tool for speculators to make easy money. “If financial speculation, rather than real factors, drives prices up too quickly, it threatens the smooth transition to an industry powered by clean energy,” it argued.
“A bubble on EU ETS is the last thing we need,” Madrid warned.
Spain is not alone in pointing the finger at speculators. An almost identical message came from Poland, which said the price surge seen on the ETS “is driven by speculation rather than market fundamentals.”
“The price hike of ETS allowances we are witnessing since the summer of 2020 raises concerns over a potential market bubble,” Warsaw said in a ‘non-paper’ of its own, circulated in October.
“This is putting the financial credibility of energy companies at risk, hindering the green transition of their assets and overburdening our most vulnerable citizens,” it added.
Energy poverty concerns
For Poland, the issue is not only about the green transition – it’s also about protecting people from energy poverty. In a country where GDP per capita is below the EU average, cushioning the impact of higher energy prices on small businesses and consumers is a top political priority.
According to Warsaw, the “creation of the new financial mechanisms and expansion of the existing instruments preventing and reducing energy poverty are needed urgently.”
Those mechanisms, it added, should be “embedded in EU funds” and “focused in particular on households, with an objective to address adverse social effects of the EU climate policy today and in the future”.
Poland also accused Moscow of engineering Europe’s gas supply squeeze and called on the European Commission’s antitrust department to look into potential abusive practices on the gas market.
At an EU summit in October, heads of states instructed the European Commission to look further into the issue, asking the EU executive to “study” trading behaviour on the EU carbon market and crack down on potential abuse on energy markets.
But until now, no smoking gun has been found.
A preliminary assessment by ACER – the EU Agency for the Cooperation of Energy Regulators – detected “no obvious indication nor evidence of systematic manipulative behaviour or insider trading” on wholesale electricity markets.
The agency only noted that nations with higher shares of natural gas and low interconnectivity with neighbouring countries were the most exposed to fluctuations in electricity prices.
Similarly, the European Securities and Markets Authority (ESMA) said growing interest from banks and hedge funds in the EU carbon market was no evidence of abusive behaviour.
“Open positions held by investment funds and other financial counterparties remain relatively low,” ESMA said in a preliminary assessment report.
Besides, the breakdown of open positions held by different categories of market participants – banks, hedge funds or traditional players – “does not appear to have significantly changed since 2018 and is broadly in line with the expected functioning of the market,” it said.
Yet, it would be incorrect to say speculators have had no influence on the ETS.
“In our work, we come to a different conclusion than ESMA,” said Dr Michael Pahle, a researcher at the Potsdam Institute for Climate Impact Research (PIK) in Germany.
“Financials might be more of a looming than a present threat to allowances markets,” Pahle told EURACTIV in emailed comments. But with the number of CO2 allowances set to shrink over time and the number of market actors widening, “allowing financials to operate without sufficient monitoring controls is a recipe for turmoil and serious market disruption,” he warned.
“In light of this, much better monitoring and integrated regulation combining financial and environmental market aspects is urgently needed,” Pahle said, noting that ESMA had also identified some data integrity issues on the ETS.
Other economists have taken a similar view. In a study published on 30 June, researchers Robert Jeszke and Sebastian Lizak said volatility on the EU carbon market is “resulting mainly from the growing role of speculative entities” and “can contribute to forming a price bubble.”
To prevent market instability, Jeszke and Lizak recommended introducing some kind of ‘safety valve’, which can be triggered when the situation requires it.
Data shows growing interest from speculators
But does the data actually confirm those claims?
Florian Rothenberg, an analyst at commodity intelligence services firm ICIS, took a deep dive into ESMA reports.
According to the data, “speculative positions from financial players have been building up since May 2020, increasing by 40 million tonnes of CO2 equivalent in net long holdings on the secondary market at the end of 2020 and oscillating between 40-64 million tonnes ever since,” he told EURACTIV.
“And at the same time, the price increased as well,” Rothenberg remarked.
New players on the EU ETS market include hedge funds, and commodity trading houses. But their positions are currently too small to be really significant, he cautioned.
“Currently there is oversupply of 1.4 billion allowances on the market. And speculative players from the financial sector – mainly hedge funds – hold about 46 million allowances on the secondary market, according to ESMA. So the fraction is very small.”
Besides, he said speculative positions on the market are held mainly by traditional players like power companies, which are required by law to cut their emissions under the ETS and buy allowances in anticipation of higher carbon prices in the future.
“Overall, we would estimate there are between 150 and 200 million speculative positions, of which two thirds approximately are held by the classic players on the market – so those industries covered by the ETS like the power generation sector,” Rothenberg said.
“What’s kind of new – and where the concern may be coming from – is so-called ETFs, or Exchange Traded Funds, which hold a long position of 11 million allowances,” Rothenberg continued, saying these positions have increased significantly and could be blocking carbon allowances that would otherwise be available to traditional market participants.
“However, we don’t see this to be a high risk at the moment, because the volume is not large compared to the oversupply in the EU ETS,” he added.
For Rothenberg, a bigger driver behind the CO2 price hike is the general tightening of gas supplies and the widespread anticipation by market players about growing scarcity on the carbon market, which is driven by the EU’s more ambitious climate policies.
Anyway, he said, speculation is not always a bad thing.
“It would be lying to say that there is not a growing interest from speculators. But speculation is not necessarily a bad thing – it’s something that helps to establish more market liquidity and price visibility and thus operators and regulated industries to hedge against future price fluctuations.”
Poland and Spain have called for restricting access to the EU ETS for financial players – basically reserving a greater share of carbon allowances to the industries covered by the ETS.
But Rothenberg dismissed the idea. “At what price would they trade? Would it be a lower price for compliance players? It doesn’t sound very realistic,” he said, adding: “Introducing holding limits as part of the current reform in my view would be rather counterproductive.”
And in case there is a sudden shortage of carbon allowances on the market, Rothenberg says mechanisms are already in place to stabilise the price.
“The European Commission already has tools like Article 29 (a) for example: If the carbon price would increase very rapidly, then they can decide to bring in more volume and liquidity to the market so that compliance players can buy volume.”
If anything, Article 29 (a) “is one of the elements that could be strengthened during the ongoing reform” of the ETS, he says.
Gas market reform
For others, the upcoming revision of EU gas market rules, due on 14 December, is also an opportunity to crack down on speculators.
“The EU should use the opportunity of the gas directive revision at the end of the year to look more precisely at the behaviour of some traders on the market,” said Claude Turmes, the energy minister of Luxembourg.
“There are indications that there are some extremely speculative traders on the market. And probably there is a need in this gas directive to come up with more detailed regulation on traders,” he told journalists during a visit to Brussels on 1 October.
Turmes also proposed imposing a minimum of hedging to all market participants to prevent excessive speculation on gas markets.
“It’s very important to understand that most gas companies in Europe have hedging strategies. We know that they have bought gas over the last year and a half at much lower prices. They have hedged their risks, and the price rise during the winter should be contained,” he said.
[Edited by Zoran Radosavljevic]