EU carbon prices have found a solid underpinning above €20 in the last four months of 2007, but there are forecasts that prices could go higher next year and beyond as we head into phase two of the EU Emissions Trading Scheme (EU ETS).

The benchmark December 2008 contract closed lower on Monday December 10 at €22.35 on the European Climate Exchange. The benchmark contract was about 10 euro cents lower than a week before and about 20 cents lower than a month before. Dec 09s closed at €22.87 and Dec 10s at €23.45.

EU carbon prices have risen since mid-year to establish a solid foundation above €20 and in the last quarter of 2007 have traded in the €21.50 to €23.50 range.

The prices of coal, gas and power in Europe, particularly the German baseload electricity contract, continue to be the main day-to-day drivers in the market. Carbon prices and German power tend to move together.

Overriding the daily influences from time to time are developments affecting the outlook for supply and demand for emission allowances and Kyoto offset credits over the medium to longer term. The biggest of these factors is the allocation of EUAs by the European Commission over the phase two 2008-12 period.

Following the finalisation of national allocation plans (NAPs) this year, most analysts and market participants agree the underpinnings of a healthy market are in place. There will it seems be a shortage of EUAs compared to emissions around the EU supporting healthy trade and prices.

There are other signals suggesting carbon prices maintain current levels or go higher. The inclusion of the aviation sector in the EU ETS from 2011, EU emissions reduction targets of at least 20 per cent by 2020 and Germany unilaterally committing to 40 per cent cuts by 2020 suggest ever tighter emissions allocations beyond 2012 - and an ongoing shortage of allowances.

A possible downside for prices lies in a large potential volume of cheap Kyoto offset credits materialising. These CERs and ERUs can be substituted for EUAs and are significantly cheaper. There are strict limits to the volume of offsets that can be used in the EU ETS but the limits still add up to a fair proportion of each country’s emissions reduction obligation.

Deutsche Bank has reiterated its price forecast for the phase two period of carbon prices in €35 range, well up on current levels in the low 20s, adding that the Bali meeting outcome, a step towards a new global climate agreement, adds to a positive picture for carbon trading beyond 2012.

While most of these developments will occur in phase three of the EU ETS, Deutsche says they will have an impact in the coming five years of phase two because off the ability to ‘bank’ allowances, or save those allocated in phase two for use in phase three.

We’ll know more about where carbon prices might be heading in late January when the European Commission reveals its plans for Phase III up to 2020. This should include details on auctioning the majority of allowances in the power sector and confirmation of bankability.

More:
How the EU emission trading market operates
Brussels finalises new ETS quotas
CER market report
ALL carbon market reports