Potential Reforms of the European Carbon Market to Enhance Price Signals

Europe’s ambition to fast-track the decarbonization of its economy requires a strong and predictable carbon price signal. The recent surge in European carbon prices level and volatility and the growing activity of financial players has sparked a debate about the role and potential impact of speculative trading in the EU Emission Trading Scheme (“ETS”) and more fundamentally about a reform of the ETS to stabilize EUA prices.

Compass Lexecon was engaged by Polska Grupa Energetyczna S.A., a state-owned public power company and the largest power producing company in Poland, to :

  • Assess the recent increase in EUA prices level and volatility in the light of the evolution of fundamental drivers of supply and demand in the EU ETS market;
  • Assess the role and potential impact of speculation and of financial players in the EU ETS market, both on short-term EUA prices volatility and long-term price signal for decarbonization;
  • Map the possible measures to enhance EU carbon price signals and the functioning of the EU ETS.

We concluded that the increase in EU carbon prices level and volatility over the past years do not seem disconnected from the evolution of market fundamentals. Some indicators suggest that the increase in financial trading could also have contributed to the increase in volatility of EUA prices. In addition, we identified the structural features of the EU ETS market design which explain the high volatility and could favor speculation, particularly at this time of high uncertainty on the future scope and design of the EU ETS.

EUA prices’ lack of predictability could have significant short- and long-term consequences on the EU policy objective to fast-track decarbonization, including higher compliance costs for obliged entities and higher decarbonization costs. The report concludes by identifying a toolkit of measures that could prove helpful to improve the ability of the EU ETS market to provide a predictable and efficient price signal for decarbonization.

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The technical paper will follow in the coming weeks.


This report was authored by Compass Lexecon professionals Fabien Roques, Guillaume Duquesne and Florian Bourcier. The views expressed in this report are those of the authors only and do not necessarily represent the views of Compass Lexecon, its management, its subsidiaries, its affiliates, its employees, or clients.