Research

For a couple of years since the “Fit-for-55” reform package became a law, the European carbon market has been driven mostly by the economy and coal-to-gas switching, as the regulatory activity slowed down. We are now entering a phase where regulatory developments are accelerating, many of which have the potential to tighten the supply-demand balance and, as a result, provide tailwinds for European Union carbon allowances (EUAs).

As the European Union advanced its “Fit for 55” legislation into law, the EU carbon allowance (EUA) market has experienced strong tailwinds, showing an appreciation of 156% since the legislation was first proposed in 2020 to when it became law in 2023. As of late, however, EUAs were in the regulatory doldrums as the EU had to deal with its election cycle in 2024, giving back 16% of these gains through the end of the last year.

The California carbon market has been a star performer, garnering growing attention from financial players. For the last five years, from 2019 through 2023, California carbon allowances (CCAs) appreciated 13.6% per annum. This great run was interrupted in 2024, with CCAs declining from $42 at the beginning of the year to $36 at the end of September. 1 While many factors may explain underperformance, we focus on what we think has been a major contributor:

The Carbon Border Adjustment Mechanism (CBAM) is poised to be one of the most transformative regulatory initiatives in the global carbon market, reshaping not only the EU Emissions Trading System (EU ETS) but also influencing carbon markets worldwide.

Supply and demand dynamics play a pivotal role in determining price direction in various markets, and carbon allowance markets, which are an integral part of the Emission Trading Systems (ETS), are no exception. However, there are specific elements of supply and demand that are unique to carbon markets, as we discuss in this paper:

In recent years, the world has experienced unprecedented climate events. September 2023 was the warmest September on record, reaching 1.44°C (2.59°F) above the 20th century average temperature. In the same month, we witnessed an unprecedented amount of rain and floods, which caused devastation in New York, Brazil, Libya, and Hong Kong. While no specific event can be directly attributable to global warming, these events highlight the urgency and importance of coordinated action to address climate change.