The end of free emission allowances in Europe
The European Union’s Emissions Trading System (EU ETS) incentivizes companies to lower their emissions to support the region’s net zero goal. Adam Gustafsson and Ellis Eckland, UBS-AM research analysts, explore how the expected withdrawal of free emission allowances within the EU ETS might affect the economics of countries, industries, and individual companies. Some novel analysis and collaboration with Marcus Ferdinand, Chief Analytics Officer at the low carbon market insights firm Veyt, provide a look at how decarbonization could provide benefits to a forward-looking steel company.
The analysis suggests a higher carbon cost for climate laggards may be significant, but likely to be passed on to customers, driving up the steel price. Companies that decarbonize may benefit twofold: they avoid the higher carbon cost while still benefiting from higher steel market prices. Threefold, if their customers are willing to pay a price premium for low-carbon products. However, decarbonizing steel production requires significant investments. Uncertainty around regulation, the future carbon price, and green price premiums makes these large transformative investments risky.
Key takeaways:
Sixty three sectors and sub-sectors are receiving free allowances essentially covering 100% of their emission cost- As the power sector continues to decarbonize at pace, industry is expected to become Europe’s highest emitting sector
- Companies in the steel sector receive the most free allowances
- Steel producers that move forward with costly decarbonization investments are dependent on support from green premiums and a meaningful carbon price
- While there are no obvious paths forward, we still believe companies taking action represents the best risk-reward for investors