The war in Iran exacerbates turbulence in Europe’s carbon market
Soaring gas prices have implications for the EU ETS, which is under review this year
“Without ETS, we would now consume 100bn cubic meters more gas”, European Commission President Ursula von der Leyen said last week. Von der Leyen’s call to modernise EU’s Emissions Trading System (ETS) came amidst growing political friction over the ETS and a bearish pressure on prices.
The war in Iran has added volatility and scrutiny to the world’s oldest cap-and-trade carbon market. Higher gas prices have implications for ETS carbon prices as well as Europe’s wider energy transition.
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Pricing conflict
When Russia launched an invasion of Ukraine in 2022, the ensuring energy crisis added nearly €1tn to Europe’s energy import bill. The on-going conflict in the Middle East has had a similar effect, although to a varying degree.
Estimates by Ember, a think tank, shows the cost of gas-fired power in Europe has risen by over 50% thus far.
“Once again, global conflict has sent gas prices soaring with potentially dramatic economic consequences for import dependent regions”, writes Chris Rosslowe, a senior energy analyst at Ember.
Rising gas prices add to the existing political pressure on the EU ETS. Italy’s industry minister, for instance, has pushed to suspend the ETS while it is under review.
“On the one hand, the high gas price is resulting in the burning of more coal, resulting in greater demand for allowances. On the other hand, higher energy prices mean that some EU member states are lobbying to weaken or even suspend the ETS”, says Richard Folland, head of capital markets policy at Carbon Tracker.
Foland, a former head of international energy policy at the UK Foreign Office, says suspending the ETS would be counterproductive.
“The ETS remains a cornerstone of Europe’s decarbonisation strategy, and the policy response in Europe to events in the Middle East should be to double down on decarbonisation and clean energy - not the short-sighted, quick fix of more fossil fuel production”, he told Net Zero Investor.
Duration risk
The EU ETS is under review this year. The backdrop of rising energy price volatility will inevitably become part of ETS-centred debates in Brussels. The conflict exacerbates political risks surrounding the ETS – in effect increasing regulatory uncertainty.
A note from Redshaw Advisors, a risk advisory firm, highlights a crucial factor at play – conflict duration.
“For the carbon markets, the impact of the war will largely depend on its duration and the ability of energy shipments to move through the Strait of Hormuz”, it reads. The longer the conflict runs, Redshaw’s note reckons, the more likely ‘industrial demand destruction’ becomes.
Another research note, published by Royal London Asset Management reaches similar conclusions. Geopolitical energy shocks, RLAM says, creates ‘two-way ESG effects’.
Shocks either improve the economics of renewable energy or produce short-term policy fixes that undermine long-term energy transitions. The difference is not only duration but also policy response.
Energy price volatility, RLAM’s note says produces social pressures that “can translate into political resistance to climate policy, including pushback against carbon pricing”.
“Higher oil and gas prices are not a reason to weaken carbon markets. The EU should have the confidence in carbon pricing as an effective and proven policy tool, and resist the calls from special interests to weaken the mechanism”, notes Folland.
Ahead of the EU Council meeting this week, the war in Iran brings Von der Leyen’s call to modernise the ETS into the limelight. Political choices over its future will shape Europe’s carbon prices – and the wider energy transition they feed into.
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