UK carbon market revival holds ahead of elections

The UK carbon market is braced for change in the event of a Labour victory in the July 4 general election, with speculation rife concerning the country's decarbonization strategy.

Analysts and traders expect a potential Labour government to look at closer trading links to the European Union, potentially seeking alignment of the UK's compliance carbon market with the EU Emissions Trading Scheme.

UK Allowances have endured a tricky 12 months as Prime Minister Rishi Sunak watered down climate commitments, delaying a ban on sales of internal combustion engine cars and rowing back on a gas boiler phase out.

This and other moves exacerbated an already weak carbon complex, under pressure from reduced gas-for-power burn, a higher share of renewables in the mix and shaky manufacturing data.

UK carbon prices, however, have seen a steady rebound in the past few months on expectations that a change in government will be bullish for the country's energy transition.

Platts, part of S&P Global Commodity Insights, assessed UKAs at GBP45.74/mtCO2e ($57.98/mtCO2e) on July 1, a steady recovery from Jan. 29, when they were assessed at a record-low of GBP31.42/mtCO2e.

UKAs briefly rose to an eight-month high of GBP50/mtCO2e on June 18 on stronger demand, along with reports that a new Labour government would seek to link the UK's compliance market with the EU ETS.

"A Labour victory could still be the catalyst for a short-term spike above GBP50/mt, but if UKAs overextend themselves without solid foundations, sellers would be glad to take money off the table again," an analyst at Carlton Carbon said.

Price divergence

UK and EU carbon prices have diverged in the past 12 months.

Last summer, EUAs were at a premium of almost Eur40/mt to UKAs as Sunak set out his energy bill-saving agenda. But in June, EUAs were trading at a premium of Eur10-Eur15/mt to UKAs, as the European market reflected a resurgent far-right in the European Parliament, along with fragile demand due to economic headwinds.

Tim Atkinson, Director of Carbon Sales and Trading at CFP Energy, said the slump in UK carbon prices last year was directly due to the rolling back of the government's net zero promises.

"However, the price of UK carbon allowances unexpectedly rose from their recent record lows over the last month, driven in part by an increase in buying from traders who see a Labour government taking a tougher stance on carbon emissions, including tougher targets for the UK ETS, should they win," added Atkinson. "It seems clear that the market views the Labour party as having a sterner approach to climate and sustainability issues."

EU ETS linkage

There is also pressure from many quarters in the energy and renewables sector for Whitehall to link its Emissions Trading Scheme with the EU's cap and trade carbon pricing system.

Trade body Energy UK has repeatedly warned that "weak and volatile" carbon prices under the UK ETS were undermining investment in clean energy, and with the introduction of the EU's Carbon Border Adjustment Mechanism, UK companies could incur "hefty costs" for simply trading with its largest export market.

If UK carbon prices remain at a sharp discount to EUAs, UK companies will have to pay a hefty cost on the price disconnect if they still want to keep exporting these goods to the EU.

Analysts with S&P Global Commodity Insights expect the upcoming UK general election to significantly influence the country's decarbonization efforts.

"The Labour Party's strategy for making UK a clean energy leader, as outlined in its 2024 manifesto, proposes advancing the net-zero electricity system target to 2030, five years ahead of the current Conservative government's goal," the analysts said in a recent note.

"If implemented, the plan aims to drive private investment in clean energy and position the UK at the forefront of the global green economy, although there has been no commitment to significant additional public funding."

The UK ETS, which became operational in 2021, is currently in its first phase, set to run until 2025. It regulates CO2 emissions from power generation, emissions-intensive heavy industries and aviation -- a similar sectoral scope to the EU ETS. The UK has set a target to reduce emissions by 78% by 2035 compared with 1990 levels before reaching net zero by 2050.