Commodities 2023: K-ETS players seek wider market, policy actions after 50% drop in KAU prices

South Korea's emission trading market participants expect wider market participation and policy reform implementation from the government in 2023 to help carbon prices sustain after Korean Allowance Units dropped 50% this year marred by oversupply.

Market participants surveyed by S&P Global Commodity Insights said the government will need to act swiftly in implementing ETS changes it proposed this year in 2023 to help strengthen the national reduction target even as economic headwinds will pressure corporate budgets for climate finance.

The KAU prices halved in 2022, as the market struggled to find buyers, with the impact of the Ukraine-Russia war and inflationary pressures preventing corporates from having dedicated ETS budgets, while an oversupply of free allowances provided little incentive to pick up KAUs.

The South Korean government announced major reforms in November split into short-term tasks and long-term initiatives, including incentives to low emitters, easier procedures, expansion of market participants, as well as adjusting emissions caps and expanding paid allocations.

That was followed by the decision on Dec. 16 to make a 20% cut in the number of allowances to be available at auctions next year, after being able to sell only half the KAUs it planned this year.

"A little too late for any impact," said one market source on the auction trim plan but expected reforms to trickle in 2023.

"We are expecting the release of the roadmap by the first half of 2023, earliest at the end of the first quarter which will give more certainty of government's reform plans," said a second market source.

An emitter source said the government did not have the will to realize the nationally determined contribution, or NDC, target through the ETS as of now. "It may be reflected in the 4th planning period (2026 onward), not now."

Another Seoul-based market source said third-party consignment sales will be allowed in 2023. However, the derivatives market is unlikely to be allowed next year.

The K-ETS currently has limited participation from emitters, designated market makers, and a handful of security companies. The government has proposed the number of market makers to be increased and 20 securities companies to get emission rights expansion of about 200,000 mt.

"If 20 securities companies start carbon asset management services and actively participate in consignment trading, the price can rise," said the Seoul-based source.

Although market makers have been able to countervail liquidity constraints by intervening, sources said trading volumes from market makers were not enough.

"New market makers would provide some buffer for KAUs oversupply, but it should be noted that they are strategic, not passive," said another market source.

Economic headwinds

South Korea, Asia's fourth-largest economy, is expected to continue facing economic headwinds with S&P Global Ratings forecasting real GDP growth of 1.4%, down from the country's estimated growth of 2.7% in 2022.

"There is a grim business environment forecast for next year's business for most of K-ETS entities," said a market-maker source. "The not-so-optimistic forecast on economic growth would lead to less demand for KAUs."

Given the oversupply of KAUs amid a tightening of corporate climate budgets in a slow growth environment in 2023, emitters may not pick up surplus allowances more than those absolutely needed for compliance, sources said.

Prices may tumble further in Q1

Sources expect KAU prices to dip further in Q1 and then likely bottom out, picking up by Q2, with market stabilization measures coming into play and as companies approach the mid-year compliance deadline.

One source pegged prices to remain around Won 15,000-20,000/mtCO2e ($11.84-$15.79/mtCO2e), while a second source said prices would languish in the Won 12000-16000/mtCO2e range for most of Q1 before any potential rise.

A third source said average prices would be around Won 12,900-18,500 until Q2 and overall prices in the range of Won 16,000-20,000.

At the market close Dec. 29, the KAU price on the Korea Exchange closed at Won 16,550/mtCO2e, just about half the value since the beginning of the year.

Global developments, pricing trends

Sources said unless a bilateral announcement with the EU regarding CBAM or anything concrete came out of further Article 6.2 and 6.4 discussions, KAU price impact will mostly be limited to national policies and economic pressures.

"The market is very interested in Articles 6.2 and 6.4 as they have a big impact on K-ETS, but also on VCM (voluntary carbon market). However, we do not expect specifics in 2023," said a source.

Voluntary carbon market prices have also tumbled this year after seeing record-breaking prices in 2021. The Platts-assessed CEC price, reflecting bids, offers, and trades for CORSIA-compliant credits, was down 63% as of Dec. 28, while the Platts CNC, which reflects the most competitive nature-based carbon credits that either avoid or remove GHG emissions, slumped 68% during the same period.

The price trajectory in 2022 for other Asian ETS markets was mixed this year, with New Zealand Units having a decent run through 2022, up about 13% to remain Asia's highest carbon prices, while ACCUs in Australia are down over 30% in 2022 driven by a supply glut.