EU Emissions Trading

Reducing carbon emissions to become climate-neutral by 2050

The EU Emissions Trading System (‘EU ETS’) is the European Union’s key tool for reducing CO2 emissions by at least 55% before 2030 (compared to 1990), and achieving climate neutrality by 2050. Following the ‘Fit for 55’ strategy presented by the EU Commission in July 2021, the trading of emissions is being expanded considerably. From January 2026 there will be an additional trading system that includes carbon emissions from the transport and building sectors. The upper limits determined as at the launch of the system will then be reduced annually. The aim is to achieve a 43% cut in emissions by 2030 compared to 2005.

In future, the current EU ETS will include the maritime shipping industry for the first time. In addition, the free allocation of CO2 certificates for the aviation industry will be gradually phased out by 2027 – with similar steps planned for other sectors.

At the same time, emissions from the current trading system will be reduced to a greater extent than previously planned: whilst previous reduction targets foresaw 43% compared to 2030, the target has now been increased to 61%.

Phase 4 of the EU ETS will bring significant challenges

Whether they joined recently or have been participating since day one, all companies involved in the EU ETS will face significant challenges in phase 4, running from 2021 to 2030, as targets are increased.

  • • Rising carbon prices: Most market participants expect the new climate targets to trigger a significant rise in prices for European emission allowances (EUA). Over the past weeks, for example, there was trading activity in call options with a strike price of €100 per tonne of CO2 equivalent.*
  • Less free allocation: More ambitious climate targets will result in a lower level of free allocations to industrial companies. As a consequence, companies will have to buy additional emission allowances if they cannot reduce their needs through avoidance measures.

Reducing emissions or buying allowances?

A sharp analysis of the current situation and current climate plans as well as active management are critical, in our view. "Make or buy?" In other words: is it possible, from a technical and economic point of view, to reduce greenhouse gas emissions, or does the current situation require that EUA be purchased? Which financing options are available, and what can active risk management in this sphere look like?

How Commerzbank supports companies with risk management and emissions trading**

When prices for emission certificates increase, clients should hedge accordingly and cover themselves with EU emission allowances. Benefit from our extensive and proven experience in risk management, and from our know-how as a leading, long-standing player in emissions trading.

The number of companies attaching importance to sustainability and climate neutrality is increasing – also amongst those that do not participate in the EU ETS. We aide companies on their climate strategies, help them cut their emissions as much as possible, and use carbon credits to compensate the emissions that cannot be reduced.

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Active management of commodity price risk is increasingly important …

We can adapt our comprehensive range of services to match our clients’ specific needs. We provide information about relevant developments in the area of emissions trading, as well as legal changes and new trends. Any cooperation always starts with a precise analysis of the specific risks involved.

Whilst the active management of commodity price risk is increasingly important to companies, we also show them opportunities pertaining to the next phase of the ETS. We support our corporate clients from start to finish in the emissions trading process – starting from the assignment of free certificates in February of each year right through to settlement in April of the following year. Based on information provided, we calculate a potential surplus or deficit of emission allowances, presenting potential action strategies. For example, we will look at how EUA allocated for free can be used to optimise financing costs.

… adding to planning certainty

Together with each corporate client, Commerzbank will help to develop a bespoke risk management strategy, setting out the resulting strategies. One advantage: active risk management enhances planning certainty.

Frequently used strategy concepts include:

  • Passive strategies: Carbon credits are acquired shortly before the compliance reporting date; sales are made at the end of the year or quarter.
  • Tactical/active trading approach: Companies use market opportunities to buy or sell emission allowances as soon as a predefined price target has been reached.
  • Hedging/purchasing strategies: With this approach, enterprises regularly define a strategy as to how certificates will be acquired or disposed of.
  • Integrated risk management approach: Commodity, exchange rate, and interest rate risks are managed simultaneously.

Stronger exposure to commodity price risks compared to interest rate and exchange rate risks

Commerzbank has a broad range of instruments to help enterprises manage commodity price risks, with a specialised range available specifically for emissions trading. Given that companies have a much stronger direct exposure to commodity price risks – compared to interest rate and foreign exchange risks – there is a strong case for using these instruments.

Spot purchase or sales:

A company acquires or disposes of EU emissions rights with immediate delivery and pays or receives the corresponding price. This instrument can be used for annual settlement in April, or generate profit through sales.

Forward purchase or sale:

The company sets a price today at which their CO2 certificates will be bought or sold in the future, allowing the customer to hedge against rising or falling prices.

Limit order:

Commerzbank buys or sells emissions rights at a target spot or forward price on behalf of the customer. This strategy can enable companies to be highly flexible.

Purchase at average price:

Emissions rights are acquired or sold at a previously defined average price. In this way, companies avoid having to settle transactions priced at historically high or low levels.

Option:

Using options, or the right to be able to buy and sell CO2 certificates, customer’s hedge against extreme price developments. These can also serve as the basis for generating premiums.

Swap:

In order to manage their compliance positions, companies can exchange a set quantity of certified emissions reductions (CERs) for EU emissions rights (EUA).

Financing:

By simultaneously selling EU emissions allowances on the spot market and repurchasing these on the forward market, companies can receive funds and finance themselves.

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* as of August 2021

**Commerzbank offers its EU ETS services only to clients in the European Union, or with a European Union Registry account.

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Disclaimer

This publication is treated as customer information within the meaning of the Securities Trading Act. This information provides information only and does not constitute individual investment advice, nor does it represent an other to buy or sell any securities or other financial instruments. This document alone does not replace individual investor and/or investment-oriented advice.

Please read Commerzbank's full important notice / disclaimer here.