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Like the temperature, the price per ton of CO2 emitted (or equivalent) continues to skyrocket: on 30 June 2021 it was EUR 56, a rise of 130% year-on-year, and over 1,000% over 5 years! As with cyclical stocks, the starting point for this surge was Biontech/Pfizer’s announcement of an effective COVID-19 vaccine at the beginning of November 2020. In principle, there is no connection between the two. Except for the expectation of an economic upturn on the back of a lifting of health restrictions, which of course resulted in a run on pollution rights and the promise of soaring industrial activity, as has indeed been the case subsequently.
Fit for 55" - Structural upward pressure from new EU directive
On top of this purely economic factor comes structural upward pressure. European legislation has shifted decisively towards energy transition. On 14 July 2021, the European Commission will unveil its new “Fit for 55” package. Its aim is to reduce European carbon emissions by 55% in 2030 versus the 1990 level, paving the way for the target of carbon neutrality by 2050. It is expected that this package will drastically reduce carbon quotas for the coming years, and that additional, previously exempt sectors such as maritime transport could also be subject to these quotas, currently applicable to only 45% of carbon emissions. This is likely just the start of a broader regulatory shift internationally, since the US has now returned to the Paris Agreement.
CO2 price increase with profound consequences
The consequences of these price rises will be profound. Whilst initially beneficial for climate stabilisation, they will automatically result in more expensive production prices for goods, and potentially some services such as transport. For many companies this will mean margin pressure, which will be partly passed on to consumers, at least by those able to do so. This will ultimately result in more inflation.
So, although the price of carbon has been too low to represent a serious cause for concern until now, it could become a real economic and even political issue. How much more are consumers prepared to pay for their essential goods and services, in order to offset their indirect contribution to carbon pollution? How much margin reduction will company shareholders accept? How far is Europe prepared to take its pioneering role and effectively depress economic growth in favour of countries where the price of carbon is zero or less? Global legislation is an urgent necessity, but is it conceivable? The US seems to be in no hurry. China, although firmly committed to energy transition, has just postponed the launch of its carbon trading market. The economic war between regions subject to differing carbon prices is only just beginning.
New asset class CO2?
For investors, there is a clear lesson: stocks that benefit from energy transition are only just beginning to prosper. The higher the cost of carbon, the more profitable direct or indirect investment in decarbonised energy systems becomes. And financial instruments for investing directly in the price of carbon emitted may even become conceivable. Of course, a ton of carbon equivalent emitted has no intrinsic return, like any other commodity. But it is physically real and has an industrial usage value. Basically, buying carbon emissions and therefore supporting their price is a means of encouraging energy transition.
A new asset class, a new source of economic conflict, inflation, and pressure on corporate profitability, a new diplomatic challenge, a new topic for scientific, political and ideological controversy: carbon will be a hot topic for many years to come.
By Olivier de Berranger, CIO, LFDE