&l;p&g;&l;img class=&q;dam-image getty size-large wp-image-83950254&q; src=&q;https://specials-images.forbesimg.com/dam/imageserve/83950254/960×0.jpg?fit=scale&q; data-height=&q;640&q; data-width=&q;960&q;&g; Didcot Power Station, in the U.K. (Photo by Matt Cardy/Getty Images)
The best-performing energy commodity over the past year is not oil or gas &a;ndash; it is carbon allowances from the European Union&a;rsquo;s carbon market, the EU Emissions Trading Scheme (EU ETS).
The price of a tonne of carbon emitted under the ETS is now nudging &a;euro;15 (it was &a;euro;14.35 at the time of writing) a level it has not seen for seven years &a;ndash; and it is predicted to rise even higher in years to come.
Financial think tank Carbon Tracker says that the allowances will double in price by 2021 and could reach &a;euro;55 a tonne by 2030 if the European Commission introduces rules that align EU emissions targets with the requirements of the Paris climate agreement. This would have a radical effect on Europe&a;rsquo;s energy markets, spelling the end for coal-fired power and leading to a surge in renewable energy, energy efficiency, energy storage, smart grids and demand-side response. It also highlights how other economies around the world could be affected by their own carbon markets.
The EU ETS limits the amount of carbon emissions that energy-intensive industries that are responsible for half the EU&a;rsquo;s emissions can emit. Companies are given a certain number of allowances (EUAs) to cover their emissions, which they can sell. If they need more allowances because they emit more than their allocation, they can buy them in the open market. The amount of emissions the relevant industries can emit falls over time, which should lift prices, encouraging scheme members to switch to cleaner fuels and cut emissions.
But the market has been plagued by a combination of fixed supply and varying demand. Allowances have languished at around &a;euro;5/tonne for the last six years because the financial crisis and subsequent recession slashed demand and led to a massive glut of EUAs. By the end of 2016 there was a 1.7 billion tonne surplus of allowances in the market &a;ndash; almost the same as the 1.75 billion tonnes of annual emissions covered by the scheme.
Now that the EU has emerged from recession, and following the signing of the Paris Agreement, the bloc has agreed a plan to get rid of the surplus. From January 2019 a Market Stability Reserve (MSR) will cancel 24% of the surplus each year up to 2023 and 12% thereafter.
Carbon Tracker expects the move to take 3 gigatonnes of allowances out of the market by 2023 &a;ndash; almost two years&a;rsquo; worth of current emissions in the ETS. As the surplus shrinks and allowance prices rise, companies covered by the scheme will have to cut their emissions or pay sharply higher prices for allowances to cover their emissions. Those that cut emissions sufficiently to have spare allowances will earn much more by selling them.
EU ETS prices are already rising in anticipation of the move. Carbon Tracker, in a new report, &l;em&g;Carbon Clampdown: Closing the gap to a Paris compliant EU-ETS&l;/em&g;, forecasts that they could reach &a;euro;15/tonne in the second half of 2018, &a;euro;20 in 2019 and &a;euro;25-30 in 2020-21 as the supply squeeze really starts to bite.
EU governments have also asked the European Commission to come up with a strategy that cuts the bloc&a;rsquo;s emissions in line with Paris Agreement targets, which would force carbon prices higher still. To meet the target, EU emissions would need to fall 55% from 1990 levels by 2030, against a current target of 40%. If such a strategy was adopted, Carbon Tracker warns that it would sound the death knell for coal-fired power generation in Europe &a;ndash; allowance prices would have to rise to &a;euro;45-&a;euro;55 to meet the targets &a;ndash; levels that would make even the most efficient coal and lignite power plants unprofitable.
&a;ldquo;Life is set to get much tougher for EU coal generators. Higher carbon prices will eat further into operating margins that have already been severely eroded by the growth of renewables, forcing less efficient coal plants off the grid altogether. Under a Paris-compliant EU-ETS cap the shock to coal would be even greater, forcing all coal and lignite plants &a;ndash; even the most efficient &a;ndash; either off the grid or to the margin,&a;rdquo; said Mark Lewis, Carbon Tracker&a;rsquo;s new head of research.
That would lead to a big switch from coal to gas in Italy, Spain, Germany and the Netherlands (the U.K. has largely already achieved this switch thanks to its higher domestic carbon floor price). High carbon prices are also likely to accelerate the development of new technologies such as large-scale energy storage, smart grids and demand-side response, where energy users shift consumption away from peak periods.&l;/p&g;
The tightening of the market could even have knock-on effects across the Atlantic, reversing a recent increase in demand for US coal exports &a;ndash; the Netherlands was one of the top markets for US coal in 2017 while Germany, Italy, Poland and Spain also became significant buyers.
The EU&a;rsquo;s move also provides an illustration of what could happen in other carbon markets, from China to regional North American schemes such as the Regional Greenhouse Gas Initiative (RGGI) and markets in California and Quebec.
&a;ldquo;A higher carbon price, in the short term, means higher costs, but it also creates an incentive for businesses to become more inventive,&a;rdquo; Lewis told the UK&a;rsquo;s Sky News recently. &a;ldquo;Part of the logic of having a traded market is about price discovery and finding ways of making things more efficiently.&a;rdquo;&l;/p&g;