Potential German carbon price unlikely to hit power sector

Debate around a domestic carbon price has ramped up in Germany this year

A recent electoral surge by the Green party as well as climate targets are driving discussions

A domestic carbon price is unlikely to apply to the energy sector

LONDON (ICIS)–Following dismal election results for the ruling German coalition and a surge for the greens in recent EU elections, the debate around a German carbon pricing mechanism has intensified. It is unlikely that an adopted domestic policy will be extended to the power sector, ICIS analysts say.

Any potential risk premium priced into German power futures contracts will be eased if ICIS analyst expectations are proved correct, as a domestic carbon price on top of the EU emissions trading system (ETS) for the energy sector would have boosted German power prices due to the high share of coal and lignite in the country’s power generation mix.

Why has the debate ramped up?

Discussion around domestic carbon pricing has ramped up this year following key events such as the publication of the final coal exit report in January, the first draft of the German climate action law and the recent European election results.

With Germany unlikely to meet 2020 Paris agreement targets, Chancellor Angela Merkel has set up a climate cabinet that will convene next in mid-June to discuss a potential carbon pricing mechanism to help it meet 2030 carbon reduction targets.

More recently, the Green party overtook the Social Democrat party (SPD) for the first time in a nationwide poll at the EU Parliament elections, forcing the SPD leader to resign.

Why is a carbon price unlikely?

There is little political appetite for a carbon pricing mechanism to be extended to the energy sector, as is the case in proposed Dutch legislation .

When Merkel has spoken on the topic she has referenced only non EU ETS sectors such as transport, buildings and agriculture.

Most calls, such as those published by influential association BDEW on Wednesday, want a domestic carbon policy implemented for sectors currently outside the EU ETS.

The EU ETS is a cap-and-trade market system whereby European power generators are obliged to purchase allowances to emit carbon.

In light of recent EU policy that artificially tightened the carbon market, carbon prices have soared. The rolling benchmark EUA front December contract has grown by approximately 50% since last June, ICE data showed.

ICIS analyst models forecast carbon prices to keep rising until 2024 where the front December could reach above €40/tCO2e .

There is evidence that the EU ETS is significantly reducing carbon by driving hard coal out of the German generation mix in favour of relatively less emission-intensive gas-fired generation.

ICIS ANALYST VIEW

Despite the current carbon price momentum, Germany has historically been opposed to such a market mechanism for the power sector beyond the emissions trading system, having repeatedly rebuffed French overtures towards a regional or EU-wide carbon price floor in recent years.

We do not expect the government to change its approach now for the power sector, especially as a coal phase-out plan is in the pipeline following the publication of the coal commission report in January.

Given this fact, negotiating directly with companies to take coal plants offline provides a lot more control and certainty over the timeline without leaving it to EUA market developments.

If the government wanted to go further than the coal commission’s proposals in cutting CO2 in the power sector, which we think is unlikely, it would be easier to directly mandate more coal capacity closures rather than attempting to raise the carbon price to push plants offline.

A full analysis including market impact, is available on the ICIS Power Perspective interactive web platform. If you have not yet subscribed to our analytics products, please get in contact with Justin Banrey (justin.banrey@icis.com).