Reducing carbon emissions through emissions trading: Achieving climate neutrality by 2050

Scenic aerial drone view of yellow rapeseed fields

Considering its climate strategy, the European Union has set an ambitious target for Europe to be the first climate-neutral continent in the world, with no net emissions by 2050. To achieve this, a comprehensive package of measures, known as the "Green Deal", has been adopted in 2019.

What is EU emissions trading?

The EU Emissions Trading System (“EU ETS“) is the European Union`s key climate policy tool introduced in 2005. The EU ETS aims to reduce emissions in a cost-efficient manner and with market-based instruments. The system works under the “cap-and-trade” principle with the definition of an absolute emission cap and the ability to trade emissions allowances (so called EU allowances (EUA)) with each other.

How will EU emissions trading develop in the future?

At the end of 2022, EU parliament, commission and council reached a provisional agreement within the so called “Trilogue” negotiations consisting of wide-ranging measures to expand the scope of the EU ETS to reach EU`s ambitious climate policy targets. The agreement comprises the inclusion of maritime shipping, the introduction of the “Carbon Border Adjustment Mechanism” (CBAM), the gradual reduction of free allowances granted to the industry and the implementation of a separate ETS (“ETS II”) for emissions of road transport and buildings (similar to the German national emissions trading system (nEHS)).

Simultaneously, measures were introduced to reduce emissions even further than before by 62% until 2030 compared to 2005 levels. These measures include both an absolute reduction of EUAs available and an increase of the annual reduction factor (“linear reduction factor”).

What are the challanges for companies?

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: due to the stricter climate targets and expected shortage, the prices of EUAs have risen sharply in recent years. In addition, the increased price volatility poses challenges for risk management.
  • Less free allocation: From 2026 onwards, granting of free EUAs will be reduced gradually until finally terminated in 2034. As a consequence, companies will have to buy additional EUAsif they are unable to reduce their needs through avoidance measures.

CO2 price in EUR per tonne

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 trading1

  • Benefit from our extensive experience in the area of ​​risk management and our know-how as a leading and long-standing player in emissions trading.
  • We advise companies on their climate strategy with the aim of reducing emissions as much as possible and voluntarily compensating for the unavoidable remainder with CO2 certificates.

Contact our expert

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 EUAs , presenting potential action strategies. For example, we examine how EUAs allocated for free can be used to optimize financing costs.

Which strategies are frequently used?

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

Passive strategies:

EUAs 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 EUAs 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.

The most important instruments for managing commodity price risks

In emissions trading in particular, there is a comprehensive range of instruments for managing commoditiy price risks. And this should adefinitely be used by everyone, because compared to interest rate and exchange rate risks, the direct impact on companies in the commodity sector is much greater.
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    Commerzbank offers its EU ETS services only to clients in the European Union, or with a European Union Registry account.