The Inevitable Correction

The EUA market has unique characteristics: a government-defined supply, no storage nor production costs and an important role in promoting decarbonisation – a role which will strengthen as the cost of pollution rises.

Supply and demand for EUAs have each been influenced by both politics and economics since the inception of the Emissions Trading System, however the introduction of the Market Stability Reserve (MSR) policy mechanism has brought a new robustness to the regime, correcting any unexpected shocks to maintain tightness by design. Examples of this have included the abrupt price drop of EUAs in the early days of the pandemic, which reverted as the market grasped that the MSR would lead to constrained supply, and latterly the approval of Repower EU Plan in response to the invasion of Ukraine, which increased the short-term supply of EUAs, leading to the current EUA price weakness.

Carbon markets have anticipated the changes in the balance between demand and supply. The current oversupply of EUAs is a favourite on the watchlist and while there has been recent bearish sentiment, a correction is inevitable given the unprecedented supply deficit indicated by the mid-term market fundamentals. Timing the inflection point in price is nearly impossible but we can look at how the market has reacted to similar situations in the past to infer 2025 structure looks remarkably similar to 2018 and 2021 when EUA price tripled and doubled respectively.

This paper first sets out the short-term bearish outlook focusing on the imbalance between demand and supply. We then highlight the reasons for the incoming correction to this imbalance and look into similar price inflection situations in the past.

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