Anyone trading in the EU’s carbon market over the last few weeks would be forgiven a bit of nausea, for it has been a rollercoaster ride around COP28 in recent weeks. After the ETS breached the historic €100/T barrier in the Spring of 2023, the run-up to COP saw it grind lower, followed by a precipitous collapse from over €80 to €70 in the few days of the conference itself – a low not seen since the post-Ukraine panics of 2022. But as COP wrapped up it began another whipsaw in the other direction, returning to €80 as I write.

Six weeks of sturm und drang, all to end up back where we started. In other words, markets are as crazy as they ever were! But there are real clues here for the direction of prices in 2024 and beyond.

The obvious explanation for this market panic was the perceived failure of COP28, and in particular the inability to agree on carbon trading rules through the Article 6 negotiations. On the other hand, a few commentators have pointed to the subsequent steep bounce as evidence of a ‘sell the news’ moment, with dour internal sentiment running far ahead of reality. 

Which side has it right? Is 2024 going to see the EU’s carbon price snap back to a secular upward trend, or be punished for the global failure to agree a common Article 6 framework? 

It’s the COP, stupid

Let’s begin with the pessimists view because it has the merit of simplicity: carbon prices crashed because COP28 failed. The Stocktake was too weak, suggesting that the risk of missing net zero has increased. Progressive blocs were outmaneuvered by OPEC and the fossil fuel lobby, demonstrating that Big Oil will continue to hamstring climate governance. And the fact we left the conference with no Article 6 text at all leaves existing carbon markets dangerously exposed. 

The common denominator in all these arguments – and the key to their appeal – is their lack of nuance. This is an impressionistic evaluation of the conference, one more interested in mood music than detail. I myself was bitterly disappointed too; but emotions shouldn’t dictate long-run investment decisions. 

A more objective observer might raise an eyebrow at the idea that COP represented a great miss on the creation of a unified global carbon market. To anyone seriously engaged in the detail of the parallel negotiations on Article 6.2 and 6.4, that was never a realistic outcome. The world is already littered with carbon market mechanisms – yes, even in the US and China – and historic path-dependency means few see a novel ‘all-for-one’ solution as particularly enticing.

Meanwhile, other market observers have also pointed to alternative explanations for struggling prices, from a warm European winter to secular weakness in the wider energy edifice. I agree, but I want to make a stronger argument here too: because the idea that COP28 represents a headwind for carbon prices isn’t just false, but backwards. If anything, events in the UAE will only drive long-run prices higher. Here’s why.

Double-plating the gold standard

The Article 6 failure was only the crowning moment in a disastrous year for VCMs, as a series of scandals demonstrated just how corrupt and poor-quality most schemes truly are. The failure to agree at COP was an extension of that, as the progressive bloc (EU, LatAM, some Asia etc) refused to let the rot creep into a UN-sanctioned framework. 

All that only strengthen the EU ETS’s position as the world’s pre-eminent carbon market. Higher regulatory hurdles and more stringent transparency and reporting leaves a European tonne untouched and undiluted, a true gold standard in carbon accounting. That is reflected in a consistently higher price floor. 

Furthermore, the ETS has been a walled garden from the beginning, with no mechanism for importing or exchanging foreign credits; and the ‘Fit For 55’ transition plan has locked in the regulatory pathway to 2030 already. The EU’s carbon price was never relying upon COP to begin with, has driven prices higher for two decades without it, and likely wouldn’t have been materially impacted by a successful negotiation anyway.

What the blow-up in Article 6 negotiations (together with the EU’s own carbon border tax) does mean is that 2023 is likely to go down as the year that the world gave up on a single global carbon market, and settled for inevitable balkanisation instead. This need not be a less effective outcome; but a patchwork system will be less efficient, more expensive, and more diverse in quality. That will make losers of some, but winners of the European Union – reinforcing their quality moat and entrenching a comparatively higher price floor.

2024 and beyond

Even the headline success/failure arguments over the Global Stocktake are bullish for EU prices. NDCs will take the cue (and feel the pressure) from the ‘transitioning away’ language to ratchet up ambitions for next year. At the same time, we have again kicked the can down the road on implementation. This combination – greater long-term ambition with more short-run delay – only steepens the eventual decarbonisation curve. That in turn will lower future caps, squeezing supply even as demand increases, with businesses competing to force mandated reductions into ever shorter time frames. Leaving aside the wider debate over greenflation/degrowth, simple market dynamics suggest higher prices to come. And beyond COP, the business world is already starting its race to the top in earnest. Failing on Article 6 won’t change that.

Overall, I see the recent market rollercoaster as sentiment – a bad case of the COP blues – momentarily overriding rationality. But when carbon traders behave like redditors, there is an opportunity for cooler heads to pick up some long-run bargains. The value of a tonne of EU carbon is only going in one direction, throughout 2024 and beyond. And strange as it might seem to say, the failures of COP 28 will only make it more valuable still.