The UK carbon market has experienced a significant downturn, with carbon prices falling to their lowest in five months during early October. Prices declined to £35.6 per ton ($47.2 per ton) as investors exited, driven by delayed policy proposals affecting permit supplies, reduced demand due to lower emissions, and the closure of the UK's last coal-fired power plant at the end of last month.
With business confidence low and economic output weak, carbon prices may continue to face downward pressure. However, potential recovery isn't out of reach. If future measures tighten supply, discussions around carbon market reforms might boost confidence. Additionally, colder weather forecasts could increase fossil fuel power generation.
Holdings data from early October revealed a one-third reduction in UK carbon futures positions held by investment funds, dropping from a record 9 million long positions to 6 million. This decrease resulted from funds selling short positions, which bet on price declines. Investment funds' futures positions have shown high correlation with UK carbon prices, averaging 75% over the past two months. If prices continue to fall, it could trigger a sell-off, further depressing prices.
The UK's legislative body is discussing a one-year delay until 2027 for the gradual removal of free quota allocations. The update might reduce initial free quotas by an average of 8% to 18%, potentially leaving up to 4.6 million quotas in the market for an additional year. This would represent 6% of the total supply for 2026.
While supply remains ample, total emissions from UK carbon market-covered industries dropped 13% last year. Emissions from the power sector, nearly half of the compliance obligations under the scheme, led with a 20% reduction. This year, emissions have continued to decline, with a 22% reduction to date. The reduced emissions and subsequent lower demand for carbon quotas are likely to increase downward market pressure.
Although the declining carbon price has almost made coal-fired generation economically viable, emissions from coal plants this summer remained at their lowest in four years. Earlier this week, Ratcliffe-on-Soar, the last coal plant owned by Uniper, closed, marking the shutdown of over 30 GW of coal capacity in the UK since 2010. Despite coal-fired generation accounting for a small portion of emissions covered by the UK carbon market, its permanent exit seems to add to the bearish market sentiment.
While risks are predominantly on the downside, there are some upward potentials. Clarifications on ongoing market reforms could shift market sentiment. This year has seen five rounds of discussions, and any confirmation or introduction of market-tightening measures, like supply adjustment mechanisms, could restore investor confidence. An exceptionally cold and cloudy winter might also drive higher gas-fired generation to meet heating-related electricity demand, increasing emissions. Current forecasts suggest UK temperatures will be below historical averages for the next month.
