To infinity and beyond!

What the non-compliance penalty and a shortage of allowances means for the price of carbon

Everything has its price, including avoiding a climate catastrophe.

With that statement in mind, what does the price of carbon actually represent? Is it the price at which coal plants are forced offline. Is it a signal for investment in industrial carbon abatement or capture technology? Does it represent the price at which past and future negative climate externalities are internalised by consumers?

The truth is that it is all of those things. High carbon prices are a sign that there is a bottleneck in the system, an obstacle in the way to achieving the EU’s climate ambitions. Of course, high prices should provide the incentive to break through those bottlenecks.

At its heart though, the carbon price is fundamentally about the supply and demand of emission allowances. It’s about obligated emitters having to comply with a legal obligation. If one party doesn’t have enough EUA’s to offset their emissions then they must purchase them from the market.

But you might ask, why can’t they simply renege on their obligations if the price gets too high? Well, there’s a severe penalty to be paid for anyone daft enough not to.

Known as the non-compliance penalty it must be paid by any obligated emitter who fails to buy sufficient EUA’s to account for their emissions. In 2021 it is set at €110 per tonne. Crucially, there is no let off. If you fail to buy enough EUA’s you must pay the penalty AND make good the shortfall in the subsequent compliance year. This reduces the available supply the following year, ensuring that even more obligated emitters are likely to get caught up by the penalty.

This is where it gets interesting.