Goldman sees changing dynamic in the carbon markets

The cost of emitting carbon dioxide into the atmosphere is set to decouple from gas prices in the European Union, marking an historic shift in the dynamic between the two markets, according to the EMEA head of natural resources research at Goldman Sachs Group Inc.

The EU is facing “a complete break from the historical relationship where lower gas always meant lower carbon,” Goldman’s Michele Della Vigna said in an interview. The development reflects the changing dynamics affecting the carbon market, including shrinking emissions caps, with industry replacing power producers as the biggest buyers of permits to pollute and “a complete change in the gas market,” he said.

Until now, gas prices have tended to move in tandem with the price for carbon allowances. But that relationship is unlikely to last, Della Vigna said.

Russia’s invasion of Ukraine triggered a new wave of energy investment in Europe, as the bloc raced to address supply holes. Not only did that race lead to a surge in the production of renewables, but with gas getting a stamp of approval in the EU’s green taxonomy, its supply is now set to pick up meaningfully. Goldman predicts that infrastructure investments will drive up global liquid natural gas supplies by 50% in the next five years, leading to a halving of gas prices over the period.

That has major implications for inflation and will ultimately have a big impact on carbon prices, Della Vigna said.

Assuming a 50% decline in the price of gas, “then actually even with a higher carbon price, we would see no inflation in energy in Europe, no hit” to consumers or industry, Della Vigna said. “If anything, the higher carbon price will be a helpful way to make sure power prices don’t fall so much that the development of renewable power becomes challenged from an economics perspective.”

Concerns over inflation may make the EU less inclined to allow the carbon price “to go much higher than where it is at the moment in a high energy price environment,” Della Vigna said. “That’s why cheaper gas actually should mean higher carbon prices. Not just because of affordability, but also because cheaper gas means European heavy industry can come back and as they come back more emissions come back, which leads to a tighter carbon market from 2026.”

“Industry has gone back into properly developing a new infrastructure for liquefied natural gas,” he said. And that “is now about to all come on stream.”

The development has the potential to drive the price of carbon allowances on the European Union’s Emissions Trading System to as much as €130 a ton by 2028, Della Vigna said. This year, prices have averaged at around €66 a ton, according to BloombergNEF.

The EU’s carbon market is set to tighten significantly in the coming decades as the bloc works toward its goal of net-zero emissions by the middle of the century. Analysts at BloombergNEF forecast EU carbon increasing to nearly €150 by 2030.

Aside from tighter supply, prices will also be driven higher by “increasing compliance obligations on removing emissions from industries whose emission abatement options are more expensive than under the power sector,” said Huan Chang, an analyst with BloombergNEF.

At the same time, financial market participants have been buying allowances in anticipation of higher prices, Della Vigna said. As an asset, carbon allowances traded on the ETS can offer value if investors think prices will rise, “which is certainly our view,” he said. 

“Clearly in a surplus the market tends to be weaker, and that’s what we’ve seen in the last couple of years,” he said. But from 2026, that surplus is likely to “turn into a deficit,” he said.

Carbon allowance prices are currently depressed after the EU brought forward some supply to help generate revenue for member states and move away from Russian energy supplies, Chang said. And for many industries, it’s still cheaper to exceed emissions caps than it is to invest in decarbonizing technologies. But with higher prices for carbon allowances, that looks set to change.

Emissions covered by the EU ETS fell by 16% last year, representing the biggest annual decline on record.

The EU, which has set a 2030 target to cut emissions by at least 55%, is gradually reducing the supply of ETS allowances as part of a defined strategy to force key sectors to decarbonize. Since the 2005 start of the EU ETS, emissions generated by companies it covers have fallen by 41%, according to EU data. That’s led to a 28% decline in total emissions across the EU. Over time, the list of industries covered by the ETS has been expanded with shipping a recent addition.

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