We’ve all heard tales of bluer skies since the shelter-in-place orders took effect.   Cityscapes can be seen with remarkable clarity as lockdowns lead to noticeably cleaner air.  Yes, the pandemic is reducing greenhouse gas (and other) emissions.

What is the effect of all this on carbon markets?  The International Monetary Fund (IMF) has warned that the virus could shrink the world’s economy by at least 3 percent in 2020.  A recent Wall Street Journal front page reports that COVID-19 has already shrunk U.S. GDP by 4.8 percent.

The IMF thinks the economic contraction will be felt the most in developed nations, in particular the United States and Europe, where the outbreak of the novel coronavirus has hit France, Italy and Spain particularly hard.  Europe has the world’s most comprehensive cap and trade system for greenhouse gases (the EU-ETS) and in the United States, California is implementing the cap and trade portions of its AB 32 program.  Both the EU-ETS and AB 32 count on a robust carbon market to achieve carbon mitigation.  What does the economic slowdown forced by the pandemic mean for compliance entities as well as the effectiveness of the cap and trade programs in implementing carbon mitigation?

Short term compliance costs are in free-fall so this looks to be a bargain for compliance entities, but the slowdown may render these programs completely ineffective in mitigating carbon emission.

While most experts think it’s too early to tell how the ETS would fare this year given the economic downturn, we do know that EU allowances (“EUA”) prices collapsed in March as the pandemic took hold throughout Europe, but later recovered for much of April. The European Parliament attributed the recovery to announcements about economic support and recovery, but the impending 30 April compliance deadline for surrender of EUAs for 2019 emissions (which was not suspended or delayed in light of the pandemic) was also likely a factor.

Likewise, in California, in April, over-the-counter prices for California carbon allowances dropped like a rock due to a combination of heavy selling and bearish macroeconomic sentiment brought on by the coronavirus pandemic. The secondary markets for California carbon allowances are expected to remain volatile in the short term, tracking movement in global equities.

Some experts have forecast that the size of the economic contraction forecast by the IMF would result in European emissions falling by 5.5 percent to 6.8 percent during 2020, regardless of the impact of the EU-ETS carbon market.  It is worth noting that the Market Stability Reserve, a price stability mechanism within the EU-ETS framework that it operates on a set of pre-defined rules (rather than at the discretion of the Commission), may if activated reduce auction volumes of EUAs and prevent the market from being flooded with cheap EUAs, hence the relatively modest predictions for EU ETS impacts. Similar decreases would be expected in the United States.  A decline that big threatens to push EUA and California carbon allowance prices to below the levels needed to ensure carbon mitigation for the entire year.