In the context of a rapid increase in energy and carbon prices over the past 18 months, questions have emerged around the functioning of the EU carbon market.

The European Union’s Emissions Trading Scheme is a cornerstone of the EU’s policy to combat climate change and a key tool for reducing greenhouse gas emissions cost-effectively. The well-functioning of the carbon market is particularly important given the uncertainties around the energy transition and the need to attract significant new investment.

In order to examine patterns of trading behaviours and the potential need for targeted action more closely, the European Commission has asked the European Securities and Markets Authority (ESMA) to conduct an in-depth analysis of the functioning of the market. ESMA published its preliminary report in November 2021 and is expected to deliver its final report to the European Commission in early 2022.

ICE commissioned Oxera to prepare a report designed to inform ESMA’s assessment of the EU carbon market. Our analysis draws on a comprehensive review of the market microstructure and environmental economics literature, empirical analysis based on market data, and insights from interviews with market participants.

Our report finds that the EU carbon market is functioning as expected and the recent increase in carbon prices is in line with changes in market fundamentals, in particular gas price rises and EU climate policy reforms. The analysis demonstrates that there is no need for significant policy reform at this point, but stresses that continuous market monitoring is required due to the range of climate policy reforms currently underway in the EU.