Over the past few years, carbon markets have captured increasing attention. This has been accompanied by a number of investable products emerging. Even so investors remain confused as to what lies ahead. We exmaine price fundamentals in this paper, which complements our carbon research published earlier this year

There are already around 100 countries identifying carbon pricing schemes as a central pillar of their net zero strategy. As a result, understanding the pathway for regional and global carbon pricing has become more important than ever

In addition, as an increasing number of corporates are also stress-testing an internal carbon price, and in some instances using this carbon price in business decision-making, providing forward guidance to carbon pricing is becoming increasingly warranted

When it comes to price forecasting, we find that those commodities with higher levels of volatility, such as European carbon prices, have significantly higher associated forecasting errors. According to our calculations, if the consensus analyst forecasting error over the past decade persists into next year, it implies an average EU carbon price of €97/tonne, compared to today’s current spot price of €68/tonne

When it comes to the track record of commodity analysts versus the respective forward curve as a predictor of the coming 12-month price, our work finds commodity forwards typically outperform the consensus analyst in the accuracy of their predictions, although mercifully for the analyst community by only a small margin

We are long-term bullish for European carbon prices reflecting fuel switching trends in the short-term and strong supply-side fundamentals over the long-term. However, a more dramatic downturn in industrial activity in Europe and an accompanying spike in risk aversion naturally pose downside risks

We also believe that the sell-off in global bond yields may have an impact as carbon prices are the net present value of future environmental liabilities discounted in today’s value. However, rising inflation ought to have a neutralising effect as it affects both sides of the equation (numerator and denominator), unlike a nominal bond.