How the Middle East Conflict and Energy Markets Impact European Carbon Prices
The recent conflict in Iran has caused a significant energy supply shock, disrupting global oil and gas routes. As a result of these energy market disruptions and evolving policy debates, European carbon markets are experiencing increased volatility with likely knock-on effects to the industrial sector.
What’s Changed: Supply Shocks and Depleted Inventories
The recent war in Iran has been the cause of a significant supply shock to the market, with some comparing it to the 1970s Oil crisis or the recent 2022 crisis caused by the invasion of Ukraine.
Iran has practically shut the Strait of Hormuz, which is one of the main waterways through which a big portion of the world’s oil and gas supplies are shipped. Furthermore, as the war intensified, both parties have begun targeting energy assets. One of the biggest blows was an attack on the Ras Laffan LNG hub, which currently satisfies 20% of the world's demand.
While the majority of the oil and gas that is shut in behind the Strait of Hormuz would typically flow to Asia, given the global nature of commodity markets, these disruptions have caused market prices for oil and gas to increase sharply all over the world. This has become a major concern for Europe and its industrial sector, which is exposed to market swings as it is still in the process of reducing its reliance on Russian imports and hence trying to secure its supply from other markets, including the Middle East. Of particular note, Europe has experienced a relatively cold winter, leaving current inventories low, and raising further questions about how gas storages will be refilled in the coming months.
Market Implications: Changing Power Generation Economics
These price shifts in gas markets are changing the economics of power production:
Uptick in Coal: As gas becomes more expensive, producing electricity with coal is relatively more attractive, and Europe has already seen an increase in coal-fired power generation.
EUA Pricing: Coal is relatively more CO2-intensive than gas, which in turn leads to energy producers having to surrender additional carbon allowances. These developments should increase demand for EUAs and could therefore exert upward price pressure.
Demand destruction: The flip side of this story is that higher energy prices might impact European industrial production, causing fewer emissions overall (this is something we saw in the Ukraine crisis and is likely again this time, especially if the disruption becomes prolonged).
Who It Affects: Policy Debates and the Industrial Sector
The main driver of the EUA price so far in 2026 appears to be government policy. As questions of the competitiveness of European industry have risen, carbon markets have recently found themselves at the centre of European policy debates.
Prominent policymakers and industry groups have made proposals to adapt the current systems to improve the competitiveness of the European industry.
The recent spike in overall energy prices resulting from the Middle East conflict has exacerbated the urgency for policy changes.
The push came from policymakers and part of the industrial sector, which is particularly exposed to energy shocks. As carbon prices make up about 11% of energy costs, policymakers saw a softening of the EU ETS rules as a possible way through which the industrial sector could be supported.
Policymakers appear to have agreed not to implement drastic changes to the system, at least as things stand at the moment. One of the solutions proposed was helping certain industries by allocating more free allowances. Nevertheless, the debate between increasing the short-term competitiveness of European industry and achieving decarbonisation goals remains very relevant. The eventual policy changes are still undecided, with more clarity expected this summer.
It is worth noting that during the Ukraine crisis, there were similar debates in Europe, and what emerged was a reinforced pro-environment agenda from Brussels. As well as the intrinsic benefit in supporting the environment, moving to more renewable power generation has the added benefit of weaning European economies off natural resources that are subject to price shocks, as we saw first in Ukraine and now in the Middle East, hence it can be argued that the EU ETS plays an important role in a security of supply agenda as well as an environmental agenda.
Uncertainty and Volatility
As uncertainty remains high due to the war in the Middle East, energy as well as carbon markets have seen increased volatility caused by several factors affecting market participants. The unpredictability of the war creates ongoing uncertainty for energy markets, with the key question being the long-term impact of any disruptions.
Conclusion
Overall, the EU ETS is increasingly influenced by policymakers and the perception of European industry’s strength, which in turn is being impacted by the current energy supply shock. This shock may be short-lived or more permanent, depending on how the conflict evolves.
The volatility in carbon markets, driven by policy updates and exacerbated by the Middle East conflict, has opened up an opportunity for market participants to make use of bespoke strategies to gain an edge over competitors.
Specialised and well-informed market participants will likely thrive in such an environment, gaining from the market volatility, while less sophisticated participants risk incurring higher costs if they do not get up to speed with the current intricacies.
Get in touch with Grey Epoch to discuss how to fix the cost of your EUA purchases, dampen volatility, or monetise volatility to secure supply at a discount to the current market price.
