Forward curves and carbon risk: how EUA expectations shape power pricing

The article should act as a guide of actionable insights for traders, power traders, portfolio managers, analysts and energy economists, explaining how carbon prices transmission into power markets. We’ll take a look at how carbon prices interact with electricity markets and influence power price formation, and how generation economics change with EUA movements.

How the carbon market works

The forward curves associated with European Union Allowances (EUAs) help to shape power pricing by directly adding cost to power generated by fossil fuels.

Overview of the EU ETS

The EU Emissions Trading System (EU ETS) limits the amount of carbon certain businesses can emit by assigning allowances to tonnes of carbon emitted. Cap-and-trade mechanisms allow policies to restrict the cap, which in theory, reduces the amount of carbon emitted. Power pricing is shaped when future projections of how much carbon might cost is priced into the power market, making fossil fuels more expensive and encouraging a movement towards renewable sources.

Allowance supply and demand dynamics

When carbon prices are high, thanks to the EUA forward curve, fossil fuel operations' costs go up significantly, making fossil fuels less competitive and renewables more competitive, increasing demand for cleaner energy

Emission intensity of coal vs gas

Because coal is a more intense carbon emitter than gas, the carbon pricing mechanism hits coal generators disproportionately to gas-fired plants. The profitability of coal plants is decreased, making them a less favoured form of energy generation. When expectations for EUA prices, driven by EU ETS behaviour, are that prices will be higher, forward power curves are shaped, driving wholesale electricity prices.

Carbon-adjusted marginal cost

Carbon pricing and power market forward curves tend to be bridged using carbon-adjusted marginal cost. This cost includes the costs associated with carbon, fuel and operation costs and calculates the exact cost of generating one unit of electricity. Increased EAU costs also raise coal costs above those of gas-fired plants, shift the merit order, and raise prices.

Transmission into wholesale electricity prices

EUA price expectations can shape forward curves in energy markets, as energy generation costs are often dominated by additional carbon costs, which can then affect wholesale electricity prices. Rising carbon prices increase the marginal cost of fossil fuel-based electricity generation, which is directly passed through to wholesale power prices. 

Marginal plant price setting

In the merit order, each type of plant, whether coal, gas, or lower-carbon alternatives, is dispatched based on its short-run marginal cost. The higher the costs, the later they are dispatched. EUAs shape this plant's price setting by increasing the price of coal relative to other alternatives, making it the last to be competitive and the last to be dispatched.

Carbon pass-through mechanisms

When EUA prices increase, the cost of wholesale energy also increases. This is partly due to regulations that allow energy generators to pass on the cost of carbon pricing through wholesale energy pricing, meaning consumers often pick up the bill. To avoid this, certain regions include regulations that don’t allow power generators to offload carbon allowance costs altogether.

Regional differences across Europe

Differing generational mixes and a complex cross-continent grid connections can result in different EU impacts across Europe.

Generation mix differences

The impact of the EU ETS has seen Eastern European countries like Poland and Hungary suffer due to their reliance on fossil fuels, with high power import costs across the region. The UK market shows more of a divergence, but this could also be affected by EU ETS integration. Spain and Portugal enjoyed some of the lowest power prices in Europe in 2026, thanks to an uplift in investment in renewables with less carbon intensity.

Fuel dependency variations

Germany has seen higher forward prices as it continues to rely on fossil fuels over nuclear, while nuclear-heavy France saw higher carbon prices due to reliability issues with its nuclear fleet.

Trading and risk implications

When volatile price fluctuations happen, there is a closer link between carbon pricing and energy markets. In order to try to manage the risk associated with these fluctuations, both traders and energy producers may choose to hedge financially in relation to carbon allowances.

Hedging carbon exposure

As volatility increases, market participants are looking to the future to set prices, with some seen as too farsighted in their approach. This can affect trading because prices are hedged so far in the future that they don't realistically reflect the demand and supply patterns currently taking place in the market.

Forward curves can be utilised by power producers to secure margins. This is done via spread trading strategies.

Spread trading strategies

Forward curves can be used to manage spread trading because the cost of fuel and the cost of carbon are so closely linked. Traders utilise dark spreads to examine the profit margins of coal, and speak spreads to examine the profit margins of gas.