Investment banks pick their top plays for a record-breaking rally in carbon prices

Published Sun, May 23 20218:24 PM EDT

Sam Meredith @in/samuelmeredith @smeredith19

Europe is home to the world's largest carbon trading scheme — and prices have been soaring . Analysts expect this record-breaking rally to continue and have picked the stocks most likely to benefit from the trend. The European Union caps carbon dioxide emissions for many businesses and surplus allowances can be bought and sold. The benchmark carbon price was trading around 51.75 euros ($63.06) per metric ton Monday, close to the 56 euros it hit earlier this month – its highest level since the launch of the market in 2005. The contract's meteoric rise from around 20 euros before the coronavirus pandemic is thought to be underpinned by Europe's more ambitious climate policy and increased financial investment in the market. Looking ahead, experts are bullish, with some backing a price-end target of more than double current levels . Here, analysts from Berenberg, Deutsche Bank , Barclays and Morgan Stanley name some of the stocks expected to outperform as a result of this burgeoning trend. How it works Europe's Emissions Trading System is the EU's main tool for reducing greenhouse gas emissions that cause climate change. It is expected to play a key role in the bloc's efforts to reduce carbon emissions and reaching net-zero emissions by 2050. The scheme operates on a " cap and trade " principle. A cap is a limit on the total amount of certain greenhouse gases that can be emitted by highly-polluting industries. It is reduced over time to ensure that emissions fall. Within the cap, polluters buy or receive emission allowances, or permits, which they can trade with one another as required. The limit on the number of allowances means that they have a value. A business must have enough allowances to fully cover its emissions in order to avoid heavy fines. Stock picks RWE : Analysts at Deutsche Bank, Barclays and Berenberg all see potential in German energy giant RWE. Berenberg expects RWE to be one of the prime beneficiaries of soaring EU carbon prices, noting that the company is likely to benefit from a "considerable portfolio" of carbon permits. Deutsche Bank singled out RWE as among its top picks in the European utilities sector, reaffirming its buy rating on the stock, citing stronger carbon pricing. Barclays is overweight on the stock. Engie : Barclays named French power company Engie as its pan-European top pick. The U.K.-based bank says the group's renewable ambitions are currently underappreciated and believes the stock is "significantly undervalued." Berenberg also picked Engie as among its prime beneficiaries of rising carbon prices. Fortum : Analysts at Berenberg highlighted Finland's Fortum as a potential winner of higher carbon prices. That's because, despite utilities companies accounting for almost half of emissions in Europe's Emissions Trading System, they are also direct beneficiaries of higher power prices — which are supported by higher carbon prices. Berenberg notes renewable players are likely to benefit indirectly from higher power prices, making their businesses more competitive. Verbund : Austria's Verbund is another of the European utilities companies identified as likely to benefit from rising carbon prices, according to Berenberg. Analysts at the German bank said the company is well-positioned to outperform as a result of having both hydro and nuclear assets with low fixed-cost businesses. LafargeHolcim : Analysts at Morgan Stanley said potential reforms to Europe's Emissions Trading Scheme in the coming months could benefit so-called de-carbonization leaders in the long term. It recognized LafargeHolcim as a leader in cement decarbonization, noting the Swiss company had already achieved the lowest carbon intensity among peers in 2019. The U.S. bank is overweight on the stock. ArcelorMittal : Higher carbon costs are expected to be a headwind for high-carbon sectors in the near term, but Morgan Stanley analysts argued that decarbonization leaders such as ArcelorMittal could benefit from greater access to capital and a potential lower relative costs base in the longer term. Morgan Stanley is overweight on the world's largest steelmaker.

Behind a drained carp pond, water vapour from the cooling towers of the Jänschwalde lignite-fired power plant of Lausitz Energie Bergbau AG (LEAG) rises into the cloudy autumn sky.

Patrick Pleul | picture alliance | Getty Images

The European Union caps carbon dioxide emissions for many businesses and surplus allowances can be bought and sold. The benchmark carbon price was trading around 51.75 euros ($63.06) per metric ton Monday, close to the 56 euros it hit earlier this month – its highest level since the launch of the market in 2005.

The contract's meteoric rise from around 20 euros before the coronavirus pandemic is thought to be underpinned by Europe's more ambitious climate policy and increased financial investment in the market. Looking ahead, experts are bullish, with some backing a price-end target of more than double current levels.

Here, analysts from Berenberg, Deutsche Bank, Barclays and Morgan Stanley name some of the stocks expected to outperform as a result of this burgeoning trend.