EU CO2 market mulls impact of supply options

LONDON Wed Jun 22, 2011 12:21pm EDT

LONDON (Reuters) - Traders in the European Union's carbon market are mulling the potential impact of EU Commission plans to control carbon permit supply on already weakened emissions permit prices.

The EU Commission has three separate proposals, which could possibly be implemented in any combination, to either bring fresh carbon permit supply to the market or limit it.

Carbon permit EU allowances (EUAs) traded under the EU's emissions trading scheme (ETS) have slumped 16 pct this week for the benchmark EUA contract lost 16 percent, mainly on fears about oversupply.

"In effect, the Commission has turned the ETS into a big Ponzi scheme with early allocation (of permits) on the top of over-allocation," an emissions trader told Reuters.

The EU Commission plans to auction the majority of EUAs in the third period of its trading scheme (2013-2020), instead of continuing to give them to utilities for free.

It has proposed auctioning 120 million Phase 3 permits in 2012, a year before full auctioning officially starts, but the details on timings have not yet been finalized.

Many emitters have lobbied for auctions to begin before 2013 so they can hedge forward power sales in advance, but there are doubts that a common auction platform will be ready in time to enable transfers.

In addition, the Commission plans to auction 300 million EUAs (so-called NER300) from Phase 3 as early as the fourth quarter this year to raise funds for clean energy projects.

The two sales combined would bring a total of 420 million Phase 3 EUAs, or over a quarter of supply in the current trading period (2008-2012), to the market early.

On top of that, an EU energy efficiency drive could reduce demand for EUAs by as much as 400 million metric tons in 2013 to 2020, some sources estimate.

The efficiency plan, released on Wednesday, has acknowledged that an undisclosed number of EUAs might have to be set aside to stop carbon prices from falling too low.

The combination of the different plans would result in three different scenarios:

1. PRICES FALL

Under this scenario, the early auctioning of 420 million EUAs would happen but the set-aside plan would be scrapped, thereby creating a glut of permits in the market and putting pressure on prices.

A study showed that the EU's efficiency plan could cause EUAs to fall below 14 euros to as low as zero by the end of the decade, based on a business-as-usual price of 25 euros.

Although prices would likely fall, most analysts ruled out a crash to zero.

"This scenario is about to be priced in as people now expect it to happen and prices will not fall to zero," said Societe Generale analyst Emmanuel Fages.

As the set-aside idea was referenced in a memorandum to the Commission's efficiency directive, not in the main text itself, some fear the notion could be dropped as some EU countries oppose deeper emissions cut measures.

2. PRICES REMAIN 'DEPRESSED'

If the early sale of 120 million EUAs was scrapped, leaving only 300 million permits auctioned early, and the set-aside went ahead, prices would likely remain relatively low.

"I would bet on the 120 million auctioning being scrapped," said Matteo Mazzoni, analyst at Nomisma Energia.

"The NER300 would be sold gradually, so it will not have a devastating impact on the demand-supply balance. Prices will remain quite depressed, between 14-18 euros," he added.

EUAs closed at 14.75 euros a tonne on Wednesday.

3. PRICES RISE?

In the least likely scenario, the early auctioning of 420 million EUAs would be scrapped but the set-aside plan would be implemented.

In this case, EUA prices would likely rise because the threat of EUA over-supply has been removed.

"This will not happen. I cannot imagine that both NER300 and early auctions will be canceled completely," said Jan Frommeyer, managing director at Tschach Solutions.

(Reporting by Nina Chestney, editing by Richard Mably)

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