(Gerard Wynn is a Reuters market analyst. The views expressed are his own.)
By Gerard Wynn
LONDON Nov 24 The European Union's emissions trading scheme now needs rescuing, but only on new terms which better address its main aims and eradicate some of its failings, using a price floor.
The scheme, launched in 2005, is at a cross-roads, as carbon prices plunge to record lows and the fact dawns on traders that there may be no strong recovery for more than a decade.
The EU carbon market is now irrelevant as an environmental policy but a price floor would reverse that, and could deliver additional tens of billions of euros to member states through 2020 from extra auction revenues.
The market works by allocating a fixed quota of emissions permits to manufacturers and power plants, some of which they get free and the rest they have to buy, from state-run and EU auctions.
A floor price would work by setting a reserve price at auctions from 2013 (the start of the next trading cycle), say at 15 euros initially rising to 25 euros for example, by 2020. Price would rise immediately on the expectation of a change coming down the pipe.
But first, policymakers must be convinced of the urgency: the scheme has taken so many blows, including tax fraud, a past price collapse, doubtful environmental benefits, theft and windfall profits, it may be hard to see that it can't shrug off the latest European economic downturn.
And even if urgency is acknowledged, past failings have injected some cynicism and apathy about whether it's worth saving.
The benchmark carbon price hit a record low of 8 euros on Thursday and without action will drift for a decade at under 20 euros per tonne of CO2 emitted, below a level which drives emissions cuts.
The scheme is meant to help the EU meet carbon emissions targets through 2020.
Carbon prices have collapsed because, in its bid to be transparent, the EU published the quota of permits to 2020 before the severity of the downturn was clear.
The recession and present downturn mean a large portion of those EU allowances (EUAs) are no longer needed but cannot be mothballed.
They also have no alternative demand outside a troubled Europe, unlike any other commodity.
Carbon prices could go lower, depending on traders' faith that the market has a future.
CAN IT BE RESCUED?
The EU Commission which oversees the scheme now has four choices:
1) sharpen the EU's broader carbon emissions target for 2020;
2) cut EUA supply;
3) set a price floor;
4) let prices languish at irrelevant levels for a decade.
The first can be dismissed: on the brink of recession there is no appetite to burden EU countries or companies with tougher carbon emissions targets, even if it can be argued that the extra cost would be minimal.
The second is messy and undermines the market: how many EUAs should be withdrawn, with what justification, and with what guarantee that bureaucrats wouldn't intervene unexpectedly again?
The third - a price floor - makes sense and arguably should have been done long ago, while the fourth clearly is not ideal.
A price floor would remove uncertainty over carbon costs for industry going forward.
It would retain the present emission caps through 2020 and beyond, which is the main success of the carbon market so far.
It would also increase emissions cuts, and as much as double auction revenues for struggling EU member states.
And it would prevent a patchwork of EU policies emerging, where Britain has already announced its own, unilateral floor price.
The scheme has two main aims. The first is to put a price on carbon emissions in order to drive cuts and support low-carbon technologies. The second is to give industry a clear annual emissions cap trajectory through 2020 and beyond.
A third potential goal is to raise money for low-carbon technologies in developing countries. Germany has done that by using revenues from auctioning emissions permits.
And businesses can offset some of their emissions by paying for carbon cuts in developing countries.
On emissions cuts, prices now and over the next decade are too low even to motivate energy savings: surveys suggest that most companies are motivated to make savings only where there's a quick pay-back in two or three years.
The scheme has been most successful in providing a transparent emissions trajectory for industry, with the caveat that this has also caused the present price crash.
The market has also raised carbon finance for developing countries, although these carbon offset revenues declined to $1.5 billion last year from a peak of $7.4 billion in 2007.
Such carbon finance will become more important over time, as a sweetener to entice developing country commitments in a future global climate deal.
The present market crash presents a window of opportunity for a rescue, imposing a price floor which would have few dissenting voices among free market die-hards, given the alternative of letting the scheme drift in limbo for years.
Miss the opportunity and that is what will happen. (Editing by Jason Neely)