(The author is a Reuters market analyst. The views expressed are his own.)
By Gerard Wynn
LONDON Jan 4 The European Commission is poised to propose the only short-term fix available for the plunge in carbon prices, removing surplus emissions permits in a move that may still do little to boost low-carbon investment.
The European Union's emissions trading scheme needs rescuing from a 10-year glut in supply of carbon dioxide (CO2) permits, which has left prices near record lows.
The best solution is a price floor, which would set the minimum cost of carbon emissions out a decade or more, sending a clear signal for low-carbon investment and the 12,000 polluting factories and power plants directly affected by the emissions trading scheme.
That is likely to court political and industry opposition, however, as an intervention limiting the flexibility of the carbon market and raising industry costs.
A European Commission spokesman for climate action, Isaac Valero Ladron, ruled it out on the basis it counted as a direct intervention.
"The Commission does not support the idea of a price floor. We don't have a price floor, we will never propose a price floor," he told Reuters.
A price floor has support from some industry and from academics and policy thinktanks such as the UK-based "Climate Strategies" group, but may have to be a solution after 2020.
For now the EU is poised to enact an alternative, more palatable intervention, to remove a certain number of emissions permits or EU allowances (EUAs) from the market, in a so-called "withholding" or "set-aside" measure.
That will not guarantee that prices are restored to more environmentally effective, pre-crisis levels (15-25 euros), barring an unlikely European economic rebound.
It has political advantages, however: it could be agreed by a majority of environment ministers in a tweak to existing auctioning regulation under the trading scheme, in a process which would only take about six months.
The Commission, the EU executive, would propose to withhold a certain number of EUAs, after more guidance including an expected Parliament vote on the issue within months.
By contrast, a carbon price floor would likely require a change to existing emissions trading law, and is clearly out of favour with the Commission anyway. A move to forge tougher, broader climate action through stricter EU-wide emissions targets would need member state approval, and would be likely to take years.
Some free market proponents suggest that no fix is needed, arguing falling carbon prices simply reflect less pollution and demand for emissions permits in the wake of the financial crisis.
But the government-led scheme fails to mimic how manufacturers of goods in real markets mothball capacity in a downturn, trimming supply in line with demand and so limiting price falls.
The carbon market has no such recourse: supply is fixed and each year's EUA surplus simply adds to a burgeoning glut, extending the price slide into the future.
The EU emissions trading scheme had a traded value of about $120 billion in 2010. One EUA accounts for 1 tonne of carbon dioxide (CO2) emissions.
Carbon prices have continued their slide since a brief recovery last month after a European Parliament environment panel proposed to withhold some 1.4 billion EUAs.
That compares with annual emissions under the scheme of about 2 billion tonnes of CO2.
A withholding of 1.4 billion EUAs would certainly help restore price tension: a renewed EUA shortage would force power generators to switch from burning high-carbon coal to gas, implying a carbon price of about 21 euros given present coal and gas prices.
That's three times the carbon price now.
But the EU may not agree to such an ambitious proposal which may have some impact on fuel bills at a time when many member states are enduring harsh austerity measures.
The European Commission has previously suggested withholding a smaller 500-800 million EUAs from 2013-2020.
And European Parliament approval is needed, likely guided by an industry panel vote recently delayed until February, rather than by the more zealous environment committee which voted last month.
The industry committee is expected to support the idea of withholding EUAs, in a vote which would push the legislative process, but the panel will not necessarily back the 1.4 billion total.
The EU emissions trading scheme allocates a fixed quota of emissions permits to industry. The present quota was agreed before the scale of the financial crisis was clear.
How many EUAs should be removed?
Carbon market analysts forecast that a glut in EUAs and other carbon credits will persist through 2020 and beyond.
They project a net surplus in 2020 of 650 million EUAs(Barclays Capital); 1,200-1,300 million (Point Carbon); 800 million (UBS); 800 million (Societe Generale); or 566 million (Deutsche Bank).
Such estimates suggest regulators should withhold at least 700 million EUAs, and likely more, to restore price tension.
Even if that could be agreed and it were effective in driving up prices, withholding EUAs remains a rather arbitrary measure and leaves the market open to future meddling.
A simple price floor would provide a surer, long-term footing, but for now the market is headed towards a second best policy. (Reporting by Gerard Wynn; Editing by Anthony Barker)