(Gerard Wynn is a Reuters market analyst. The views expressed
are his own.)
By Gerard Wynn
LONDON Oct 5 European carbon permits, shorn of
fundamental drivers, have become a bet on recession and the
psychology of players including distressed polluters and
European Commission officials.
Prices have gradually neared levels seen in the 2009
recession and are down nearly 30 percent year-to-date,
under-performing almost all commodities.
The European Union's cap and trade scheme forces nearly
13,000 European factories and power plants to submit an
emissions permit, or EU allowance (EUA), for each tonne of
carbon dioxide (CO2) they emit.
Alternatively, they can top up by buying carbon offsets
called certified emissions reductions (CERs) from low-carbon
projects in developing countries.
To work properly, the scheme should be collectively short of
EUAs to drive emissions cuts, but in fact that cornerstone
requirement was met just once since its launch in 2005 after a
financial crisis curbed industrial output and pollution.
The EU does have tools to limit EUA supply, but one wonders
if it has the courage to use them, given its concern not to be
seen intervening in its flagship carbon market, and the risk of
over-compensating and driving up industry costs.
The EU emissions trading scheme (ETS) has demonstrated that
the knack of achieving a small EUA short -- not too short to
cripple industry nor long rendering the scheme useless -- is a
difficult balancing act.
It may represent a critical flaw in carbon markets over a
technically simpler but politically unpalatable carbon tax.
The Commission this year published two documents, a "2050
Roadmap" and Energy Efficiency Directive which both explicitly
allowed the removal, or "set-aside", of excess EUAs from its
emissions trading scheme (ETS) if EU efficiency goals were met.
A Commission spokesman reiterated the option by email late
on Tuesday: "The Commission considers that setting aside a
corresponding number of allowances in the third period may be
needed," he said, referring to the third ETS trading period from
Some EU member states support proceeding with set-aside,
according to documents seen ahead of a meeting next week of
environment ministers .
Fully wiping out a combined CER and EUA surplus could triple
carbon prices, forcing power generators to cut emissions by
switching from high-carbon coal to gas-fired power.
Present coal and gas prices imply an EUA fuel switch price
of 25-30 euros, compared with prices now of 10 euros CFI2Zc1
and a previous recession low of 8.1 euros.
At present the available supply of CERs is probably enough
to make up the EUA shortfall through 2020, analysts say, meaning
they instead set the marginal cost of emission reduction. CERs
are currently trading at about 7.5 euros CEREZc1.
EUA prices in the short-term follow the selling behaviour of
industrial companies which hold most of the present surplus, and
recent price falls suggest distressed polluters may be cashing
Long-term prices depend on the persistence of the EUA/ CER
surplus through 2020 and beyond, as polluters can in theory use
these through a fourth trading period which ends in 2028.
Analysts calculate the EUA/ CER excess through 2020 at
roughly plus or minus 500 million tonnes.
European Commission officials could cancel that by full use
of set-aside, removing up to 800 million EUAs as proposed in one
early draft, sending prices back up to their fuel switch value.
In addition, the Commission could postpone the forward sale
of 300 million EUAs, ear-marked for 2011-2012 to raise money for
clean energy projects.
That sale process run by the European Investment Bank was
conditional on not influencing carbon prices, now fragile, and
it makes less sense to auction an under-priced asset.
However, both such measures would spook the market, raise
existential questions about what the ETS is for and in
particular whether regulators have a secret target price in
The ultimate game-changing intervention would be for EU
states to introduce a carbon price floor, but that would start
the shift towards a carbon tax and represent a major climbdown
on a key EU project.
(Editing by Keiron Henderson)