(The author is a Reuters market analyst. The views expressed are his own.)
By Gerard Wynn
LONDON Jan 24 The European Commission can win significant gains from defeat on its carbon market reform if it can extract concessions for a more ambitious scheme from 2020.
The European Parliament energy and industry committee on Thursday rejected the Commission's planned, modest boost to carbon prices, spotlighting the mountain it has to climb.
The vote saw carbon prices tumble as much as 40 percent on the day before they recovered a little. A more critical vote awaits the parliament's environment committee on Feb. 19, where an unlikely rejection would halt the reform in its tracks.
European Union carbon prices are poised to fall to zero because of an over-supply of allowances swollen by the financial crisis, something the Commission is determined to avoid by re-allocating emissions permits due this year and next until later this decade.
Poland leads the opposition camp, saying the weakness of the emissions trading scheme simply reflects the financial crisis, and higher carbon prices will dent economic activity.
"They are toying with something very, very dangerous," Climate Commissioner Connie Hedegaard told a Brussels debate on Tuesday, as reported by Reuters, regarding objectors.
Such rhetoric may be unwise, given opposition by powerful polluting sectors and countries, German indecisiveness on the issue ahead of federal elections later this year, and a looming, larger debate about climate and renewable energy targets.
Hedegaard would snatch some kind of victory from defeat on emissions trading reform if she achieved support instead for an ambitious 2030 carbon emission cap, upon which debate is due to kick off shortly with a Commission paper expected in the first half of this year.
Such a cap will set the trajectory for the next trading cycle of the scheme from 2020, and will guide not only emissions trading but wider European energy measures and investment and so is arguably a far more significant policy.
The present argument around carbon market reform is a phoney war given it hinges on the timing of allowance auctions which will only have a brief impact on carbon prices.
The bigger prize is subsequently to cancel permanently the surplus allowances, as the Commission plans to do if it passes this first step, and which would herald years of further negotiations.
The Commission estimates that the scheme has a structural surplus of emissions allowances of around 2 billion tonnes, or one year's emissions under the scheme, which polluters can roll forward year after year and some of which need cancelling.
Permanently removing around 900 million tonnes, the amount the Commission has so far proposed to re-allocate, would see carbon prices rise to 15 euros or so, analysts estimate.
From an economic perspective, a 15 euro carbon price would have a noticeable impact on European electric utility costs and wholesale power prices in liberalised markets.
It would add 6-12 euros per megawatt hour depending on whether gas or coal is the marginal power plant, assuming full pass through of carbon costs and compared with a zero carbon price scenario.
That compares with European wholesale year-head power prices of 40-55 euros.
From an environmental perspective, a 15 euro carbon price would have no impact on the competitiveness of gas versus coal combustion, and therefore rather little impact on carbon emissions.
At current prices for British gas, European imported coal and German year-ahead power, the carbon price would have to rise far higher to drive power plants to switch from coal to less carbon-emitting gas.
But the Commission's concerns are also about avoiding institutional drift where traders, banks, advisers and NGOs desert the market until its next trading cycle.
Some of that drift may be imagined: traders and analysts, for example, switch easily between carbon and power markets.
For coal-dependent Poland, its campaign follows a long-run, visceral objection to higher carbon prices which could crimp its growth more than any other EU member state.
A compromise in the present stalemate could include a limited financial handout to the steel and aluminium sectors in exchange for a smaller quota of emissions allowances, which may keep Poland and polluting sectors happy and the market ticking over.
Detail of such a compromise will emerge ahead of the next parliament vote.
Failing that, all is not lost for emissions trading.
A zero carbon price would be temporary if the EU can agree an economy-wide emissions cap which sets an ambitious trajectory from 2020, capping factories and power plants.
Utilities hedge power sales and purchases of emissions permits two to three years ahead, meaning carbon market activity would pick up from 2017.
Such a 2030 emissions cap will be central to European energy policy, and with more at stake negotiations will be testy and concessions valuable.
Backing down on emissions trading would be difficult for the Commission, consigning its market to limbo for four years.
It would be embarrassing to a world leader on emissions trading, which has trumpeted the emergence of similar schemes in Australia, South Korea, New Zealand, California and China.
The alternative, however, is years of negotiation over deeper structural reform, which may end in failure, and will suck oxygen not only from talks on a 2030 emissions cap but other hugely significant low-carbon energy policies including new mandates for auto fuel economy and carbon capture and storage.
It may be time to pick the right fight.
(Editing by Keiron Henderson)