EU carbon prices hit two-year high, follow oil

By Gerard Wynn

LONDON (Reuters) - Carbon prices on the European Union's emissions trading scheme hit a two-year high in early trading on Thursday, as the most traded contract hit 26.55 euros ($41.85) on the European Climate Exchange.

The rise had most to do with record oil prices, traders said.

Oil galloped to a high above $135 on Thursday, extending this month's near 20 percent rally after a sharp drop in U.S. crude stocks and the weakening U.S. dollar triggered short covering by investors.

A Reuters analysis shows carbon's price correlation to oil and natural gas strengthened in 2008.

Higher oil prices prompt higher gas prices, which in turn encourage power generators to burn higher carbon-emitting coal instead. That leads to more demand for carbon emissions permits called EUAs.

"A large part of the carbon price increase in the last two weeks has been the rise in gas prices," said Guy Turner, analyst at New Carbon Finance.

Cap and trade schemes force participants -- often energy-intensive industries -- to buy permits to emit greenhouse gases such as carbon dioxide, which is produced from burning fossil fuels.

The European Union launched its cap and trade scheme in 2005, and now other governments are turning to emissions trading as a weapon to fight climate change in a carbon market worth $64 billion last year.