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.

New Zealand will launch a similar initiative this year. Canada and Australia propose to launch schemes in 2010. U.S. senators will debate next month details of a proposed federal U.S. climate change bill which includes cap and trade.

CONFIDENCE

The present EUA price rise also reflects a revival in confidence in the carbon market after the EU last year set tougher caps on carbon emissions by industries under the second phase of the scheme from 2008-12, driving up EUA demand.

Carbon prices collapsed in 2006 after a surplus of permits emerged under the first phase of the EU scheme from 2005-07, meaning that there were more permits than actual emissions.

The price of benchmark EUAs for 2008 delivery on Thursday passed a high of 26 euros set in May last year, and is now higher than at any time since the EU carbon market crashed in April 2006 from an all-time peak then of 33.7 euros.

"There's now a fundamentally short position, people will realize there's a big deficit in carbon," said Deutsche's Mark Lewis.

New Carbon Finance forecasts a carbon price above 30 euros this year, not least because of an expected shortage of carbon offsets which companies can earn by funding emissions cuts in developing nations to count against their EUA shortfall.