October 29, 2008 / 6:25 PM / 10 years ago

Carbon market's future hangs in the balance

LONDON (Reuters) - The future of global carbon markets is finely poised as recession threatens the political will to shoulder costs but New Zealand, Australia and Japan follow Europe with their own cap and trade schemes.

A general view of the Cofrentes nuclear plant near Valencia in this July 21, 2008 file photo. REUTERS/Heino Kalis

Strong carbon markets depend on tough climate change goals, now under discussion in international talks to replace the Kyoto Protocol from 2013.

Clear visibility is therefore limited to a four year horizon, in a market tipped to exceed $100 billion in 2008.

“(Comparing) the financial crisis and the post-2012 uncertainty, uncertainty is a ten times bigger problem,” said Alex Wyatt, director of Emissions Zero, a project developer that advises Chinese companies on securing carbon finance under the Kyoto Protocol.

U.N. executives and EU officials are concerned that recession concerns may sap political support for tough climate goals in post-Kyoto talks intended to agree a new treaty in Copenhagen at the end of 2009.

Cap and trade schemes force businesses and countries to buy permits to emit the greenhouse gas carbon dioxide (CO2). They enjoy more political support than carbon taxes — possibly because carbon trading has a similar but less obvious impact on voters’ fuel bills.

Environmental groups, bankers and U.N. agencies strongly favor cap and trade as a tool to drive private sector investment in climate-friendly technologies.

“This will spur the kind of innovation which will be an important part of making those emissions reductions,” said James Leape, director general of environmental group WWF International.

“It’s a cornerstone for an effective climate programme.”

SLUMP

In Europe, Italy and east European countries including Poland have cited the impending economic slump as an argument to press for free emissions permits for their power generators.

At present industry gets most permits for free under the EU emissions trading scheme, but the EU executive Commission wants utilities to pay for them all. Even now utilities are already considering their emissions more carefully.

“Utilities are very much looking at how their investment choices are compatible with a carbon-constrained world because of the emissions trading scheme,” said Cambridge University’s Karsten Neuhoff.

Neuhoff cited research estimating that the EU scheme had cut carbon emissions against historical trends by 3-5 percent in 2005-06. “It’s a starting point. To alter investment choices, and feed through to carbon (reductions), will take some time.”

Another impact of anticipated recession is that it has dragged down EU carbon prices, as there is less expected demand for electricity that emits carbon.

That lower EU carbon price will weaken the incentive for rich countries to fund emissions cuts in developing countries, to acquire cheap carbon offsets that are valid in the EU.

“That margin has compressed and may no longer justify the risks for some investors,” said Garth Edward, carbon trading manager at Citi, citing a narrowing gap between EU and carbon offset prices to as little as 2-3 euros from about 5-6 euros three weeks ago.

Many industrialized countries are planning cap and trade schemes to follow the EU’s pioneering step, including New Zealand in 2009, Australia in 2010, and Japan this autumn.

One battle to come will be to make these compatible by imposing comparable targets. That would fulfill an ultimate aim for companies and countries to be able to trade emissions permits around the world and find least-cost curbs that would cut the cost of fighting climate change.

So far, the signs are mixed — Japan’s pilot scheme is voluntary, the New Zealand scheme has no emissions cap, and the Australia scheme may include a carbon price ceiling — all contrasting with the EU model.

“They may as well turn it into a tax,” said Justin Woolsey, a carbon trader at Canada’s RBC (Royal Bank of Canada) Capital Markets, referring to a carbon price cap.

Finally, carbon offsetting schemes have attracted criticism for paying companies to avoid emissions which they might not have made anyway.

Media reports have highlighted how companies can suddenly earn carbon offsets under a Chicago Climate Exchange (CCX) scheme for behavior that may be unchanged from the previous decade.

But the criticized projects had been recommended as “high quality” by a panel of environmental experts convened by the U.S. Environmental Defense Fund, said Richard Sandor, CCX chairman. “We design and implement systems that anticipate policy and inform the debate,” he added.

Additional reporting by David Fogarty in Gold Coast, Australia and Michael Szabo in Toronto, editing by Anthony Barker

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