CLIMATE SPECTATOR: Can Europe save the carbon market?

Labor's move to get rid of the floor price and link with Europes leaves us broadly in the same place – with a weak and uncertain carbon price. But if Europe can get organised, the potential price upside is extensive.

Climate Spectator

The announcement by Climate Change Minister Greg Combet to drop the $15 floor price and reduce the use of international carbon credits known as CERs (Certified Emission Reduction) still leaves Australia in pretty much the same place – a weak and highly uncertain carbon price. However the potential carbon price upside is far greater under these new arrangements.

The extent of the upside is driven by European policy settings as well as whether Europe can pull itself out of its current depressed economic conditions.

The base case scenario, assuming no change to European policy settings, is that rather than having the Australian carbon price plummet from $25.35 in the last year of the fixed price period to the $15 floor on July 2015; they instead drop to around $10-$15 – the forecast price for European carbon allowances (EUAs). Such a price would be insufficient to drive much fuel switching in the electricity sector, nor support serious amounts of tree planting, nor notably improve the economics of energy efficiency initiatives.

Of course we’ll probably still be pleasantly surprised by abatement in some obscure areas (these might include such things as refrigerant gases), but overall it’s not anything close to a level that would stimulate a clean energy transformation.

Decision provides for carbon price upside

But there is an upside built on a belief that the European Commission and Parliament, as well as key member nations, believe that the price of European allowances are far too low. When the EU originally locked in the parameters for their emissions trading scheme for the period 2013-2020 they were expected to result in a carbon price reaching €39 ($47.25) by 2020.

Why on earth would European leaders consider their carbon price to be "too low”? This must seem like a parallel universe for us in Australia where debate seems to centre around a fear that we might get slightly ahead of the world. But for Europe creating a clean energy future is more than a political slogan selected because it works better in focus group testing than ‘CPRS’. Rather it is the basis for a serious industry policy.

Europe knows it has a technological edge in clean energy engineering over the rest of the world. Yes, they may have been slaughtered by the Chinese in manufacturing solar PV. But guess where all the machine tool equipment came from that the Chinese are using to make those solar panels? Europe.

Europe’s wind turbine engineers and their designs are the best by a country mile. Their cars also achieve superior levels of fuel economy for a given level of performance. They may trail Japan on hybrid technology, but they’re not far behind.

Also the EU is a major importer of fossil fuels. And it gets them from places that it doesn’t consider reliable or particularly friendly – Russia, the Middle East and North Africa. Europe has coal but it’s expensive to extract, and contains nasty impurities.

So putting fossil fuels out of business works in two ways for Europe – less imports and more exports.

But such upside requires significant policy change that is far from certain

Yet, as we all know, Europe is mired in an economic morass with deeply indebted governments. The severe recession in Europe has led to a large drop in industrial output and energy consumption that has meant that they’ve banked up a huge amount of surplus EUAs.

According to the European Commission, they now have a surplus equivalent to 2.4 billion tonnes of CO2 out to 2020. That’s enough to cover Australia’s entire emissions trading scheme’s requirements for six years without the Australian government having to issue a single permit of its own!

The European Commission in combination with the European Parliament has put forward multiple ideas for lifting the price of EUAs. This has included increasing the stringency of Europe’s emission reduction target to a minus 30 per cent cut on 1990 levels instead of minus 20 per cent. This has been rejected by the member countries of the EU via the European Council (EU laws passed by the European Parliament still need to gain approval from the member countries via what’s known as the European Council which is the heads of state for each country). Poland, keen to maintain and expand its use of its own coal deposits, has been the key blocker.

Right now the European Commission is working on a plan where it would set-aside or substantially delay the release of a large amount of EUAs onto the market. It was widely understood that this could be done without getting the approval of the European Council, making it easier and faster to implement. However it has taken them longer than originally anticipated to finalise a plan.

The EU Parliament’s environment committee originally proposed that 1.4 billion allowances be set-aside. However in July the European Commission put forward options that would reduce the amount of permits auctioned in 2013 to 2015 by 400 million, 900 million or 1.2 billion EUAs, with these then auctioned in later years. According to analysts Reuters Point Carbon, they consider 800 million the upper limit of what might be politically feasible. This might increase prices from current levels of €7-8 to around €12.

Yet because these permits would ultimately re-enter the market rather than be permanently removed, it won’t make a major difference to prices after 2015, which is what actually matters for Australia’s carbon market.
For things to really change and for prices to go beyond Australia’s original floor price of $15 will require more substantive fixes. The Commission will release a report later this year reviewing the functioning of the emissions trading scheme that is expected to recommend some more fundamental structural changes to the scheme.

These are likely to require European Council approval. Current depressed economic conditions suggest obtaining approval for measures that will increase carbon prices will be challenging.