EU proposal to resuscitate carbon market

With major implications for the level of Australia's carbon price and UN carbon credits (CERs), the European Commission overnight put forward six options for permanently reflating the European carbon price and addressing the huge glut of carbon allowances. These go beyond delaying the sale of 900 million allowances - which was announced a few days ago - to include the following alternatives:

1- Increasing the EU's carbon reduction target for 2020 from 20 to 30 per cent below 1990 levels;

2- Retiring a certain number of phase three allowances permanently;

3- Revising the 1.74 per cent annual reduction in the number of allowances to make it steeper;

4- Bringing more sectors into the EU ETS;

5- Limiting access to international credits; and

6- Introducing discretionary price management mechanisms such as a price floor.

The price of carbon allowances under the EU emissions trading scheme has been depressed below €10 due to the build-up of a huge surplus of allowances as a result of the severe European recession.

The European Commission, and most market analysts, expect that without structural reform along the lines of the options outlined above, the ETS will be burdened with a two billion allowance surplus for the rest of this decade, which will act to keep the price depressed at low levels even declining below the current price of around €8 or $A10. 

This would mean that Australian carbon permits would also suffer these same low prices because the Australian government will recognise a European allowance as a one for one replacement with an Australian carbon permit. Therefore any changes Europe makes that would substantially reflate its carbon market would also improve the prospects for Australian carbon abatement technologies and service providers.

When the parameters for the 2013 to 2020 period of the EU ETS were put in place, the European Commission expected carbon prices would sit in a range around $25 to $40. With the recession leading to a build up of surplus of permits and prices below $10, they are now deeply concerned that the ETS is no longer effective in providing a signal for investment in low carbon technology and practices that are necessary over the longer term. 

The European Commissioner for Climate Action Connie Hedegaard said in a statement today,

“The Commission wants an even more robust European carbon market that provides a stronger driving force for carbon markets elsewhere. Our carbon market is delivering emissions reductions. But because of the oversupply in the market, the ETS is not driving energy efficiency and green technologies strongly enough. This is bad for Europe's innovation and competitiveness.

"This is why, as a first immediate step, we propose to delay the auctioning of 900 million allowances in the next three years. We must not flood a market that is already oversupplied. Market operators must have clarity before year-end on this. At the same time, the Commission presents options for possible structural measures that can provide a sustainable solution to the surplus in the longer term.''

However for such reforms to be implemented they must first obtain approval from the European Parliament and the member countries of the EU, known as the European Council.

According to reports from Euractiv, the EU's biggest economy, Germany, with a major bloc of votes on the Council, has not taken a formal position. In addition Poland has been outright opposed to any efforts to reflate the carbon price because it would undermine the value of its extensive coal resource and coal-powered electricity. The Polish economy ministry said in a statement, "Poland maintains its negative stance towards any interference with the CO2 permits market that would lead to an artificial rise in their prices."

As outlined in Climate Spectator last month getting these kinds of reforms passed will be incredibly difficult. This is due to the fierce opposition of Poland, and the need to obtain 74 per cent of the votes within the European Council, not just a simple majority. These reforms are at the very least unlikely to be implemented before 2015. So as Australia heads into the trading period of our scheme we'll still face major regulatory uncertainty even if Labor manages to win the 2013 federal election.

The one glimmer of light is that the proposal to backload the auctioning of 900 million allowances to 2019 and 2020 could help increase prices in the meantime. At the low end Barclays estimates this might lift prices above $13 by 2015, while at the higher end Bloomberg New Energy Finance suggest $25 in 2015 could be possible.  However prices then decline afterward because these set-aside permits re-enter the market closer to 2020.

So if Australia is to have a carbon price that makes a meaningful difference to investment decisions, we'll need the Commission to succeed in implementing the more substantive reforms floated today, ideally a combination of them.