EU vote shows carbon pricing not dead yet

Yesterday the European Union’s parliament voted in favour of a proposal aimed at reviving the flagging EU carbon market (For: 344, Against: 311), after previously rejecting a similar proposal in April.

It led the price of EU carbon allowances to rise in yesterday’s trading by 9 per cent to €4.67 or $A6.67.  This was on top of earlier rises in the lead-up to the vote as the market priced-in an expectation of a ‘yes’ vote.

This proposal, commonly referred to as ‘backloading’, will involve withholding the sale of 900 million emission allowances over the next few years, and then returning them into the market towards the latter years of 2020. 

However, for the measure to be implemented, it still needs to receive approval from the European Council (the government ministers for each member country of the EU).

The EU’s emissions trading scheme is currently suffering from a very large oversupply of emissions allowances, thanks to Europe’s deep recession. This has led to carbon prices slumping to such low levels that they become almost irrelevant to investment decisions in carbon intensive sectors such as power supply.  

In a normal physical commodity market like metals or grains, when there is a large oversupply and prices plummet, firms curtail production. However government-designers of the EU carbon market, as well as the Australian scheme, failed to incorporate in-built features that would act to automatically mimic these self-adjusting features of normal commodity markets. The end result is prices can plummet in quite a volatile manner once an oversupply is reached, and then become stuck. 

This backloading proposal, by reducing the level of new allowance supply in the short-term, aims to temporarily address this shortcoming.  However because the issuance of allowances has merely been delayed, rather than permanently withdrawn, the carbon market is still stuck with a large, long-term oversupply. 

Consequently carbon prices are still not expected to rise to levels that would provide a strong incentive for investment in low carbon technology.

For the backloading proposal to be implemented it still needs at least 255 of the 345 votes held by member countries (votes per country are listed at bottom) in the European Council. 

Energy ministers of countries representing 180 votes issued a joint statement a few days ago strongly supportive of the EU ETS and backloading (Denmark, Estonia, Finland, France, Germany, Italy, The Netherlands, Portugal, Slovenia, Slovakia, Sweden and the UK were signatories).

The statement argued the EU carbon price is too low, stating:

“We remain deeply concerned that the ETS as currently designed cannot provide the price signals needed to stimulate the low carbon investment needed now, because the supply of allowances substantially outstrips demand, leading to a very low carbon price. This also threatens the credibility of carbon markets as the most flexible, cost-effective way to achieve emissions reductions.”

Importantly it argued in favour of more permanent solutions beyond backloading to address the oversupply of allowances and low carbon prices,

“Targeted interventions may be necessary and we are convinced that only through proper structural reform and by giving investors a clear signal on Europe's low carbon ambition beyond 2020 can the EU ETS be restored to its original purpose of driving down carbon emissions and stimulating low carbon investments.”

However there is resistance to reform of the EU ETS, from Poland in particular. 

This parliamentary vote, on top of Obama’s recent commitments and China commencing its pilot emissions trading schemes represents a very positive development. But hurdles still remain before the European and therefore the Australian carbon price outlook materially improves.