Lumbering toward carbon price limbo

The European Commission is in favour of higher carbon prices to drive emissions cuts, but at least one EU member state, Poland, disagrees, and from there stems a skirmish which threatens the scheme.

EU allowances (EUAs) are trading at or near record lows, after recession dented pollution and demand for permits.

On Thursday the commission's head of climate action Connie Hedegaard proposed a short-term solution. The question is whether this will work – in raising prices – and whether a longer-term back-up is ready.

At present, there is no obvious reason why the short-term remedy of temporarily withholding permits should boost prices, as it simply holds these in reserve to swamp the market later.

Almost all analysts agree that the present carbon credit glut is sufficient to leave the market over-supplied throughout its third trading phase from 2013-2020.

That throws the debate forward to what longer-term, back-up solution the European Commission has.

It turns out this is the same as before Thursday – to amend the underlying law, the Emissions Trading Scheme (ETS) Directive, and permanently cancel surplus EUAs.

Given that amending a directive takes more than a year, and the commission hasn't kicked off that process yet, that leaves carbon prices potentially in limbo through 2015.

On Thursday, the Commission proposed, from next year, to limit the supply of EUAs under an amendment to an existing Auctioning Regulation, which is secondary legislation under the ETS Directive.

It drew a firm riposte from Poland's environment minister: "We simply do not have a mandate for manipulation in the market mechanisms," said Poland's Environment Minister Marcin Korolec.

The coal-dependent economy was playing its trump card: that the proposal deliberately manipulates carbon prices and so requires a re-opening of the founding ETS Directive.

In the EU, amending a directive and a regulation are quite different: the first takes over a year and requires a decision by member state ministers and parliament; the other is a technical decision achievable in months, requiring majority approval by experts plus parliamentary scrutiny.

The Commission's interim proposal hinges on successfully arguing that it is ‘non-essential' to the carbon market, and so doesn't need a re-opening of the directive.

However, even if successful, the commission then has to make the withholding of EUAs permanent.

That would certainly require a re-opening of the ETS Directive: if Poland loses the first round, it gets a re-match.

As well as being time-consuming, such a re-opening of the ETS Directive is fraught with danger.

Directives, and amendments, are often approved by a majority vote. One major exception is where these apply to tax measures, where unanimity is needed.

The original ETS Directive was agreed by majority vote.

Emissions trading could be put on ice, or killed off, if east European objectors successfully argued that cancelling EUAs manipulated the carbon price and so counted as a tax measure.

That threat is probably a major reason why the Commission is reluctant to back a carbon price floor, which would turn the scheme more into a tax.

A price floor would be the simplest solution to support EUAs. Proposed cap and trade schemes in California and Australia, expected in 2013 and 2015, both propose price floors.

But in Europe, that would have to be legislated retrospectively: and could be argued to be a tax measure.

While the existing EU Auctioning Regulation allows member states to hold a carbon reserve price, that's more intended as a technical feature, rather than a floor price.

It is meant to ensure that EUAs fetch fair value, in relation to the market price, allowing states to withhold EUAs for example if there were suspected collusion among bidders.

Analysts favouring a floor price argue it could operate in another way, by setting an absolute price level.

This argument has a long way to run: supporters argue a floor price is the only way to give the market a transparent future. Detractors point to its legal hurdles as well as the problem deciding where the floor should be set, and the windfall it would hand traders if set far above present levels.

Meanwhile, waiting in the wings is Poland.

This article was originally published by Reuters. Republished with permission.