Who can rescue the UN-backed offset market?

Any lifeline European Union regulators throw to the bloc's own troubled carbon market may do little to help the United Nations' ailing emissions offset scheme.

The EU emissions trading scheme and the UN-backed offset market have been in an interdependent relationship since 2005, particularly since most of the demand for offset credits comes from the 12,000 or so big polluters in the EU scheme.

Both markets are flooded with supply. The European Commission is expected later this month to propose to fix its oversupplied market by delaying the sale of up to 1.2 billion carbon permits for several years.

Such a proposal could help buoy EU carbon prices from near record lows in the near term, but it may not be enough to help UN-offset prices from sinking, analysts said on Tuesday.

Already there are signs of decoupling. Benchmark prices of EU allowances (EUAs) are trading around 4.45 euros above the benchmark UN-backed certified emission reduction (CERs), a level not seen since February this year.

"I believe a progressive decoupling between EUAs and CERs will gear up later this year," Matteo Mazzoni, an analyst at Nomisma Energia, said. "There are too many offsets all around to be absorbed by the market in the short-term," he said.

Benchmark CER prices for December delivery were trading around 3.30 euros after hitting a record low of 3.08 euros on Monday. And the CER discount to EUAs of the same vintage has widened nearly 50 per cent since early June.

Even if the EU carbon market were rescued by holding back supply that would lift EUA prices, the CER market could continue to drop, said Benoit Leguet, head of research at CDC Climat, a subsidiary of French bank Caisse des Depots.

"The price of CERs and that of EUAs have very different dynamics," he told Reuters in an email. In a May report, CDC Climat said CER prices could fall close to nil, as demand for the credits "will be saturated" over the next two years.

Demand drop

The Clean Development Mechanism is a UN-backed scheme to help developed countries meet their emissions targets under the 1997 Kyoto Protocol, the world's only legally-binding pact to limit greenhouse gas emissions widely blamed for global warming.

Under the CDM, governments and companies in developed countries can earn emissions offsets (CERs) by investing in low-carbon projects in developing countries. They can use the credits to achieve their Kyoto targets.

But CER prices have lost around 70 per cent of their value over the past 12 months, beset mainly by the supply glut and flagging demand due to a slowing European economy.

Most of the demand for CERs comes from the EU emissions trading scheme, the world's biggest carbon market, which itself is oversupplied by over 1 billion carbon permits. Many analysts expect the EU scheme to be oversupplied at least through 2020.

Last year, EU members states agreed to ban the use of CERs from certain industrial gas projects in its emissions trading from May 2013. These credits account for over 40 per cent of the 968 million in total CERs issued to date.

"Sellers of such credits have to find buyers in the coming nine months. "It may put pressure on CER prices," Isabelle Curien, an analyst at Deutsche Bank, said.

CERs prices might rise with positive headlines for the EU-ETS, but the spread may still widen, she said. "Without a new source of demand, the outlook for CER prices may be grim."

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