Why traders are rushing into the EU carbon market

There is talk of the EU carbon price falling to €0, but that hasn’t scared off traders... who are happy fundamentals aren’t playing a great role in pricing.

The risk of carbon prices tumbling to zero is not scaring off investors in the European Union's trading scheme, where fraught efforts to draw up a rescue plan have seen daily trade volumes soar.

Those rescue efforts are eclipsing energy prices, economic data and currency fluctuations as the market's main driver in a trend likely to continue for months, even years.

"The carbon market is broken in that it is driven by regulation, and not by fundamentals," Paolo Coghe, analyst at Societe Generale, said.

"We believe the combination of characteristics of the carbon market at present make it particularly attractive for speculators."

Emissions trading platforms in the EU handled record volume of 9.25 billion carbon units last year, or 22 per cent more than 2011.

At the same time, the value of the EU Emissions Trading Scheme (EU ETS) shrank by more than a third to around €50 billion ($A65 billion) due to the falling carbon price.

Daily trade volumes have soared, averaging 23.7 million tonnes this quarter compared with 8.8 million in the fourth quarter last year, Coghe said, adding the increase was too great to explain using fundamentals.

Speculative trade is also exaggerating swings in the price, which hit a record low below €3 a tonne last month.

Traders have focused in particular on EU talks on a proposal known as backloading, a plan to tackle a glut of carbon allowances by temporarily removing some of them.

With relatively few official Commission announcements and very slow progress, market participants are seizing on incremental steps and betting on the outcome of different EU meetings, traders said.

"Most of the initial reactions are massively exaggerated in this market," one trader, who asked not to be named, said. "This is a unique market, principally because it is politically managed and designed to be finite."

Not so quick

EU Climate Commissioner Connie Hedegaard, who announced the backloading proposal last April, had hoped to have the process agreed to by the end of last year, but that has been pushed back.

She has often referred to the ease with which the European Union achieved the opposite move - frontloading - when member states in 2011 agreed to the early auctioning of a batch of allowances.

That was agreed in three months.

This time, opponents of a higher carbon price, notably heavy industry and Poland, which is reliant on carbon-intensive coal, have been able to hold off a decision.

Those in favour of backloading cheered on Tuesday when the European Parliament's environment committee voted through a legal amendment.

Yet their failure to agree on early legislative drafting was cause for concern, driving the carbon market down by as much as 20 per cent.

Some worry extensive debate will now ensue at a plenary session of the European Parliament set for March or April.

In parallel, member states are also debating.

Their representatives meet on February 27 when the major question is whether Germany, the EU's dominant power, will give its support after months of indecision, setting aside the concerns of some politicians wary of inflating energy prices in an election year.

Even if agreed, backloading is expected to have little lasting impact on the carbon price.

But significantly it would mark a step toward deeper reform, which is the only way to raise high enough carbon prices to make a difference to low-carbon investment, analysts said.

That could sustain the market's regulatory focus, as the EU and member states pursue reforms looking to safeguard 2020 environmental targets and begin work on ones for 2030.

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