Saturday, August 1, 2009

Carbon Bubble bursting?

The EU Emission Trading System is in a mess. The first round was widely accepted to be a disaster- free allocation of carbon credits meant that many companies could stay under the emission caps easily and sell off surplus credits, which in turn meant the value of the credits sank to almost nothing. The second round, from 2008, had been a bit better- until the recession hit. With energy demand falling, once again caps were easy to meet and some companies decided to off-load credits before their value collapsed again, thus making sure that happened! Their value fell to €8.2/tonne carbon, from €31the previous year.

Negotiations for the next round, from 2012, have been stymied by economically hard pressed countries like Poland claiming that they couldn't afford to buy credits- so that there had to be some free allocations again.

The end result of all this is that not many emissions have been reduced by the ETS so far, but some companies- and market traders- have done well financially. It’s a familiar story from other sectors - that's how markets behave, unless very carefully regulated. Now this particular bubble looks like it may burst.

In a way this is odd. Presssure for reducing emission is bound to grow, so the market for carbon credits should also grow - if it’s properly set up. Certainly governments in the EU have looked to the EU ETS as a way to provide income for stimulating new energy technologies- including nuclear power and renewables. And the EU ETS was meant to be a prototype for a global carbon trading system as proposed at the Kyoto Conference in 1997.

While that was a hope for the longer term, the Kyoto conference introduced the Clean Development Mechanism to support projects in the developing world. Sadly that too has been less than wonderful. As several reports (e.g. from WWF) have suggested, despite the process of application being agonisingly slow, some projects have allegedly been supported that were not 'additional' to what would have happened any way. And some bore very little relation to the original aims of radical CO2 reductions- most were low-grade process efficiency or substitution projects, done often for purely economic reasons; few involved renewables, which really needed the extra support.

In the end, this is what you might expect when you try to enlist market forces to deliver environmental gains. Without a lot of regulation, markets simply reward to rich and undermine the poor. And the carbon market doesn’t provide a stable enough economic context for investors to rely on – so we don’t get much new green energy technology. In desperation, there have been calls for government to underwrite the floor price of the EU ETS carbon credits- essentially asking the taxpayers to subsidise the market! Whether this would make potential investors in green energy less risk adverse is unclear. The carbon price level needed for that would probably very high- certainly much more than has ever been achieved so far. We’re talking €100 /tonne or more. A guaranteed floor price might stabilise the variations to some extent and possibly help push the overall level up, but not that far. More likely it would be the carbon markets’ various financial advisor who would to benefit- and although they evidently have suffered from the recession, there are perhaps more deserving cases for state aid!

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