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Environmental Risk: The Changing Climate: Sins of emission

The bottom has fallen out of it for now, but Elisabeth Jeffries finds the EU Emissions Trading Scheme becoming the model for others around the world

In one of the darkest periods in the short history of the EU Emissions Trading Scheme (EU ETS), the sun is rising – but in the West. For years, the US was criticised for not ratifying the Kyoto Protocol, while efforts to establish a federal emissions trading scheme collapsed in 2010. But in 2013, America’s first major cap-and-trade scheme will start up in its most second most polluting state – California.

That is not to say that the schemes will be in any way linked, of course. California’s will be linked to Quebec’s, although an Australian trading scheme that started in 2012 will connect up with the EU. That will eventually allow businesses to use carbon units from Australia or Europe for compliance under either system. However, the Californian scheme could have a significance of a different kind.

“California is an encouraging sign and will act as a beacon this year,” comments Guy Turner, director at market intelligence provider Bloomberg New Energy Finance. “The scheme suffered from regulatory uncertainty at the end of 2012 but is happening and will happen. The market is short and prices will go up there. But the scheme may also send a signal elsewhere, moving prices upwards.”

Another scheme, the Regional Greenhouse Gas Initiative, has been running since 2008 in nine mid-Atlantic states, but this relates to power plant emissions alone. Turner argues that, as the most populated, high profile state in the world’s largest economy, California could influence market sentiment globally.

Meanwhile, the EU ETS continues to suffer from an oversupply of carbon credits, generating a price insufficiently high to justify most clean-tech investment. Having hovered around €5-7 per tonne for most of 2012, the carbon price is unlikely to change significantly during the first half of this year, according to analysts. Demand is sluggish, and this is attributed to a number of factors – most clearly the economic crisis which prompted a fall in industrial activity. But a glut of credits from Russia and the Ukraine has made matters worse.

Russia issued 210m Emission Reduction Units (ERU) in 2012, flooding the market with surplus credits. These relate to emissions-cutting projects in Russia producing credits available for purchase by companies in the EU ETS. However, demand is not high enough to absorb them, driving the price further down. Worse, Russia is due to release more this year.

A total cap of 300m has been announced, but Russia has indicated even this could change. “The release of ERUs was expected, but Russia had issued next to nothing by December 2011,” observes Frank Melum, senior carbon analyst at Thomson Reuters Point Carbon. “Then they issued almost all their ERUs in Q2. This was always a bit of a risk.”
However, there is another possibility that could mean ERUs have less impact: “If Russia produces more ERUs, that could displace Certified Emission Reductions rather than adding to supply,” points out Guy Turner.

To remedy the problem of a long market, EU authorities have proposed to backload EU Emission Allowances (EUAs) – a supply-side measure. This would mean reducing the number of allowances auctioned to curb supply, but feeding them back into the market at a later date. Not feeding them back in would constitute a reduction in the market cap. However, this proposal has not yet been accepted, and an EU vote on this point is expected by May 2013.

“Until May, the market will live with uncertainty on backloading, keeping the prices at a low level,” explains Marcus Ferdinand, senior carbon analyst at Thomson Reuters Point Carbon. “If there’s a positive vote on backloading, prices will rise in the second half of 2013 because a certain amount will be removed from the market in 2014-15.”

However, the position of major players such as Germany is critical. “Germany is divided on this issue. But if it does not, in the end, give its support, backloading is dead,” argues Ferdinand.

That might look like bad news to traders who would like a more buoyant market. But, as Ferdinand explains, the principles behind moves like this are sometimes poorly received.
“The EC might withdraw allowances, but investors have planned according to the existing situation, so it undermines the predictability of the market framework,” he says. “And who can guarantee it’s a one-off measure? They don’t want policy makers to argue with prices.”

Manipulative steps, both by industry or government, have cast a shadow over the ETS ever since its beginnings. Emissions caps were criticised at the start for being far too high. Yet it looks like several other regions are taking the EU lead. Guangdong, China’s most heavily emitting province, drafted a pilot emissions trading scheme in autumn 2012. Mexico and the Republic of Korea have passed legislation laying the foundation for future trading schemes, while similar plans are emerging in South Africa.

A new post-Kyoto agreement under development could be influencing some of these
plans. However, there is little evidence that the EU ETS has made much difference to emissions. “We think in 2008 the carbon market reduced emissions and triggered fuel switching, and it still has an impact on investment decisions,” says Ferdinand. “But policy makers made decisions on caps before they knew about the economic crisis.”
Instead, the role of the EU ETS has perhaps been to entice power companies and industry to accept previously unpalatable environmental policies using incentives like free allocations.

“It’s encouraging that market-based mechanisms like these are being established around the world,” says Jonathan Grant, director of sustainability and climate change at PWC.
“But as we recognise from the EU experience, the mechanism doesn’t cut emissions unless the targets are stringent enough, and [in new schemes] it’s not likely to be demanding in the early stages.”

PWC’s calculations show targets need to be tough – emissions reductions by developed countries should be about 5-6% every year from 2020, compared with total reductions of around 5% over five years in the first commitment period of the Kyoto Protocol.

 

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