Would you credit it?

One of the less obvious impacts associated with the economic troubles in Europe has been a collapse in the price of carbon allowances under the EU Emissions Trading Scheme (EU ETS).

The EU ETS scheme requires businesses to hold sufficient allowances (EUAs) to cover each tonne of CO₂ they emit. It is a market-based scheme, and as with all functioning markets, when demand is low the price falls. Ordinarily, changes in price would stimulate changes in supply, so when the price is low, the level of supply will fall and drive the price back to an optimal level. However, the overall supply of EUAs is not fluid, but influenced only by achieving specific climate change targets. It therefore doesn’t react flexibly to price signals.

With European industrial output static or falling – especially in carbon intensive sectors, such as cement production – the demand for EUAs has dried up, and they are now trading at around €8, down from €30 in 2008.

The cost of low prices

In so far as this reflects lower than expected emissions of CO₂ across Europe, you might ask “What’s the problem?”

Firstly, one of the clear consequences of the low EUA price is uncertainty, and the consequent loss of confidence in the market. Undoubtedly, this has resulted in a short-term approach to decision-making and is currently stifling investment in low carbon technologies.

Secondly, and perhaps most ironic, the EU’s largest investment in renewable and low carbon energy is dependent on high EUA prices. The New Entrant Reserve (NER) 300 Programme is wholly funded through the allocation and selling of 300 million EUAs – two thirds of which are required to be sold before 2^nd October 2012. When the ‘NER300’ was first announced, it was expected to raise €9bn to support low carbon projects.  But at current prices, the funding available for the first tranche of projects will only be around €1.6bn, which will severely restrict the number of projects that can be funded. Those more cynically minded might point to the failure of the Commission to set an effective regulatory framework as the main reason for the impending failure of the NER300.

A floor in the plan

Solutions to the problem are complex. In the UK, the Carbon Price Floor (CPF), set at £70 per tonne by 2030, will ensure that the power sector will have to price CO₂ emissions into decision-making. But this approach isolates the UK from the rest of the EU market, arguably undermines the competitiveness of businesses, and does nothing to address the low carbon price experienced by other industries across the UK.

One pan-European option is to decrease the volume of EUAs in circulation.  Phase III of the scheme is implemented in 2013 and will act as a greater constraint to the number of EUAs on the market – but this will come too late for the NER300.

In fact, if the NER300 is to be saved, the answer lies in changing the competition’s rules, not the ETS. For most projects, no money is due to be handed out until after 2015; yet the scheme rules require the carbon credits to be monetised years beforehand. If the EU announced that the EUAs from the NER300 were to be sold over a timeframe which included 2013 or 2014, with a target price of €10 or €15, this would in itself remove a major downward pressure on prices.

Such intervention in the NER300 is currently critical if the competition is not to rank as a major missed opportunity. Doing so will not only be a boost to low-carbon generation – it will help to smooth the transition to Phase III of the ETS and avoid an unwanted systemic shock to European Industry in 2013. Truly a creditable result all round.