Carbon Junk Bonds the demise of the Energy Trading Scheme

With carbon allowances below the level of junk bonds, perhaps it’s time for the European Union to restructure its climate change strategy.
Published: Wed 02 Oct 2013

The Emissions Trading Scheme (ETS) has been a failure from the very beginning. Many say the scheme is fundamentally flawed and was always doomed to fail. An over-allocation of free carbon allowances, improved EU energy efficiency levels, ambitious renewable energy targets, and the recession are adding to its imminent demise.

The ETS was originally created to decrease carbon emissions by setting a limit on the amount of pollutants a company emits. The limit is allocated or sold to firms in the form of emissions permits. But, with the current low price (the price has fallen dramatically over the last five years from €30 to under €3 a ton of carbon dioxide), the scheme is not achieving much as it is too low to incentivise companies to turn towards greener technology.

For the scheme to really work, the price should be around €30. This is an absolute minimum but to really see positive results, the price should actually be €80 to €100 a ton. As a result, the scheme could face collapse. Stig Schjølset, Head of EU Carbon Analysis at Thomson Reuters Point Carbon, views the EU ETS as “irrelevant as an emissions reduction tool for many years to come.”

The low price has created headlines but perhaps a better view is that this is the result of a free market- see Engerati’s podcast interview “do markets beat regulation” with Stephen Woodhouse, Director Pöyry Management Consulting (UK) Limited. He explains that a few of the challenges are formed around mixed policy messages and whether the target is renewables generation or carbon.

Investor confidence not a crystal ball

The other challenge is that we pretend to believe in market-based measures and energy trading but in practice if we try to understand what a market would look like that leads to a decarbonised power system, it does not seem plausible. To solve this a price of carbon must be established with a visibility of 20-25 years. This will attract investments in low carbon generation to be based on carbon price rather than on a feed-in tariff, support regime or green certificate.

There have been attempts, such as back-loading, to increase the price but without success. The European Commission (EC) planned to postpone the auction of 900 million European Allowances (EUAs) with the hope of increasing the price. The decision required approval from the European Parliament and the EU Climate Change Committee (CCC), which is comprised of representatives from national governments, as well as the EC. After much political wrangling, the majority finally voted against back-loading. This ussling l and political involvement and threat thereof leads to uncertainty which could well be another factor leading to the downward drift in the carbon price. Participants don’t want to trade in an uncertain market. They want reasonable certainty. and visibility of r risk.

What happens if the ETS is scrapped?

It may not be good news for the environment as the scheme acts as a deterrent to pumping out carbon. Cheaper carbon will definitely make coal more attractive than gas and other clean sources of power. Already, research shows that European countries are planning 69 new coal plants, with a capacity of over 60GW.

Georg Opperman of EON says that it would be a major setback for European climate protection targets and renewables development. But truth be told, subsidies and feed-in tariffs are probably doing more for renewables than the ETS ever has or will.

Tamra Gilbertson of Carbon Trade suggests that the scheme be scrapped and that EU parliamentarians rather establish strict regulation and policies in order to reduce emissions at source and not through a market-based emissions trading scheme.

Means to an end

But, surely the carbon price is a means to an end? The idea of the ETS is not to make emissions more pricy but to eventually eliminate carbon emissions. Figures show that the EU’s carbon emissions have dropped by 18% over the last two decades. The good news is that the EU has already reached its 2020 target (that is, to cut emissions by 20%) nine years early. So, should we really be concerned when the carbon price falls? Perhaps not.

Hello subsidies meet the market

The EU has a mandatory declining cap therefore emissions will continue to decrease by 1.74% every year. This will occur with or without politicians’ meddling. The cap will ensure that approximately 70% of the reductions are below 1990 levels by 2050. The EU’s national policy ensures that emissions continue to fall. This is because it’s law.

This commitment is one of the headline targets of the Europe 2020 growth strategy and is being implemented through a package of binding legislation. This legislation is driving the reduction in comparison, the US does not have a policy in place. Gas in the USA is helping to cut emissions but this will eventually increase again if the opportunity to legislate is not taken.

We do not believe that the poor carbon price will lead to the dismantling of the EU’s climate policies. Many European environmental policies are set at national level and a vote on the ETS will not change national opinions.

Engerati Analysis

The European Union may be at risk of missing the point by citing energy efficiency and renewable energy targets as two of the main instigators of the falling carbon price. We should not be chasing carbon but focus on global energy security. The EU emissions trading system is described as the cornerstone of the region’s policy to combat climate change but the evidence suggests otherwise. More time should be spent on creating clear regulation and policies and building on a framework that has already delivered results than debating over a controversial market system.


Sources

Financial Times-Judge a carbon market by its cap, not its prices

Point Carbon-Backloading voted down, EU ETS in disarray

Redd-Monitor-EU carbon price collapses: Carbon trading is not the solution to climate change

Risk.net-‘Half dead’ EUA market hit by political uncertainty

The Economist-Below junk status

The Economist-ETS, RIP?

Washington Post-European carbon market in trouble