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Europe's Slushy Carbon Market: Weaker Every Day

Politics / Climate Change Jan 25, 2013 - 09:20 AM GMT

By: Andrew_McKillop


Anybody who wants to know how Europe's forced and mandatory Emissions Trading Scheme or ETS works - or doesn't work - needs only to check out the figures. One barrel of oil emits about 430 kilograms of CO2 when burned; 1 tonne of CO2 is therefore equivalent to burning about 2.25 barrels. European total CO2 output was about 5.1 billion tons, or 7.5 tons per capita in 2012, for a 3% decline on 2011 according to Holland's PBL Environmental Assessment Agency.

In the first week of January, European emissions traders who shuffle EU emissions permits which cover about one-fifth of Europe's total CO2 output, showed every sign of kicking the permits down the road to oblivion, from price levels a little higher than their recent record low price of 5.93 euros ($7.75) for a metric ton CO2 equivalent, set in late December. The reason is drastically simple: there are too many permits chasing too few emissions but the EU's agencies and institutions which handle the issuance and allocation of this "carbon money" go on increasing its output.

The present "carbon price" works out to a levy of approximately $3.40 per barrel of oil or barrel equivalent of fossil-based energy in Europe. This is a drastically unimpressive levy, relative to the delirious figures spouted by "those in the know" as recently as 2010: for instance then chief of the IMF, Dominique Straauss-Kahn (before he took up horizontal-type activities) who forecast global emissions taxes and trading could rise to an equivalent of "up to $500 per tonne of CO2", and market turnover to "above $10 trillion a year". Some national governments, especially the UK, as recently as 2011, continued to scenarize future UK CO2 taxes as high as, or more than $500 per tonne "by about 2025".

The EU’s regulatory arm last year proposed to delay the sale of some permits in a process known as "backloading" to boost prices through shrinking supply of most types of permits to the approximate 12 000 entities in Europe, especially power producers and cement makers, that are forced to buy, sell or trade permits. In European Commission energy directorate newspeak, a failure to tackle the glut "may discourage" utilities from switching to natural gas and other less-polluting energy sources, from coal. In fact, the shift to gas has stalled for completely different reasons including high gas prices in Europe and the unexpectedly fast increase of wind and solar capacity, coupled with the stagnation or decline of electricity consumption in most EU states, including Germany.

The bureaucratic newspeak continues by saying that official estimates of needed power sector investment in Europe to 2020, of 400 billion euro ($520 billion) is now "compromised", in turn making it "uncertain" that EU’s 2020 climate targets can be achieved. So-called backloading has complex frills, such as the future role of carbon reduction commitments, Clean Development Mechanisms (CDMs) and CO2-equivalent permits for an alphabet soup of supposedly "climate-threatening" gases. However and basically, backloading means cutting the supply of permits - but not as soon as possible. Analysts estimate it as unlikely there will be any cutback in supply earlier than Q4 2013, at best, making it altogether possible that permit prices will collapse, potentially to 2.50 euros a tonne. After that, new material for making lampshades could become available.

One major reason for the "unreality component" in European Union response, or non-response to this carbon money crisis is the refusal of Commission bureaucrats to accept that Europe is in recession. The limits on CO2 discharges by "designated emitters" were set before the euro area entered what is politely called a W-shaped recession but in fact is an M-shaped recession, operating since 2008. The bureaucratic system operating ETS is so multi-layered, opaque and cumbersone that there is little room to prevent a decline in permit prices, because the existing allocation and issuance mechanism denies that emissions can decline due to companies going out of business or shifting out of Europe - rather than "cleaning up their act".

The ETS assumes that "designated emitters' will need to buy more permits as their activity expands.

When bureaucrats panic, they never do it in style. The present "backloading" proposals are the result of fevered talks involving the Commission, the Investment Bank (EIB), close-linked European "carbon market maker" banks such as France's Soc Gen, Germany's Deutsche Bank and Britain's Barclays, and other better-hidden "players" (such as agencies and entities controlling CDM payments), as well as energy and environment, and finance ministries in countries with either high or low potential amounts of permits to buy or sell.

The only agreement that has so far been cobbled together was to make large-scale and repeated auctions of permits "sometime soon". Timing of these auctions has caused massive disarray among the "carbon money" fixers and dealers, resulting in the auctions being unlikely to start before Autumn '13.

Companies will need to buy almost half the permits they need per year in a few weeks or months, in the new system, which would be backdated to January '13. In previous years, the "designated emitter" entities got most of there needed permits for free, on a regular basis through the year, and had to buy extra permits if and when needed. As already noted, one of the biggest "reality hits" for ETS is that most designated emitters do not foresee any need to buy additional permits - some are simply going out of business -  but this need was expected to be permanent by Europe's permit system operators.

Today, accusations of open rigging of permit markets are not coming from isolated bloggers on the Web - but as one example, from Poland’s Environment minister Marcin Korolec. His country is among the "designated losers", also including Cyprus, Estonia, the Czech Republic, Bulgaria and Romania who stand to lose about 1.9 billion euros from 2013 to 2020, according to Korolec in December 2012.

To be sure, open swindling of permit buyers, by operators based in the above countries has been common: the government agencies receiving free permits would "monetize" them their own way, by selling the permits outside their country a second or third time, after wiping clean the data on the permit. This particularly concerned the "exotic gas" permits, on fluon-type refrigerant gases with a higher face value per tonne CO2 equivalent, and the corruption-riddled CDM compensation system.

The EU plan to sell fewer permits in the three years through 2015 will probably be delayed until next year, according to UniCredit. UBS of Switzerland said that EU nations will probably discuss the plan throughout 2013, not arrive at any coherent result and then abandon it next year. The company forecasts prices at a maximum of around 6 euros a tonne in 2013.

Connie Hedegaard, the bloc’s climate-action commissioner, said in November that the carbon market "needs clarity on backloading" but as many as 9 or 10 of the EU's 27 member states may either vote against, or abstain from voting when or if the "ETS crisis" moves back up to the high ground. European governments may formally vote on the strategy in March 2013, according to EU officials in Brussels.

Germany and the UK are among nations still undecided on whether to vote in favour of backloading and these 2 countries together hold almost 17% of total votes in the EU ballot system, meaning their support will be needed to avoid deadlock. For portfolio holders however, this is too little-too late. ETS permits, since active volume trading started in January 2008, have lost about 77% of their value and at end-2012 the number of excess permits - relative to emissions by designated emitters - stood at  1.1 billion tons or close to 50% of Europe's self-imposed annual grenhouse gas pollution limit.

The 17-nation Eurozone's economy will contract at least 0.5% in Q1 2013 according to analysts' forecasts necessarily and further dragging down emissions permits turnover, on permits with a delcining unit value. For 2012 against 2011, the value of transactions in the global carbon market made up of the EU27, Australia and New Zealand (New Zealand will quit this system in 2013), dropped by 36% to a year-total of 61 billion euros nd may decline to as little as 45 billion euros in 2012 according to Bloomberg New Energy. Wal-Mart's turnover in 2012 was estimated by analysts to have been about $112 billion.

Due to a fatal combination of economic decline, de-industrialisation, delocalisation outside Europe, improving energy efficiency and the development of non-fossil energy the EU’s estimated surplus of permits may swell to 1.3 - 1.5 billion tons CO2 equivalent this year, without backloading, according to analysts at Barclays and Soc Gen. The same analysts, being optimistic, claim that backloading could or might enable the carbon price to regain 2010 value levels of around 10 euros a tonne - only if nations agree on the backloading plan.

The EU Commission needs 255 out of the 345 total number of official votes from member states, and approval from the European parliament to tackle the glut. Most observers are highly sceptical about this Happy Ending, mainly because lawmakers and market actors will realize that backloading does not offer the ‘once-only silver bullet’ change that is needed. Merely implementing the presently unagreed and unsure plan would seriously impact confidence. 

The Commission has now revealed its shaky hand by proposing a plan where auction delays will be followed by another glut, simply as a short-term measure to fix the market, opening up the Pandora's Box of "non-market regulation" as the real alternative to to fixing the possibly non-existent problem of global warming through human CO2 emissions. These include tighter CO2 emission limits and cancellation of carbon permits as well as mechanisms to restrict re-imported offset credits, such as CDM offsets (now worth a princely 43 euro cents per tonne) and simple energy taxes - which are already high in Europe.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2013 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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