Carbon prices head higher as emissions targets start to bite

There was some important information this week from over 10,000 power generators, steel, cement and aluminum manufacturers. The effectiveness of carbon trading in creating the right incentives for power users to cut emissions depends on there being a scarcity of carbon permits reflected in a price high enough (and sufficiently predictable in the medium term) for investment in improved fuel efficiency to be commercially viable. A couple of years ago the market price of carbon collapsed when it became clear that the EU had been overly generous in handing out free gifts of carbon permits. The criticisms were valid and the long term future of the carbon trading scheme was called into question.

But the signs for the second phase of this innovative market mechanism look more promising.

Yesterday the EU announced that industries covered by the EU carbon emissions trading scheme (EU-ETS), emitted almost 1.88bn tonnes of carbon dioxide against combined allowances of 1.91bn tonnes. France and Germany came in well below their permitted levels while the UK, Italy and Spain overshot their targets. The undershoot ought to have caused a fall in carbon prices but prices in the emissions market actually headed higher because the market is already looking ahead to the effects of much tighter pollution caps that are coming in during the second phase of the EU-ETS.

Phase two of the scheme started in January 2008 and under its provisions, the EU has reduced CO2 targets by about one-tenth, leading to a CO2 price that has remained above €20 (£16) per tonne. Going forward, a rising share of the future annual CO2 permits will be auctioned off rather than being grandfathered to the industries concerned. Each permit confers the right to emit one tonne of carbon dioxide, or the global warming equivalent in other greenhouse gases, into the atmosphere. Under the Clean Development Mechanism which is an important part of the EU-ETS, CO2 emitters covered by the scheme can offset their carbon credits by paying someone else outside the scheme to cut their emissions instead. For example a UK power company might pay for carbon emissions saved by a power station in India that uses renewable sources of energy rather than coal. The scale of carbon trading is rising rapidly - last year, the value of all the carbon credits traded in Europe topped $40 billion.

According to the data, CO2 emissions in the EU are rising although we should remember that the EU economy has enjoyed faster economic growth in the last couple of years and also, that only half of the industries spewing out carbon are part of the trading scheme. The Wall Street Journal has cast doubt on the effectiveness of the programme.

“Europe’s struggle to make its cap-and-trade program work shows just how hard it will be for the industrialized world to achieve any meaningful reduction in greenhouse-gas emissions .... Europe’s cap-and-trade system has been plagued with design and implementation problems from the start. Chief among them: National governments issued too many carbon permits—essentially a license to pollute—to regulated industries. As a result, companies had no real incentive to revamp their factories.”

I am quietly confident about the EU trading scheme although it will take stronger leadership to really make it work. Europe cannot go alone on this - we need to make emissions trading more widespread and find innovative ways of bringing the USA, China and India along with other emerging economies into a broader system.

BBC: EU industry sees emissions rise

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