http://www.politico.eu/article/carbon-eu-ets-emissions-trading-system-oil-gas/

 

Political gridlock and collapsing commodities sent the carbon price in the EU's Emissions Trading System spiraling to a 20-month low this week, making it even more unlikely that polluters will be encouraged to cut greenhouse gas emissions.

 

The plummeting price is a blow for the already reeling ETS, which was supposed to be the EU's main vehicle for getting polluters to cut emissions but has so far been plagued with problems. Under the system, companies receive or buy permits to emit a ton of CO2, with the goal of prompting them to steeply reduce emissions over time.

But wildly gyrating prices undercut that rationale.

There are two main reasons for the unexpected drop in carbon prices: politics and economics.

First the politics

The fall, in a market already plagued by dismal prices, comes as the European Parliament and EU countries prepare to debate the European Commission's proposals for reforming the ETS after 2020.

The fundamental problem is that Europe's sluggish economy combined with a boom in renewable and energy efficient technology has created a huge surplus in the emissions market, pulling the price down to a high of about €8 per ton, rather than the €30 or more needed to encourage a shift away from emissions-intensive coal.

Even that €8 per ton is looking pretty good right now. The price of the benchmark contract for emitting a ton of carbon dropped by more than 7 percent to €5.91 on Monday. On Tuesday, prices rose slightly to €6.10.

Those kinds of prices aren't at all what was supposed to happen when the ETS was created, and Brussels is now trying to fix the scheme.

The EU took a first step to fix the system last year, creating the Market Stability Reserve to soak up surplus permits. But Poland has filed suit at the European Court of Justice to annul the introduction of the reserve. Warsaw says the reform creates uncertainty in the ETS, and they've been trying to protect the country's smokestack industries from higher costs.

Now the Commission's 2020 reform effort is being held up in the European Parliament with infighting between two of its most influential committees: environment and industry.

Then the economics

The debate in Brussels was probably not the main thing on traders' minds as they watched the carbon market start the week with a flurry of short-selling by industrial players, market analysts said.

"What is happening is only on the sidelines of overall turmoil in the markets. Market participants are looking at gas and oil and coal," said Philipp Ruf, lead analyst for EU carbon markets at ICIS Tschach Solutions.

Ian Duncan, the European Conservatives and Reformists MEP overseeing ETS reform, agrees that the "rock-bottom" oil price is likely the single biggest cause of the fall in carbon prices. However, the fact that the price could fall by so much in just one day reflects an underlying problem in the system: too many allowances.

"When you see a carbon price that's so low, even modest fluctuations appear to be amplified," Duncan said. "I'd say the oil price was a bigger factor than the debate in Parliament, but it is difficult to tease out."

The carbon price fall comes on the heels of a particularly brutal month in global commodity markets.

Crude oil prices hit around $28 per barrel last week, leading to speculation that they could slide to as little as $10 - a spectacular fall from more than $100 about 18 months ago. Oil prices have dragged down natural gas prices, shrinking a previously wide gap between the high cost of burning gas to generate power and low cost of burning coal, even though coal emits much more carbon dioxide. The economic slowdown in China has made matters worse, cutting into demand from one of the world's biggest and fastest-growing markets for oil, gas and coal.

That means it now makes sense for utilities to generate power with gas rather than coal, leaving them with unused emissions permits that can be sold on.

As well, metals producers hustled to sell emissions allowances when a plunging Chinese stock market made it clear that commodities demand there was unlikely to rebound.

All of these factors came to a head on the EU's carbon market on Monday, said Marcus Ferdinand, manager of EU carbon analysis at Point Carbon.

"It depends really on a calming of the current bear-trend for traders to feel confident enough to enter long positions and bet on a rebound again. A rebounding oil price would definitely be a major factor in this," he said.

Battle in the Parliament

While it may take a much broader market recovery to resuscitate European carbon prices, a little more certainty on the ETS reform could come out of the Parliament as soon as Thursday, when political party chairmen meet.

The ETS reform falls under the environment committee's purview, as the EU's primary tool for tackling climate change. But the industry committee has asked to oversee measures in the reform to set up a fund for the bloc's poorest countries to modernize their power generators and to keep European industries from moving their operations to countries with looser environmental rules.

"The [environment] committee has always been lead committee on climate change matters, and anything that erodes that matter would cause unease," Duncan said.

The dispute has caused delays in the discussions, which were expected to start soon after the Paris climate summit in December.

The problem is that there is a lot of uncertainty around the future of the ETS reform, said Sarah Deblock, EU policy director at the International Emissions Trading Association, pointing to the Parliamentary debate and Poland's lawsuit over the Market Stability Reserve.

"It's a reflection of volatility in the market and the lack of certainty and lack of clarity on what might affect the EU ETS," Deblock said of the carbon price drop. "Any development would help create a feeling that the work is beginning. A political commitment to revising the EU ETS post-2020 should help restore market fundamentals."