EU Carbon Emissions Trading Scheme In Freefall

The European Union carbon emissions trading scheme­—the biggest in the world and the heart of Europe’s climate-change program—is in dire straits. The scheme’s carbon price has collapsed. The primary reason: The economic recession has suppressed manufacturing, thereby reducing emissions and creating a huge oversupply of carbon emissions allowances.
Carbon trading is a market approach to reducing greenhouse gas emissions in which each facility involved is given an emissions cap for the year, and each year that cap is reduced.
A firm must record and report its facilities’ emissions and must obtain allowances for its total emissions. An allowance permits a facility to emit 1 metric ton of carbon dioxide or its carbon equivalent; some allowances are given for free by the government, others can be bought at auction or from other firms.

If a facility exceeds its cap, the company operating it has options: It can reduce emissions, buy allowances from other companies, or obtain allowance offsets by reducing emissions at another pollution source. The cost of an allowance is referred to as the carbon price and is driven by market conditions such as supply and demand.

If the low carbon price continues, the region’s ability to meet long-term reduction targets for greenhouse gas emissions will be severely hampered because the trading scheme will fail to provide money for cleantech programs and incentive for manufacturers to adopt cleaner technologies.

The trading scheme is a key component of the EU’s climate-change strategy because about 40% of all greenhouse gases emitted in the region fall under EU’s control. The mandatory scheme applies to 11,000 industrial installations, including power plants and major chemical facilities, across all 27 member states.

The goal of the European Commission, the EU’s administrative body and the architect of the emissions trading scheme, is to reduce all greenhouse gas emissions by 20% from 1990 levels by 2020. To contribute toward this goal, the trading scheme has targeted a 21% cut in the emissions of participating sectors by 2020 from a 2005 baseline.

In recent weeks, however, the EU carbon price dropped to a new low of $5.20 for each metric ton allowance of CO2, down from a high of $23 in 2011. This is despite an annual reduction of the EU emissions cap of 1.74% through 2020 and the introduction on Jan. 1 of a new phase of the scheme requiring companies to purchase allowances.

Analysts agree that the primary reason for the EU’s low carbon price is the economic recession, which has suppressed demand for emissions allowances because production is down, thus manufacturers’ emissions are too.

A secondary reason for the low carbon price is the high number of “generous” exemptions for the scheme handed out to energy-intensive industries, says Marcus Ferdinand, senior market analyst for Thomson Reuters Point Carbon, a carbon market information provider. In 2013, just over 50% of the 2.1 billion metric tons of allowances provided by the EU will be sold through auctions with the remainder due to be allocated free of charge.

A recent report by ECN, an independent Dutch energy research organization, forecasts that without intervention this situation will result in zero emissions reduction from the trading scheme until at least 2020. This lack of reduction is because the oversupply of allowances is projected to last through 2025. The market is on course to have a surplus of 2.2 billion allowances in 2013, equivalent to a full year of emissions by industry, ECN states.
For its part, the commission in a recent report accepts that the allowance surplus “in the longer term could affect the ability of the EU emissions trading scheme to meet more demanding emission reduction targets cost-effectively.”

There are already signs that the low carbon price is having an impact on the functioning of the trading scheme. The German government withdrew 4 million allowances from an auction on Jan. 18 because they failed to meet the reserve price. With the drivers for oversupply showing no signs of abatement, analysts expect more of these auctions to fail.

The commission had planned to generate billions of dollars by auctioning carbon allowances and then reinvest the money to subsidize cleantech development programs including renewable energy projects. As a consequence of the low price, the available funds are now far smaller than expected, and the scale and number of projects funded has dropped.

The catch is that to start backloading the commission must first gain legal approval from both the European Council, which represents all of the governments of EU member states, and the European Parliament. That won’t be easy because a small number of EU countries, led by Poland, are enjoying the low carbon price and are resisting the commission’s proposal. Poland is the world’s 10th-largest consumer of coal—the fuel that generates the most carbon emissions—and is even considering building new coal-fired power stations.

The development of low-carbon and even zero-carbon technologies will be slowed by the low carbon price, however, and that is a problem, says Michael Carus, managing director of Nova Institute, a privately owned firm in Hürth, Germany, providing expertise on low-carbon technologies. In particular, the move to develop chemical processes based on the use of CO2 as a feedstock will be adversely affected by the low carbon price just when it is starting to emerge as a viable commercial option, Carus says.