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CLIMATE CHANGE: Carbon Prices Reflect an Uncertain Year

Matthew Berger

WASHINGTON, Dec 29 2009 (IPS) - As what was supposed to be a breakthrough year for action on climate change comes to a close, one indicator of the disappointment surrounding an anti-climactic outcome in Copenhagen and stalled U.S. Senate legislation can be seen on the European Climate Exchange.

The main exchange for the carbon emissions allowances that are traded as part of the European Union’s Emissions Trading System saw carbon dioxide emissions drop to a six-month low of 12.4 euros in Copenhagen’s aftermath and remain around that level since.

Prices have been volatile throughout the ETS’s first five years, but this year they dropped to an all-time low of eight euros in February, following a record high of just under 30 euros the previous July.

For cap and trade approaches to greenhouse gas regulation to achieve their ends and provide the incentives that will push companies to invest in cleaner technologies, prices will need to be much higher, say analysts.

“You need carbon prices at 25 to 50 dollars a tonne to start sending the right market signals,” says Daphne Wysham, a fellow at the Institute for Policy Studies and co-director of their Sustainable Energy and Economy Network.

The International Energy Agency’s World Energy Outlook for 2009 said carbon prices should be at 50 dollars (35 euros) a metric tonne in 2020 and 110 dollars (67 euros) in 2030 in order to stimulate investment in alternatives to greenhouse gas emissions.

A major reason for the downturn in prices this year versus last is the economic recession, which has meant lower production, and thus lower emissions and less need for emissions allowances.

But there are other factors at play as well. The price of carbon, as with that of any commodity, is seen as a function of demand. The current dip in prices, then, is a reflection of low demand brought on not only by the slower economy but also by the lowered expectations for carbon dioxide regulation following the disappointing summit in Denmark and the stalling of climate legislation in the U.S. Senate.

Wysham, who has been critical of cap and trade as a method of mitigating the effects of climate change, also points to offsets as “a drag on price because they’re the cheapest option out there” for meeting the emissions targets on paper.

“These offsets represent the cheapest and lowest capital cost of numerous compliance options for industry,” concurs Michael Clingan, who has researched the business side of climate regulation as a partner at Ascendant Consulting. He believes, however, that there is growing pressure to allow more offsets into the carbon trading system, and that this shows businesses expect carbon emissions prices to rise.

Offsets include the Certified Emissions Reduction credits of the Kyoto Protocol’s Clean Development Mechanism, which allow emitters in rich countries to invest in clean tech ventures in developing countries in exchange for credits to put toward their emissions cuts tallies, as well as programmes where emitters can pay for forests to be conserved or replanted.

“You’re essentially keeping the price low by allowing for carbon offsets,” Wysham says.

The U.S. House of Representatives passed a climate change bill in June based around setting up a cap-and-trade system in the U.S. Like the ETS, the proposed U.S. system would limit industries’ emissions and eventually force companies to pay for allowances to offset their emissions – or allow them to sell excess allowances if their emissions are lower than expected.

The EU system and any future U.S. system are supposed to encourage a movement away from dependence on high-emitting, fossil-fuel based production by making those activities more expensive relative to cleaner alternatives. It is all about motivation. But for businesses to be sufficiently motivated to reduce their emissions they need a price incentive.

The non-binding international accord announced by the U.S., China, India, Brazil and South Africa and “taken note of” by the other countries is not likely to raise demand enough to push up that price.

Meanwhile, prices in the Regional Greenhouse Gas Initiative, which caps emissions in 10 northeastern U.S. states, dropped to around two dollars in the most recent quarterly auction of emission allowances, at the beginning of December. Analysts say supply is easily overpowering demand as that system tries to hit its stride after getting its start last September. The EU ETS also faced the early problem of having allocated too many allowances at its start.

But low prices stemming from over-allocation may simply be the unavoidable growing pains of implementing a brand new regulation.

The ETS prices are low right now, Clingan says, due to “overly generous initial allowances” that “expedited the political process needed to launch cap and trade.” Though he admits this delayed emissions reductions – and stretched the patience of those hoping to see reductions – he says it also allowed emitters and markets time “to develop the machinery” needed operate under a cap.

Jill Duggan, a senior fellow with the World Resources Institute who has helped run and design emissions trading schemes in Britain, the EU and U.S., has questioned whether the over-allocation that plagued the early years of the ETS and can be seen in RGGI really is over-allocation.

Perhaps the EU just “underestimated how cheap and easy it would be for companies to reduce their emissions,” she suggests.

“Companies, once they started to implement greenhouse gas reduction measures, were quite effective at cutting back on emissions, and needed fewer allowances than predicted,” Duggan said in November. She also says the price of allowances has been no more volatile than other energy commodities over the past year.

As for the future of cap and trade, currently low prices are not expected to, by themselves, slow the momentum toward a cap-and-trade system in the U.S. or elsewhere.

“A more ‘realistic’ market will soon come into play as early allowances begin to expire and the cap begins to lower,” Clingan predicts. “My thoughts are that cap and trade will survive internationally and will be put into place here in the U.S.”

The Senate is expected to vote on climate legislation in the spring, but several conservative Democratic senators have told the White House and congressional leaders that legislation to cap greenhouse gas emissions would be too contentious for them to support.

For cap and trade to eventually achieve its ends – that is, for reliance on processes that emit greenhouse gases to become more costly relative to alternatives – carbon offsets and derivatives based on the carbon markets need to be eliminated, says Wysham.

But, she adds, those features are “implicit in any cap and trade system… The entire approach and the entire architecture of that approach is flawed.”

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