LONDON: The European Commission’s latest plans for near-term supply tightening in its carbon emissions market have implications for the forward curve, depending on clarity over longer term structural reforms.
Benchmark carbon contracts for December delivery are presently in contango, with successive contracts traded through 2015 rising constantly at a roughly 6 percent cost of carry, Point Carbon data show.
Beyond that, contracts are barely traded while 2015 futures are very illiquid.
The European Commission, the carbon market’s regulator, announced plans this week to delay the sale of European Union allowances (EUAs) from next year, in a process called “backloading” meant to temporarily remove a glut of emissions permits and support prices.
The commission’s ultimate goal is to remove, or retire, the EUAs permanently, but that involves re-opening primary legislation in a process which will take several years.
In the near-term it is focusing on the legally simpler stop-gap, to take EUAs off the market temporarily.
The commission brought that process closer this week, confirming that it would tweak the underlying law, the emissions trading directive, in changes which it said could be signed off by the end of the year.
Outlining new details, it proposed to delay sales of EUAs due from 2013-2015, in the range of 400-1,200 million EUAs.
It proposed to release them back into the market in equal amounts annually from 2016-2020.
It was the first time that the commission had proposed such a time schedule, raising implications for the forward curve.
As the commission noted: “Backloading is expected to increase the price in the short term when auctioned volumes are decreased, and reduce it when the volumes are increased again.”
There’s an element of cat and mouse here: the commission has no intention of returning EUAs to the market as it tries to peel prices CO2 off the floor, but it has had to describe plans for doing so, to complete its backloading proposal.
The next step is to propose how to remove the EUAs permanently, in more controversial plans the Commission will publish later this year, including the precise number of EUAs it wants to retire and through which legal route.
It’s worth reviewing the obstacles to permanent removal of EUAs. As these challenges loom larger, a flattening of the forward curve will follow any failure to progress.
First, there are objections from polluting states and industry lobbies.
There will inevitably be some back and forth between member states about precisely how many EUAs to retire, which will draw out the process probably to two years or more.
What’s at stake is the level of carbon price, which is passed directly to wholesale electricity prices by an amount determined by whether gas or coal is the marginal fuel burned in European power plants.
Less affluent, more coal-dependent east European countries, and notably Poland, have made it abundantly clear that they dislike the whole idea of raising power prices at a time of economic hardship.
The European Commission will need a majority of EU member states to support its amendment of the directive in a drawn out process called co-decision which also involves the European Parliament which is likely to be supportive.
The steel lobby is the most consistently antagonistic to the EU emissions trading scheme (ETS), reflecting its desire to maintain international competitiveness.
The British trade body, UK Steel, made its opposition clear both to near-term tightening and permanent removal of EUAs.
“This further tinkering of the system demonstrates that the EU ETS as currently conceived is fundamentally flawed,” it said, in an earlier announcement.
A second and related hurdle is the euro zone crisis. The longer this continues, the less enthused will be member states and their respective industry lobbies about a proposal which raises power prices.
Third, European Commission elections in 2014 could delay progress with a change of personnel and possibly of strategy.
Finally, international climate action will rear its head. The EU has long led on climate action, but it cannot step too far ahead of the rest of the world, to keep its domestic industry on side.
The failed Copenhagen climate summit in 2009 is partly responsible for the present glut of EUAs: the emissions trading directive had allowed for steeper carbon cuts if other countries agreed an international deal which they spectacularly failed to achieve three years ago.
Countries have subsequently agreed a rather modest ambition of clinching a global climate deal by 2015.
If that target appears out of reach, starting with a UN conference in Qatar at the end of this year, the prospects for the Commission’s EUA retirement plan will recede with it.
The outlook will be clearer by early 2013, at which point the 2015 and emerging 2016 contracts can be expected to flatten if there are no signs of progress.
— Gerard Wynn is a Reuters market analyst. The views expressed are his own.
