European Carbon market – ETS Market Outlook for Post 2012: IETA Side Event.

European Carbon market – ETS
Market Outlook for Post 2012

IETA Side Event.

Notes by Lloyd C. Irland [1]

I attended a side event sponsored by IETA, the International Emissions Trading Association.This is a trade group of the financial institutions involved in trading allowances and in financing carbon offset projects.In a way, collectively, their members are the “carbon market”.I thought this summary might interest those who are following the development of US Cap and Trade programs, and who look to the price of carbon in these markets as a major factor in developing RED and other forest-based offset projects.This panel was moderated by John Scowcroft, or Eurelectric, a trade group of the electric utility industry.

This session focused on understanding how the rules and market forces will affect the development of the carbon price to 2020.The panelists had somewhat different views of the markets.Overall they covered major issues and agreed that the trend for price was up.

The purpose here is to just report on what was said.I will at times footnote obscure terms or topics.

Note: because this is based on notes taken from complex and sometimes hard to read slides, and fairly rapid delivery, it should not be used as a source for individual data items.It is likely that typos and minor errors have crept in.

Why do we care about the price of Carbon?

Several reasons:

Cheap carbon allowance prices reflect weak emissions caps

Low carbon prices will not support REDD or other forest based offset programs

Low carbon prices will not provide adequate incentives to really change emissions from Business as Usual (BAY).Experts estimate that strong emissions reductions will not occur unless carbon prices reach the $50 to 100 euro/ton range.

Principal Changes to the market –

A talk by Hans Bergman of the Euro Commission’ Environment Directorate described the principal points on the upcoming market structure changes.Principal points:

They will move to a single Europe wide cap

There is to be a 1.74% per yr reduction in that cap to 2020, to 1,720 MM mt

Cap will be adjusted for inclusion of new sources and industries (prim air and bunker, aluminum and certain chemicals).

From 2013,50% of allowances (EUAs) to be auctioned.This % to increase.If I correctly understood,100% of electric generating EUAs to be auctioned.

They will create a single EU registry to supersede national ones.

Their longer term goal are:

A robust OECD-wide[2] allowance market by 2015, and later to include more advanced developing nations.

CDM reform to move beyond low cost options

Strong enforcement of credit mechanisms

Some issues will include ensuring strong emissions reduction targets, isolating the wider C market from the AAU surplus[3] and moving toward a sectoral crediting approach where feasible.

Marc Lewis of Deutsche bank, Paris Office

.. offered his view of the dynamic of the market.Key piints:

The 2008 global carbon market had turnover of $126 billion of which 92 B was ETS, rest was Kyoto mechanisms (largely CDM)

Phase 2 (2009-2012) is long in terms of market balance.This means that the actual emissions are likely to be below the caps for some years.Result, no demand for EUA’s nearterm.Major reason is the economic crisis which has reduced industrial production and overall power usage.Before crisis, it looked as if emissions would exceed caps, meaning strong demand for allowances and offsets.The surplus is now being banked – people are holding EUAs they do not need at present.

“Pricing tension” will persist, however, because the utilities know they will need EUA’s in future.(Based on current year market balance prices should be a lot lower).In Phase 3 ( post 2012) there will be “pricing tension”

The ETS cannot be viewed in isolation.There are 3 things going on:

  1. The Kyoto emissions caps
  2. A policy goal to reach 20% renewable energy by 2020
  3. Policy goal to reduce energy intensity economy-wide.

Basically, DB does not believe the second 2 goals are likely to be achieved.To reach the Renewables goal would require a near doubling of the annual rate of wind capacity from the past 8 yr.Those yrs saw abundant financing, available onshore sites, and other favorable factors.Beyond 2010, more of projects will have to be offshore with attendant uncertainties and longer time lines.Meeting the goal would mean a significant CO2 emissions cut.

Further, imported offset credits will be important and help fill whatever gap there is between caps and emissions[4].

Likewise, the efficiency goals would be the best way to go, but are very hard to implement, especially in the household sector.If met, this would be a 16% cut in emissions.Every tonne of oil equivalent we avoid using = 2 tonnes CO2.

If above goals met, would not need a carbon market as the EU 20% target would be met.

Cheapest emission cut option in power sector is fuel switch to gas.

Based on analysis of above factors, and fuel prices (ave $85.bbl for oil, $125.ton for coal)

DB sees aeuro 50carbon price by 2020,which would mean assuming a cost of carry of 4%, aeuro 30 price today.Market currently trades at euro 14 or so due to the economic conditions.

So, the price will go up.Some power generators will need to hedge EUA needs for post 2013, thereby holding prices up in short term.

Above analysis largely based on current EU 20% cut goal.If boosted to 30% as result of COP15 etc, this would raise the price from a 40-50 range to a far higher level, but would not double due to role of offsets.

Carl MagnusMaribu, of Point Carbon, a major carbon consultancy,

….offered Point Carbon’s analysis, which was set up slightly differently.

To them, the largest single uncertainty is whether the cuts to 2020 will be 20% or 30%.

He noted that on current market balance alone, prices would be lower, but the buyers who can now bank them and will need them in future are supporting the market,so it is “working” in that sense, tying things together over time.

They analyzed 4 scenarios:

CutAmount to cut

Current ETS legislation21%1800 MMmt

25% cut25%2300

30% cut30%2800

ETS linked to others (presume US)36%very large

Cut ests allow for enlarged scope and for offset supply.

They see that the 20% cut scenario would lead to carbon prices in the euro 20-40 range

30% cut would lead to euro 30-60/mt by 2020.The 30% scenario is less clear is it is unknown to what extent offset credits would be permitted.

Based on a suvey of the market, they estimate probabilities of the scenarios as follows:

20% cut20%

25%30

30%40

ETS link10

Weighting by these probabilities they get a 2020 price at euro 37 per mt.(vs 14 today)

He observes that he thinks financial investors would want to use much higher discount rate against this future price than 4%.They use up to 20%.

Fabien Roques of HIS LERA, a consultancy,

…gave a somewhat different view of the outlook.He talked about:

Market fundamentals as prices have fallen with the recession and are expected to continue to fall.This restrains EUA prices but also should bolster fuel switching to gas.

Political questions, and

The issue of markets v mandates

They see the C price going to the euro 30s in 2009 nominal dollars by 2020.

This is partly influenced by their view on fuel prices.In Europe, g

They see Europe industrial production rebounding only slowly, which will mean slow increase in EUA demand from that sector.

They see Phase 3 average prices in range ofeuro 12-18, with mode at about 15.(Lower than other forecasters)

There is a concern that the mandates by reducing demand for EUAs could undermine the market.They have asked what is driving technology choices?Companies say it is the mandates and not the C market.Carbon prices do not support low C new build decisions. To hit Renewables target will require euro 35 billion

Investment per yr.

Auction revenue may affect behavior.,Auctions will affect C price in short term, not in loingrun.Revenue projected to reacheuro 26 billion.

Guy Turner of New Carbon Finance

… offered his analysis.

He observed with the carbon market has recently been less volatile than fundamentals would suggest.It has not collapsed in view of weak current demand for EUAs,and highly volatile fuel prices,but it has remained ”remarkably stable, esp in view of surplus of EUAs.”Instead, the price focuses on the future.In this respect he feels it is working.This is partly because one can arbitrage carbon over time but not gas.

The shape of the future system will affect prices in nearterm.

He argued that the energy efficiency polices are “ineffectual”.So they pose no risk to market balance.CER’s will affect the market to 2015.This will mean in practice no need to actually abate emissions in EU until 2016.

They see a 2020 carbon price at euro 30.which is above extrapolated forwad curve as of today.

He says “keep on keeping on”market is working.

Issues:

Enforcement is key(e.g. the euro 100 fine for exceeding caps)

Get the auction right

Do not shy away from reglatoins and support for other measures.

Turner argues that many important emissions cuts, as in homes, should be done by regulations and other means and not by carbon price.So he does not seem troubled by competition from emission reductions from the mandates affecting the cabonr allowance markets.

He does believi a stable market structure an set of targets is critical,changing them unexpectedly and to often will injure its ablility to do its job.

Result, a 3 prong policy

  1. Carbon market for bulk power and industry
  2. Regulation on small scale opportunities, e.g, domestic
  3. Targeted support, as for biomass power, high cost renewables, new techs like small scale CHP.

Q & A and General Points:

Note: Eurelectric has a new report looking at implications of carbon neutral power sector in Europe by 2050 ( I should read)

Long Lead times for Utility investment

Several panelists, following Scowcroft, agreed that cumulative emissions reductions due to the ETS itself were small, maybe 2%, in the power sector.One reason is the extremely long lead times to build plant and grid improvements.Current C prices should have some impact on fuel mixes and emissions reductions in future as new plants come online (not to return to precrisis level till 2012).Major investments, as in CCS,cannot be in operation until the early 2020s.

Is the market Working?

A question was raised as to whether the market, with its modest emissions cuts to date and modest targets, could meet its stated goal of keeping global temp rise to 2 degrees C. Several panelists agreed that as now designed with current caps it cannot meet that goal.

(LCI personal note:I would argue that the issue is with the caps and not the market; given the caps, the market seems to be “working” in response to those caps.This illustrates that there are different views out there as to whether the market works or not)

Impact of a US Cap/trade system?

Panelists never mentioned this in prepared remarks. Asked a question, tho, they made a few points:

  • Would help EU move to their 30% target.( depends on some wording and interpretation of the EU‘s decision.What Obama has offered might be enough.
  • Would have major effect on offset markets, broadening them and presumably making prices higher
  • A US cap/trade market would be 2X the size of the ETS and thius the major market in the world.
  • A US market would dampen volatility in EU ETS
  • Linking might boost prices in US market, and somewhat reduce them in EU.
  • If this occurs, some concern that it might then indirectly weaken the EU market from an environmental viewpoint.

Time does not permit a comparative summary and comment on these notes.I hope that letting the speakers speak for themselves is useful these notes are informative.


[1] Lloyd C. Irland is Lecturer and Senior Research Scientist, Yale School of Forestry and Environmental Studies, and President The Irland Group, a small New England forestry consulting firm.He is attending as a member of Yale’s delegation.In 2006 he conducted an informal assessment of the development of the ETS while serving as research Professor at ENGREF, Nancy, France.lloyd.irland@yale.edu.

[2] OECD =30 nations, western and cen. Europe plus US, Canada, Japan, Korea, Australia and New Zealand.

[3] AAU’s are offsets under the JI program, basically Eastern Europe and former Soviet Union nations, who hold allowances of “hot air” under the Kyoto Protocol(KP).

[4] On this point, moderator Scowcroft later observed, “ what the Commission says is ambitious, most others say is unachievable”.