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Europe, Australia and the slow death of carbon trading

Europe’s carbon pricing woes cast further doubt on the credibility of Australia’s scheme and on Treasury’s revenue forecasts. Climate change law research Fergus Green writes at Inside Story.

With last week’s federal budget slashing the forecast revenue from Australia’s carbon pricing scheme for the second half of this decade, it’s a good time to have a closer look at the Gillard government’s decision to link the scheme with its embattled European counterpart from July 1, 2015.

It may seem moot to be analysing the medium-term prospects of a scheme that seems likely to be repealed if an Abbott government comes to power later this year. But it is important to understand that, even if the scheme stayed in place, the EU linkage is likely to weaken its effect so drastically that its retention would be scarcely better than its demise. My purpose is not to advocate that demise or support the Coalition’s alternative, “direct action” plan (which I think would be a shameful regression). Rather, in the hope of improving the design of future climate policy, my intent is to expose the linkage decision, and the ideology on which it is based, as mistaken.

One of the putative benefits of putting a price on climate-warming greenhouse gas emissions is that the government generates revenue from the sale of carbon permits. Up until last week’s budget, Treasury had been forecasting future revenue from the carbon scheme based on the assumption of an Australian carbon price of $29/tonne. The latest budget, however, slashed the forecast scheme revenues for 2015-16 and beyond, basing its forecast on a new carbon price assumption of $12.10 in 2015-16, 60% less than the previously assumed $29 figure.

Why the sudden change? Well, the $29 figure was always optimistic; over the past couple of years, as the handful of existing overseas carbon markets have stumbled and the prospects for global collective climate action have dimmed, it has looked fantastical. Most importantly, though, the downward revision is a recognition of the structural imbalance between demand and supply for European carbon permits that is keeping the EU carbon price extremely low.

Understanding the dynamics of the European scheme is vital, because the price in Europe will effectively set the Australian price from 2015. The third phase of the European scheme, which operates across its 27 member states and covers sectors responsible for about 45% of Europe’s emissions, began at the start of this year and will continue until 2020. The annual “cap” on European emissions is driven by Europe’s emissions reduction target (20% below 1990 levels by 2020). Permits are allocated freely to some emitters and auctioned by member states according to figures determined by the European Commission (the EU’s executive arm). The supply of permits is obviously affected by these allocations and auctions, but also by the supply of international credits from the Kyoto Protocol’s emissions trading mechanisms (which are mostly from emission abatement projects carried out in developing countries, and are eligible for compliance purposes in Europe) and the number of permits “banked” by scheme participants from Phase II.

Due to a flood of cheap international credits, banking from Phase II and the early auctioning of Phase III permits, the number of permits in the European market has been extremely high at a time when demand for permits has been depressed by the economic downturn in Europe. The result has been a large surplus of permits — that is, an excess of permits above the emissions cap — in each year since 2009 and a correspondingly low carbon price (currently around 3.50 euro, or A$4.65). The Commission projects the surplus will reach a cumulative total of around 2 billion permits — about the equivalent of Europe’s entire annual emissions cap in 2013  — and that this surplus will persist for the rest of the decade, meaning prices will stay at their farcically low levels.

In a bid to avoid this spectacle, the Commission has initiated a two-stage reform process that seeks to redress the supply side of the surplus problem. The first stage involves a proposal to postpone the auctioning of 900 million permits from the years 2013-15 until 2019-20. This proposal, known as “backloading”, would not alone change the number of permits in the system released in total over the course of Phase III, but it would serve two important functions.

First, on the assumption (which the Commission makes) that demand for permits will have grown by the end of the decade, backloading some of the permits would “smooth” the price somewhat over the course of Phase III, raising it now (while demand is low) and depressing it later (when demand is expected to be higher). Secondly, it would buy some breathing space within which more fundamental structural reforms could occur, such as removing the surplus permits altogether, or some other measure to push the price higher. (The Commission released a paper late last year canvassing six such options, about which it is currently consulting with stakeholders.) Jonathan Grant, director of sustainability and climate change at the consultancy PwC, says some such deeper structural reform and an increase in permit demand driven by a return to growth in Europe would be necessary to send the price into the 15-20 euro range.

*Read the rest of this article at Inside Story

7
  • 1
    Mike Flanagan
    Posted Friday, 24 May 2013 at 12:13 pm | Permalink

    While it may be true that the EU Carbon market is both at odds with recent past projections contained in our budget, and is a dominant factor today in setting of our permit prices, I doubt, that will last for many more months or years.
    The adoption of a cap and trade system of permits by Chinese regions, California and a number of other smaller economies around the world, I suggest will quickly supplant the influence of the EU permit prices, if internationalised.
    I would also suggest the coming IPCC report will create an avalanche of scientific reports that will predominant suggest that the physics is telling them we need to radically accelerate our emissions reductions and our adaption policies and endeavours.
    That also should have implications to permit pricing in the market.
    Thanks Fergus! A good yarn!!

  • 2
    Scott
    Posted Friday, 24 May 2013 at 5:20 pm | Permalink

    @MikeF
    “The adoption of a cap and trade system of permits by Chinese regions, California and a number of other smaller economies around the world, I suggest will quickly supplant the influence of the EU permit prices, if internationalised”

    Somehow, I don’t think so. The EU’s permit auction volumes of 818,855,500 a year (in 2013) dwarfs the Californian scheme(57,000,000 in 2013) so any influence will be lost in translation (in world financial markets it’s the market that turns over the biggest volumes that sets the price…liquidity is key). The Europeans have also voted once already on “backloading” in April, and it didn’t get up. Another vote due in July I believe, with some ammendments but likely to fail again. I don’t see the price of carbon increasing massively any time soon.

    As for the Chinese schemes, let’s wait and see. The potential is huge (plenty of emissions to reduce), but none of them are running at the moment (the smallest city starts up in June) and details are sparse at best.

    Hoping for a sense of urgency from AR5 might also be a bit optimistic. Since AR4, most research has been pointing to a reduction in the climate sensitivity estimates rather than an increase. But again, we will wait and see what the IPCC can produce.

  • 3
    Patriot
    Posted Friday, 24 May 2013 at 5:24 pm | Permalink

    Won’t bother reading your article, but you can forget about carbon pricing in this country for a generation or longer. After the Gillard government’s disastrous and deceitful handling, it is politically untouchable. No government or party in their right mind will chain themselves to the putrid corpse that remains after it’s repealed.

  • 4
    AR
    Posted Friday, 24 May 2013 at 10:50 pm | Permalink

    Why has PatrIdiot returned to these comments? Typical to proclaim “won’t read the article” but here is my beaten boilerplate bullshit noentheless.

  • 5
    Mike Flanagan
    Posted Saturday, 25 May 2013 at 7:24 am | Permalink

    Well said AR.
    Scott; Thanks for your comments but may I suggest that it is the number of permits available that appears to be corrupting the system. Supply and demand equations?
    The Cameron retreat from their green agenda, and their fright from the UKIP platform and recent electoral successes, is the driver of their obstruction of the European efforts to revive and renew their original C and T, together with Merkel trying to preserve her dwindling support.
    I venture to suggest much of that obstruction will dissapate over the comming months following the public presentation of the accumulating science that suggests our past and current efforts at mitigation are inadequate to meet agreed targets.
    If the history is anything to go by, we will have a considerable number of up to date science assessment and reports preceding the presentation of the IPCC report.

  • 6
    Stephen
    Posted Monday, 27 May 2013 at 9:47 am | Permalink

    Cap and trade is just the market’s latest and smartest ploy for business-as-usual. It doesn’t care much about reducing emissions, or the natural environment.

    Once you read the word ‘market’ in any so-called environmental measure, you can fairly safely assume that its main priority is not about human overpopulation and the effects of that on habitat, biodiversity and species.

  • 7
    Thorn
    Posted Monday, 27 May 2013 at 11:16 am | Permalink

    The Australian scheme is obviously a prisoner to the other schemes around the world - as is every other aspect of global policy in this country. This carbon trading concept is all new to every country involved and it is no surprise that it is not running like clockwork.

    But at least they are doing something. Abbott has exactly the same targets as Labor (reiterated by Hunt this morning) and has absolutely nothing to offer as a way to achieve them except clap trap like the magic soil and giving my tax money to the worst poluters in the country in the hope they will solve the problem for him.

    Of all the vague hints at policy that Abbott has alluded to, his mystical carbon reduction policy is the most idiotic.

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