Of all the equity and commodity prices that plunged last week in the global market carnage, the most dramatic falls came in the European and international carbon price. And, curiously, it all occurred to the sound of wide applause.

The European carbon price, known as EUAs, or European Union Emission Allowances, closed the week at 10.70, their lowest in almost three years, as fears intensified of a renewed debt crisis and an extended recession. They have fallen 38% since March, when traders were confidently predicting a bull run for the carbon market before sovereign credit risk fears took hold again.

The international carbon price, known as CERs, or Certified Emission Reductions, closed near a record low of 7.6, and are now about 40% below their March levels. Even the New Zealand carbon unit, known as an NZU, slumped to a record low of $NZ13.20, a slump of more than 20% in a week. Ironically, all three units traded broadly steady or slightly up overnight on Monday as the European and US equity and oil markets extended their falls after the S&P downgrade of US debt. It appeared European utilities had decided that the carbon price was proving an excellent buying opportunity.

These are the commodities to which Australia will seek to link its carbon price when its fixed price period ends in 2015 and there were two main groups applauding the gyrations from the sidelines. The first and loudest were those opposing a carbon price, in any form or at any time. They have seized upon the political opportunity of slumping markets to ram home their message that the plan should be ditched. “Given the global economic uncertainty, the Australian dollar and the slump in retail trade, this is the worst time possible for a new tax to be imposed on Australian families and businesses,” said the Opposition’s spokesman on climate change Greg Hunt, who gives the impression of someone who has forgotten more about carbon pricing than most people will ever learn.

The second source of applause, albeit in a more discreet manner, were those who argue that a carbon price set by a market mechanism is the most efficient means to achieve the required abatement. It may be “ugly”, as Nigel Brunel, from  New Zealand-based carbon trading firm OMF Financial described it in a report late last week, but a plunge in the carbon price is exactly what is supposed to happen in such circumstances — it’s what occurred in 2008/09, when the market last feared a slowdown in European economic growth. If industrial production is slowed, and less electricity consumed, there are less emissions and the abatement task is reduced. The number of buyers decreases and the price falls.

“Broadly, you could argue that the carbon price has responded precisely how it was supposed to,” says Emme Herd, from Westpac. “(A lower carbon price) means lower costs for business,” says Deutsche Bank’s Tim Jordan. “It acts as an automatic stabiliser.”

An apparent embarrassment for the Australian government is that all the international carbon prices are below the proposed starting fixed price of $23 a tonne, which will rise to $29/t by 2015 when the fixed price ends and is replaced with a market mechanism linked to international prices. If international prices remain subdued for a long period of time, it could lift the political pressure, but while some European analysts have cut their price forecasts for 2012, 2015 and the average price for the period out to 2020, their forecasts are still above the Australian government’s best guess of where the prices would be in 2015.

The key factors playing on the these forecasts are the start of the third phase of the EU ETS, which covers more sectors, such as aviation, and will issue less allowances. There is also expected to be greater demand caused by Germany’s decision to close its nuclear fleet. Deutsche Bank and Barclays Capital still forecast a 2012 close price of €17-19/t, and about €24/t for 2015. Barclays still expects the 2013-20 average price to be €30/t, albeit down from a previous forecast of €40/t.

The more volatile market is the CER, the market that Australian businesses will tap for international offsets. Its slump has been exacerbated by a sudden rush of new credits approve by the UN approvals body, just at a time when there has been little demand. The slump below eight is considered to be a key barrier, because below this level Chinese developers don’t consider it worth investing in abatement projects. The CER market is also awash with so called “industrial gas” credits, but Europe is no longer interested in these, and Australian firms are unlikely to be able to buy them either. So the market is expected to see self-correcting, a shortage of supply, and a sudden increase in demand — from the likes of Australia and other countries, but even Australia alone — would likely push CER prices up significantly by 2015 and beyond. Analysts believe it is highly improbable that the international carbon price would be below Australia’s proposed floor rice of $15. If it was, then the rush to buy credits would quickly fix that problem.

But while the market response to slowing economies eases the pressure on companies with significant carbon liabilities, it has a flip side for those wanting to invest in low carbon assets. The $23 a tonne price for Australia was a product of political compromise, but was considered to the bare minimum required to make the private sector shift funds to low-carbon investments.

The pricing concern is echoed in the UK, which wants a floor price for the electricity sector to guarantee investments in clean energy will remain attractive; and is now the subject of considerable debate in the EU, where some suggest that abatement targets should be adjusted when the economy slows, to maintain the impetus towards the green economy — which is still considered, despite all the fiscal problems, to be the most promising industrial growth sector in the European economy.

The subject of variable targets is also raised by the ClimateWorks think tank, which takes a much more optimistic view of the abatement potential in the Australian economy than federal Treasury. While Treasury believes that two thirds of Australia’s 5% abatement target would likely be sourced from international markets, and thus slow rather than reverse the country’s domestic emissions growth, ClimateWorks believes that the introduction of a carbon price, along with various complementary measures such as energy efficiency, will effectively remove barriers to much greater domestic abatement.

ClimateWorks director Anna Skarbek argues Australia could and should push to a 25% reduction target — which would be about 272 million tonnes. She argues that one quarter of this abatement was already profitable before the government’s clean energy package, but was not being done because of regulatory barriers and split incentives. She says that 76% of the abatement target would be profitable with the package, although some barriers still remain.

All in all, she concludes that about 133 million tonnes, or about 50% of a 25% abatement target, could be unlocked by the government’s package, and more would follow if the government introduced other measures, such as more ambitious energy efficiency and fuel efficiency targets.

This is broadly consistent with a whole range of international studies, including by the International Energy Agency. It’s not simply a matter of setting a market price that allows the private sector to find the cheaper cost of abatement.

*This first appeared on Climater Spectator

Peter Fray

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Peter Fray
Editor-in-chief of Crikey