Isramart : Hiccups in carbon trading

Isramart news:
The Copenhagen conference in December was supposed to be the forum at which big cuts to carbon dioxide emissions were announced, sending the price for the permit to emit one tonne of CO2 into overdrive.

But the failure of the UN climate summit to produce anything like a binding agreement to cut CO2 emissions caused prices to slump.

In four trading days after the Copenhagen summit ended, the spot carbon permit price for a standard European Union Allowance, the tradeable unit under the EU's emissions trading scheme, fell by 17 per cent, to E12 a tonne. It has since recovered to E13 ($19.90).

That's a far cry from the record high of E31 in July 2008 (when oil prices also spiked). But it's an improvement on the low of E8.43 12 months ago.

"The post-Copenhagen fall was the market reacting both to a political message and to a fundamental message," says Andreas Arvanitakis, senior analyst at Point Carbon.

"The market is saying bluntly that Copenhagen was disappointing, and in specific terms it's saying that the market was taking into consideration that there was a probability that the EU would increase its emissions reduction target from a 20 per cent reduction on 1990 levels to 30 per cent by 2020.

"Had the target within the EU ETS been made tougher, companies would have had to buy more permits to meet their emissions targets.

"If there's more demand and less permits, the price goes up.

"But the market has decided that the probability of that target being upgraded has gone down, so the permit price has come down."

The carbon market has also been blindsided by recession, which has reduced emissions naturally.

"The global recession has resulted in a fall in the amount of CO2 being produced, as energy consumption has fallen," says Ursula Tonkin, portfolio manager at Australian Ethical Investments' Smart Energy Fund.

"At the same time, supply has remained unchanged, as the allocation of permits for the 2008-12 period (phase II) was determined on a business-as-usual scenario, which assumed continued economic growth.

But with the demand for carbon permits reduced, there is an oversupply and the decline in the EU carbon price reflects that."

Welcome to the world of carbon trading, a market worth E80 billion globally last year, and projected to rise to E121bn this year, according to consultancy firm Point Carbon.

The largest market is the EU's ETS, which accounts for 64 per cent of transaction volume, a dominance Point Carbon expects to widen to almost four-fifths of volume this year.

The carbon market also includes:

* Certified emission reductions (CERs), project-based credits generated from emission reduction countries in developing countries via the clean development mechanism (CDM), and tradeable in the EU ETS.

* Emission reduction units (ERUs), project-based credits achieved through joint implementation (JI) projects, an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (the Annex 1 countries) to invest in emission-reducing projects in another industrialised country as an alternative to reductions at home.

* Assigned amount units (AAUs), project-based credits generated from economies in transition, such as Russia and Ukraine.

* Other compliance markets, including the regional greenhouse gas initiative (RGGI), a co-operative effort by 10 US states to limit greenhouse gas emissions; California's climate action reserve (CAR) offset standards; Canada's Alberta and British Columbia provincial schemes and New Zealand's ETS; Australia's renewable energy certificates (RECs), which is supported by legislation requiring electricity retailers to buy a certain portion of their electricity from renewable sources; andNSW's greenhouse gas abatement certificates (NGACs).

Then there is the over-the-counter market, by which companies in jurisdictions not covered by compliance schemes (for example, the US) strike voluntary transactions for their own corporate social responsibility reasons.

For example, a Google or Wal-Mart may arrange a carbon offset deal through a broker or by going straight to a carbon uptake provider.

Milo Sjardin, head of US carbon markets at Bloomberg New Energy Finance in New York, says OTC trading represents about 50 per cent of the global market.

Sjardin says "there weren't a lot of high expectations" among market participants about what was going to happen at Copenhagen. "In the main market, which is obviously the European market, the prices go up and down according to fundamentals and the system is pretty secure until 2020.

"But there is definitely uncertainty, because the market doesn't know what's going to happen after 2012, whether there is going to be a market outside of the European ETS, and potentially something in other countries. Certainly in CERs, the Kyoto Protocol expires in 2012 and investment is dropping there. It's becoming less and less interesting to create new projects, because time is running out.

"Investment in new emission reduction projects across the world is still happening, but it's going slower and slower. In Europe, at least you know what you need to do; you've got a market, you can buy EUAs, you can buy CERs, and that's how you can deal with your risk exposure. Outside Europe, t there is not that certainty."

Clearly, Sjardin says, the market is waiting on some kind of US scheme. "I think some sort of bill that will create a program that ensures emissions reductions going forward will keep being put back to the [US] Senate.

"What you will see, here in the US at least, is that the regulatory side, the Environmental Protection Agency, will push regulations forward, and you'll get more activity again from the states, because they still find this issue important. If the federal government doesn't do anything, the states will. Not having a carbon price at all simply complicates everyone's investment and risk management decisions too much."

In Australia, the REC market is the closest proxy for a carbon price. The REC market works by requiring energy retailers such as AGL Energy and Origin Energy to buy enough RECs to ensure they meet the federal government's 20 per cent target.

Each REC represents one megawatt-hour of electricity: a wind farm, for example, will generate RECs through the life of the project.

But complicating the REC market is the fact that to encourage the installation of rooftop solar power, the federal government gives households five RECs upfront for every MWh of electricity they generate. Last year, says Jenny Cosgrove, cleantech and renewable energy analyst at Wilson HTM, the REC market was over-supplied -- mainly from this source -- with 15 million RECs generated compared with 8.1MWh of RECs required.

From $50 in May last year, the spot REC price has fallen to $34.

This works against the large-scale renewable energy producers -- for example, wind projects -- which rely on the REC price to be high enough to compensate for the higher cost of generating renewable energy. If the price of the RECs doesn't rise, investment in large-scale renewable energy projects could be jeopardised.

"The REC market is really designed to encourage emerging renewable energy supplies, which aren't yet economic at the current wholesale power price. On a global scale, Australia has a relatively low wholesale power price, at $40 per MWh. At the moment, most renewable energy sources are not economic at that price, so the REC regime is a subsidy scheme purely to support the emergence of technology in the renewable area," Cosgrove says.

Not only is the REC price not high enough to encourage the investment that is needed, they are also being banked.

"RECs can be banked, and we're aware of a number of companies, including Infigen and Transfield Services, that banked RECs in 2009 rather than sell into a depressed market.

"How those banked RECs will [affect] the market over time is very uncertain," she says.

Cosgrove says a private member's bill to be introduced in the Senate this month by Greens senator Christine Milne would add RECs from solar hot water, heat pumps and the solar multiplier to the renewable MWh target, ensuring that the technologies are supported but do not crowd out large-scale renewable energy.

"If this is successful, we believe it would help the REC price to recover," she says.