As carbon hits 21 month low, analysts insist market is "undervalued"

The price of EU Allowances (EUAs) in Europe's emissions trading scheme (ETS) hit a 21 month low today as concerns over falling industrial output continued to drive a week long sell off.

Just a month after analyst IDEACarbon warned that the short to medium term price floor for EUAs could be as low as €15, the price of EUAs fell over two per cent in early trading to €15.10.

The latest drop means that EUAs are now trading at almost half the price of their July 1 peak of €29.33.

Fears are also mounting that the price could fall still further over the coming months, according to Henrik Hasselknippe of research firm Point Carbon, as concerns about the state of the economy worsen

"The projection for 2009 is that industrial output will be down quite severely, and anecdotal evidence shows that it is already down in Q4 of 2008," he said, adding that reduced industrial activity resulted in lower carbon emissions and therefore reduced demand for EUAs.

However, he argued that a complete collapse in the price of carbon, as happened in the first phase of the scheme, was unlikely as demand from energy companies for EUAs was likely to remain relatively stable. "We still have to heat our homes and we'll still see demand for EUAs," he said. "We're reaching the lower level for EUAs – I can't see the price going lower than €10."

However, concerns are mounting that the falling price of EUAs is beginning to impact demand for the CER carbon credits generated through the UN's Clean Development Mechanism (CDM) offsetting scheme.

Hasselknippe explained that the falling price of EUAs was putting downward pressure on CERs, which are seen by many buyers as higher risk than EUAs, and as a result CDM project developers are experiencing "dwindling margins".

With emission reduction projects in the developing world also struggling to attract credit, Hasselknippe said there was a danger that the flow of new CDM projects could diminish, meaning that when the recession ends and demand for carbon credits recovers the market could face shortfall.

A potential contracting of the supply of CERs, combined with tighter emission caps during the next phase of the EU ETS from 2013 means that the long term outlook for the carbon market remains remarkably bullish, according to Hasselknippe.

"The carbon market now is undervalued," he said. "We know phase III will be tighter and we know there will be a post-Kyoto deal – all those signals are bullish. We still expect the average price for EUAs over the next four years to be €29."