Emission trading suffers as carbon prices plummet

A leading economist this week warned that the world's two leading carbon trading schemes are failing to deliver the expected benefits due to a collapse in the price of carbon credits - and the situation is likely to get far worse before it gets better.

Many politicians have identified carbon emissions trading schemes as the best means of tackling climate change, arguing that by putting a price on carbon emissions firms have a financial incentive to reduce their carbon footprint.

However, speaking to an audience of academics and business leaders at this week's Tyndall Centre conference on investments in low carbon technologies, Professor Catrinus Jepma of the University of Amsterdam warned that both the EU's Emissions Trading Scheme and the UN's Clean Development Mechanism were in danger of failing with prices for the carbon credits used under both schemes predicted to reach just a few cents.

"The Stern Report suggests we need a price for a tonne of carbon emissions of $20, rising to $30, $40 or even $50 to stabilise [the level of CO2 in the atmosphere] at manageable levels," he said. "But there is a good chance that the carbon credits that are meant to provide incentives for reducing emissions will be available for next to nothing."

The problems with the European Trading Scheme are well documented with the collapse in the price of a tonne of carbon dating back to May last year when it emerged that most countries in the scheme had set their carbon caps far too high, resulting in fewer firms than expected having to buy credits and causing the price of a tonne of carbon to plummet from over €30 to less than €10.

As one delegate observed "with some firms having carbon emissions capped at 110 percent of what they actually required it was always going to fail".

The EU is seeking to rectify the problem ahead of the second phase of the scheme, which starts next year, and recently rejected many member countries proposed emission allowances for the next phase as too high, ordering them to go away and come back with lower caps that will force more firms to cut emissions or buy credits.

However, Jepma argued that with no link existing between the first and second phase of the scheme the cost of carbon credits will drop to almost nothing by the end of the year. Currently the price is already below one euro meaning there is little incentive for firms to cut emissions as it is cheaper to just buy in credits to offset their pollution.

He also warned that something similar was in danger of happening with the Kyoto Protocol's Clean Development Mechanism (CDM), which is designed to allow signatories to the agreement to meet their carbon emission reduction targets by buying in Certified Emission Reductions (CERs) or carbon credits from CDM-approved carbon reduction projects in the developing world.

Jepma said the scheme was in danger of becoming a victim of its own success with over 500 projects already approved by CDM and a further 1,000 projects in the pipeline awaiting approval. He predicted that as a result over 2.4bn CERs will be available by 2012.

Meanwhile, Jepma warned that Russia and many of the Central European States are on track to be well below their Kyoto emission targets for 2012 meaning they will generate 2.8bn credits or Assigned Amount Units that they can sell to those countries unable to meet their Kyoto obligations.

This means that there will be a supply of 5.2bn tonnes worth of assorted carbon credits available under the various Kyoto carbon trading mechanisms by 2012, but the biggest polluters in the scheme – the EU, Canada and Japan – are expected to exceed their targets by just 3.6bn tonnes.

"Under the Kyoto targets the supply of credits will outstrip the demand," said Jepma. "We are going to see the same scenario as with the ETS whereby the price for a tonne of carbon starts high and then collapses to close to zero by the end of the scheme… which is precisely the wrong message."

He added that such a scenario would not only remove the financial incentive for countries to invest in clean technologies that help them stick to their emissions targets - as it would be cheaper to continue polluting and just buy credits - but it would also discourage investment in carbon reduction projects in developing countries as they would have to pay for CDM approval only to find they could not get a good price for the carbon credits they generate.

Jepma said the only hope for keeping the price of the various carbon credits high enough to act as an incentive for countries to hit their Kyoto targets lay with convincing the Russians to retire the bulk of their credits.

"We need to convince the Russians that if they put all the credits they have into the market they are going to undermine their own returns from the system," he said. "We need to implore them to be sensible and help push the price [of carbon] up to a workable level."

As one delegate observed what we need is a "CDM version of OPEC" to control the flow of credits onto the market. But until such an organisation emerges the success of the scheme up until 2012 rests entirely upon the goodwill of the Russian government.