COLUMN-EU carbon prices may be best left in limbo: Wynn

Fri Sep 28, 2012 12:29pm BST

By Gerard Wynn

LONDON, Sept 28 (Reuters) - Britain's prospective carbon floor price, meant to motivate low-carbon investment, illustrates some doubts about the environmental and economic impacts of wider reforms to Europe's emissions trading scheme.

The EU's emissions trading scheme (ETS) has driven emissions cuts partly by driving a shift to gas from higher carbon coal, by forcing polluters to pay for their emissions in a measure which also raises wholesale power prices.

The scheme has suffered setbacks including most recently a glut of emissions permits following the financial crisis which has caused carbon prices to crash.

Its goals are both to set a clear cap on carbon emissions by industry and give companies flexibility over how they meet the target whether by cutting emissions or buying EU allowances (EUAs).

In a less strategic but lower cost approach to driving cuts in carbon emissions, burgeoning U.S. exploitation of cheap shale gas has also driven a shift from coal, in a process which has cut wholesale power prices instead of raising them.

While drilling for shale gas is not a carbon policy, it may flag up a warning for European cap and trade: not to rush into emissions trading reforms which may hike carbon and power prices.

Alternative, pre-2020 approaches to cutting carbon emissions include improved cross-border energy trading and connections to boost gas and renewable energy, investment in liquefied natural gas import terminals, and exploitation of European shale gas, as well as continued support for renewable energy.

Short-term carbon market reform to boost carbon prices, as planned by the European Commission, has no guarantee of success, given opposition from some member states and a rather convoluted process of EU approval.

And the impact is unclear given the lack of conclusive research on how far emissions trading cuts carbon emissions.

A prospective, unilateral UK carbon floor price illustrates the dangers of tinkering.

EMISSIONS IMPACTS?

Perhaps surprisingly given emissions trading is now in its eighth year, there is no conclusive research demonstrating how far it has cut carbon emissions.

Such a lack of knowledge appears a flimsy basis for rushed reform, especially where there is a possible negative economic impact.

The European Commission reports that carbon emissions per participating installation in 2010 were 8.3 percent below 2005 levels, but it is more important to establish cause.

Emissions are impacted not just by carbon prices but by drivers of energy demand, falling in response to high oil prices (in 2008), recession (2009-present) and mild winters, for example.

A paper for Britain's Department of Energy and Climate Change (DECC), published in July, found that evidence that the scheme had cut greenhouse gas emissions across all sectors by about 3 percent annually from 2005-2009 compared with business-as-usual trends.

It found no firm evidence for cuts beyond fuel switching in the power generation sector.

"Despite being of prime interest for policy design, the evidence on the drivers of abatement was scarce and anecdotal, based on surveys of a small number of participating firms," it said.

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Chart 1:

Chart 2:

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FUEL SWITCH PRICE

In the power generation sector, the scheme has driven cuts by causing emissions fuel switching, when carbon prices make gas-fired power more economic than coal-fired generation.

But gas prices are now relatively higher than coal prices, meaning EUA prices would have to be six or more times higher than at present to force such fuel switching, see Chart 1.

That dims prospects for policy tinkering to drive emissions cuts in this way.

The European Commission is presently trying to get member state approval to remove temporarily several hundred million emission permits, or EU allowances (EUAs), with a view to cancelling these permanently.

If the aim is to drive long-term, low carbon investment, then direct support for renewable energy may be more effective, coupled with long-term cap and trade reforms beyond 2020, focusing on a tough emissions cap in 2030, dove-tailing with global efforts to secure an international climate deal.

UK CARBON PRICE FLOOR

Britain next April introduces a carbon floor price which is illustrative of the dangers of pushing up carbon prices.

The aim is to reduce volatility in carbon costs, for a clearer signal for low-carbon investment.

Chart 2 shows the schedule for the carbon price floor which starts at 15.7 pounds next year, or nearly 20 euros, more than double present EU carbon prices.

Polluters will pay the difference as a carbon tax and pass the extra cost to energy consumers.

The UK government estimated in 2011 a top-up of about 5 pounds per tonne of CO2 in 2013/14, but the number could be far higher subsequently, taking account of sharp cuts in EUA prices.

That top-up is now nearer 10 pounds according to a panel of UK lawmakers, which would drive UK wholesale power prices up about 10 percent. "This could have a devastating effect on UK industry," the panel reported in January.

While Britain plans to compensate energy-intensive users, that will add to the complexity of the scheme.

The policy will also deliver a windfall to existing nuclear and renewable energy operators, compared with coal, while a UK impact assessment of the price floor made no detailed case for how it would drive certain estimated emissions cuts.

In the same way, intervening now to raise EU carbon prices will provide a one-off economic rent for speculative investors in carbon emission permits, will raise wholesale power prices, and could over-reach itself and drive carbon and power prices too high as economies recover.

Britain may be wiser to wait for EU cap and trade reforms, which in turn may be better to focus on a tougher emissions caps after 2020.