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Pricing Carbon
Europe’s Carbon Market is Still Hopelessly Ineffective

And it’s not going to fix itself anytime soon.

The EU’s carbon market—called the Emissions Trading System (ETS)—has from the very beginning struggled to set a reasonable price for its carbon credits. Like any other regional carbon market, the EU ETS has had to balance concerns that a too-high credit price would chase big emitters (read: heavy industry) outside of the region to less regulated parts of the world, with avoiding setting a price too low to actually incentivize emissions reductions.

That’s a devilishly tricky balance to set, but the risks of erring either too high or too low are not equal: EU ETS planners have understandably acted with an abundance of caution and chosen to over-allocate credits to avoid chasing away business. The result has been a long history of a carbon price so low so as to border on irrelevancy for the EU’s industrial producers. While other regional markets have pushed for carbon prices in the region of $25-$50 per ton of CO2, the EU ETS is now seeing expectations for its credits slide 5 percent down to just $5.91 per ton in 2017 and $6.60 the year after. Reuters explains:

[A]nalysts said increasing use of gas at the expense of coal in power generation…would lead to weaker than previously expected demand for [carbon credits]. “Coal generation is declining faster than anyone expected and the fall is far from being over. Gas is picking up and low prices (of natural gas) are here to stay,” said Matteo Mazzoni, analyst at Nomisma Energia in Italy.

Electricity generators are the largest buyers of carbon allowances in the EU ETS, which charges power plants and factories for every ton of carbon dioxide (CO2) they emit.

European coal futures have surged by around 70 percent this year, due in part to a sharp cut in Chinese coal mining, while gas prices have fallen, meaning power generators are switching to the cheaper fuel. Gas-fired power generation emits half as much CO2 as coal-fired power plants.

Perhaps eurocrats will find some solace in the fact that these projected prices are up from the January 2013 nadir of just over $3 per ton of CO2. But that is a small comfort when the market is as oversaturated with permits as it currently is. It’s especially concerning that the outlook is getting worse, when you consider that Brussels has been actively working to constrain the supply of permits through a process called backloading (therefore making those permits pricier).

Those reform efforts are coming to an end next year, though. “As of 2017, we expect that the price will be under pressure with auction volumes coming back to normal and demand not increasing the same way to mitigate this effect,” ICIS Tschach Solutions analyst Philipp Ruf told Reuters. As a result, Europe’s carbon price should resume its fall next year—hardly the signs of a healthy system.

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