EU Carbon Market Reserve Seen Absorbing 85% of Glut by 2021

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CHART: The EU's Carbon Market Fix

An unprecedented overhaul of the European Union’s carbon market will probably remove 85 percent of a glut of permits that sent prices tumbling and eroded incentives to reduce emissions.

A proposed reserve to control the number of allowances in circulation will probably hold 1.7 billion metric tons of the contracts by 2021, according to the median estimate in a survey of eight analysts and traders. The European Commission will unveil on Wednesday a package of rules for the market through 2030, some of which will probably set the size of the reserve.

The 28-nation EU is tightening permit supply after prices collapsed more than 70 percent since 2008 to levels that fail to deter the burning of coal, the most polluting fuel. Carbon futures closed Monday at the highest in more than two years before the bloc details its latest attempt to fix the biggest emissions market.

“Greater scarcity of free allowances may prompt factories to hold onto their existing stockpiles, eroding industrial supply” of permits for sale, Ingo Ramming, the London-based co-head of commodity solutions at Commerzbank AG, said Tuesday by e-mail.

Withheld Permits

Starting in 2019, the market stability reserve, or MSR, will absorb permits if the surplus exceeds a fixed limit and release them to the market in the event of a shortage. The reserve will also take in 900 million allowances being withheld from auctions in the three years through 2016. Each contract gives companies the right to emit one ton of carbon dioxide.

The six estimates for the size of the MSR by 2021 ranged from 1.5 billion tons to 2.1 billion tons.

The EU’s 10-year-old cap-and-trade program gives away or auctions allowances to about 12,000 factories, utilities and airlines, which need the permits to match their carbon dioxide output or pay fines if they exceed quotas. The accumulated surplus in the system exceeds 2 billion tons, or more than a year’s supply, according to the European Commission, as overlapping climate policies and sluggish economic growth weakened demand.

The reserve “may finally return scarcity to the market in the next decade, but increased use of renewables and more energy efficiency may offset some of its impact,” Commerzbank’s Ramming said. The bank estimates carbon allowances will rise to 9 euros a ton by the end of the year.

September Vote

Ministers from EU nations will vote on the final details of the stability reserve Sept. 18.

Benchmark carbon futures settled down 0.8 percent at 7.74 euros ($8.52) a ton Tuesday on the ICE Futures Europe exchange in London after touching 7.85 euros, the highest level since Feb. 24, in intraday trading.

The EU should resist the temptation to cut the reserve’s size and use the allowances for other purposes such as distribution to new factories, said Jill Duggan, author of a report on the carbon market for the Prince of Wales Corporate Leaders Group, a climate-protection advocacy organization.

“Maintaining a decent carbon price is going to be an ongoing struggle,” Duggan said July 10.

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