Carbon Glut Fueled by Generous EU Cap, Climate Mundial Says

Europe’s glut of emissions permits is the fault of regulators’ overgenerous allocation of the allowances, rather than the region’s economic slowdown, according to carbon-market adviser Climate Mundial Ltd.

U.K. companies won allowances for about 410,000 metric tons of carbon dioxide per 1 billion euros ($1.4 billion) of gross domestic product in 2010, or 47 percent more than needed under a 2005 European Union economic model that measures so-called carbon intensity, said Daniel Rossetto, a Climate Mundial director in London. Austria, Greece and Spain got at least 15 percent more permits in the five years through 2012 than the model indicated they would need, Rossetto said.

“By choosing not to go deeper in its cutting of the allocations and because it didn’t install any system to deal with oversupply, the commission left the whole program vulnerable,” Rossetto said in a Feb. 5 interview. “The surplus wasn’t caused by economic recession.”

The European Commission, the EU’s regulatory arm, blames the region’s economic crisis for contributing to an 85 percent plunge in carbon prices from a peak in 2008. The surplus of permits in the EU’s emissions trading system may rise to about 2 billion tons by 2020, Jos Delbeke, the commission’s director general for climate said in Brussels on Feb. 6.

“There’s a surplus of allowances that needs to be tackled,” said Isaac Valero-Ladron, a spokesman for EU Climate Commissioner Connie Hedegaard. “That’s why the commission has put forward both short-term and long-term measures to address the problem.”

Less Intense

By 2011, carbon intensity across the EU dropped below the level assumed in the bloc’s so-called Primes model, Rossetto said in a January report. That means factories and utilities needed fewer permits, contributing to the carbon surplus.

The EU’s carbon intensity model assumptions are based on a price of 5 euros a ton, Rossetto said. That compares with an average 13.50 euros a ton since ICE Europe first offered futures on the allowances in April 2005. Carbon futures for December fell to a record 2.81 euros a ton on Jan. 24.

The carbon surplus will surge 80 percent from current levels to about 1.8 billion tons by May as factories and power stations use cheaper United Nations offset credits in April to comply with their 2012 emissions allowances, said Rossetto.

The market’s total supply will be 2.29 billion tons this year, according to a Feb. 4 estimate by Bloomberg New Energy Finance in London.

Avoiding Curbs

The EU introduced the carbon system in 2005 to help meet the emission-reduction targets under the 1997 Kyoto Protocol. The bloc decided to give free allowances to factories to prevent them from leaving the region to avoid the greenhouse-gas curbs. It reduced the number of free allowances in 2008 by 6.5 percent after prices slumped to 1 euro cent a ton a year earlier.

EU carbon for December rose 8.3 percent today to 4.55 euros a ton on the ICE Futures Europe exchange in London.

The EU should install a system that adjusts each year’s emissions cap five years in advance, a practice already established in the Australian carbon market, according to Climate Mundial.

Under the commission’s November plan to temporarily fix the glut, known as backloading, 900 million tons of allowances will be removed from the market in the next three years and returned near the end of the decade.

New Surplus

Backloading is not the correct policy response in this case because it will create a new surplus in a few years, Rossetto said. While policy makers say they want intervention to be a one-off, the nature of their plan will actually increase the chance another rule change is needed closer to 2020, he said.

Should backloading be approved it will probably become a cap change “sooner or later,” Jens Teresniak, an energy economist in the trading and generation unit of Stadtwerke Leipzig GmbH in Leipzig, Germany, said in an e-mailed response to questions. “In my opinion no one really believes that these allocations will be brought back to market in 2019 and 2020.”

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