Carbon Price Slump: Question marks over emission trading

Michael Richardson, Straits Times 23 Mar 09;

FIRST, came the credit crunch and recession. Now there is a carbon price slump that may undermine one of the main ways governments have chosen to combat global warming.

In 2005, the European Union (EU) pioneered a trading scheme for greenhouse gas emissions from industries. The scheme imposes a cap on emissions from factories and power plants that rely on fossil fuels in the 27-nation bloc. It uses a fixed quota of emission permits.

Firms that lower their emissions by saving energy or turning to non-fossil fuel sources like solar and wind power can sell their permits to less efficient companies. The programme was designed to be a major component of Europe's plan to deliver a 20 per cent cut in emissions by 2020 over 1990 levels, making it the global leader in fighting climate change.

Earlier this month, Australia confirmed that it would follow the EU when it unveiled legislation that it hopes to pass establishing a carbon pollution reduction scheme that in some respects is more comprehensive than Europe's.

Energy-intensive Australia committed itself to reducing emissions by 5 per cent of 2000 levels by 2020, but has said it will back a 15 per cent cut if other rich nations promise to make similar moves at a United Nations climate change summit in Copenhagen in December.

Meanwhile, the United States, which rejected carbon-capping under the Bush administration, now aims to pass a cap-and-trade law later this year.

Whether these initiatives become an effective global mechanism for reducing emissions depends on the willingness of other big energy users and industrial polluters to adopt similar schemes. Among them are China, Japan, India and South Korea. Most developing countries oppose measures that would impose extra costs on their economies.

However, some critics assert that developed economy carbon trading is fundamentally flawed and that although it was intended to cut emissions by making polluters pay, it is now removing this incentive.

The EU's emission trading scheme got off to a controversial start when prices plummeted after some governments issued too many permits. No sooner had this problem been fixed, the economic slowdown struck. With industrial output and exports falling, there are less emissions.

Cash-strapped firms have been selling their permits to raise funds. As a result, prices on Europe's six carbon exchanges hit a low of ¥8.05 (S$16.60) per metric tonne last month, a drop of nearly 75 per cent from the level of ¥31 last July.

Declining emissions are good for the climate. However, Europe's trading scheme was not intended to deliver a 20 per cut in emissions on its own. It was supposed to have raised large amounts of revenue for the government, which would then have used the money to help pay for renewable energy development, carbon capture and storage, and measures to ease the cost impact on business and consumers of the change to a lower carbon economy.

The Australian and US cap-and-trade schemes are similarly designed. All the schemes allow the market to set the basic price of carbon. Canberra has forecast an initial price of around A$23 (S$24) per tonne when it starts auctioning permits to the country's biggest companies, covering 75 per cent of national greenhouse gas emissions, from July 2010.

Based on this estimate, the government expects to raise around A$11.5 billion in the financial year that starts in mid-2010 and over A$23 billion in each of the following two years. Of course, economic recovery may be underway by then and drive carbon prices higher.

But at present the price is more than 25 per cent below the budgeted level. Unless it rises, governments in Australia, Europe and the US will be short of money to fund their side of the cleaner energy bargain with companies and consumers. Worse still, the low carbon price makes it relatively cheap for industry to keep polluting.

Emission trading schemes allow firms either to buy domestic permits from the government or import them under a UN programme known as the Clean Development Mechanism. Project developers who establish clean energy projects in the developing world, mainly China and India, sell the emission credits to companies that buy them to comply with environmental regulations at home. But UN carbon permits, called certified emission reductions or CERs, are also at record-low prices. As a result investor interest in clean-energy projects in the developing world is being stifled.

Some argue that if governments are serious about climate change, they should tax carbon pollution. This would provide business and consumers with cost certainty, and governments with assured revenue. However, imposing such taxes would be very unpopular.

Emission trading raises objections at a time of deepening recession and rising unemployment. But at least in the initial phase, it is a relatively low-cost option. Whether it is an effective mechanism for ushering in sustainable economic growth over the long term remains to be seen.

The writer is a visiting senior research fellow at the Institute of Southeast Asian Studies.