Crashing carbon prices puts EU climate policy to the test

Reports that six EU countries had emitted far less CO2 than anticipated sent carbon prices plummeting last week. Attention now turns to the EU's next round of emission allocation plans due on 30 June.

The Emissions Trading Scheme (ETS) is the EU's flagship instrument to fight climate change and meet its Kyoto pledge to reduce emissions of global warming gases by 8% by 2012. Under the ETS, some 12,000 energy-hungry industrial installations have been able, since 1 January 2005, to buy and sell permits to emit carbon dioxide, covering about 40% of the EU's total CO2 emissions.

A CO2 cap is set for each plant covered by the scheme in order to create a shortage and keep prices high, thereby encouraging companies to emit less than what they have been allowed. Pollution credits can be exchanged on an EU-wide carbon market, favouring greener utilities that can make a profit from selling their excess credits.

Carbon prices dropped by more than 50% last week upon reports that the Czech Republic, Estonia, France, the Netherlands and the Walloon region emitted far less CO2 last year than initially anticipated by the market. Low carbon prices are bad news for the EU's climate change policy as the CO2 trading scheme draws its strength from the benefits companies can make from selling their potential surplus pollution allowances on the market. With falling prices, incentives for companies to cut down their emissions and free up extra credits are consequently diminished.

The reported CO2 emissions represent only about 15% of the total emitted in the EU with reports for the biggest emitters like Germany, Italy, Poland and the UK still pending. The Commission will publish full emission statistics for the entire EU on 15 May. The news took the market by surprise because of the magnitude in the discrepancy between the caps placed on countries' emissions and the amount of CO2 actually emitted. The shortfall was as much as 25% in Estonia with other countries reporting between 8 and 15% fewer emissions than anticipated. In France, this amounted to 19 million tonnes surplus allocations, authorities said.

According to Frank Brannvoll, an analyst at Point Carbon, the news has had a snowball effect made worse because market prices were bullish up till then, reaching an all-time high of over €30 a tonne of CO2 only days before the reports came out. "Markets are anticipating that the trend will continue," Brannvoll told EurActiv. But he indicated the drop also has positive effects, sending electricity prices down as CO2 market valuation is integrated into power prices.

Electricity prices already fell by 5 to 10 euros in Europe in general on hearing the news, Brannvoll said. "There is no doubt that the market is now monitoring what reaction the Commission and the member states will have and whether they will reduce their allocations for the second trading period," said Brannvoll. The Commission tried to play down the significance of the price drop saying there was "no crash".

"The market started at €6 and nobody then thought it would go above €10", EU environment spokeswoman Barbara Helfferich told EurActiv. 2005 emissions data for the entire EU will be published on 15 May. Helfferich said this would allow the Commission and the member states to base their next round of allocations on reliable data based on "actual emissions".

There is widespread criticism that EU countries allocated too many pollution credits to industry for the period 2005-2007. This, critics say, gave companies a free ride to pollute since the vast majority of allocations were given away for free by EU governments. In a recent study, WWF estimated that German power utility Vattenfall Europe received 99 % of its certificates for free. It said other German utilities such as E.ON and RWE had to pay for presumably only 7 % of their emission certificates.

WWF calculated that German utilities were set to make windfall profits of between to €31 and €64 billion until end 2012 due to the free carbon allocations.