EIC NewsBy Liz Morgan, Carbon Solultions Manager.
January 2011 saw the EU Emissions Trading Scheme (EU ETS) celebrate its sixth anniversary. The scheme aims to minimise the economic costs of the EU's commitment to combating climate change under the Kyoto Protocol. As part of this scheme, an internal market was set up to enable European organisations covered by the scheme to trade carbon dioxide allowances for compliance purposes.
Under the EU ETS, around 10,000 energy-intensive installations across Europe are able to buy and sell allowances to emit carbon dioxide (CO2). This represents around 40 per cent of the EU's total CO2 emissions.
Phase II prices
During 2008, high energy prices led to an increase in the cost of the European Union Allowances (EUAs). However, in 2009 both the global recession and selling activity ahead of annual reporting brought prices down. This, as well as the cold temperatures seen at the beginning of 2009 and 2010, increased demand but large falls in coal prices at the start of 2010 kept the EUA price supported by more than had been predicted.
More recently, there has been relative stability in carbon prices although some upside was seen during the summer of 2010. This was linked to issues with the authenticity of some Certified Emission Reductions (CERs).
In the early part of 2010, buying pressure was the main factor driving prices. Freezing temperatures boosted demand for heating, supporting requirements for allowances. As the year progressed, expectations grew that 2009 emissions would be much lower than in 2008. The potential allowance surplus provided a steady fall in prices during March. However, in April the European Commission showed emissions were down by 11.2 per cent below those seen in 2008. As the surplus had been expected to be larger, some upside returned.
The oil markets and German power prices then became the key focus. This led to prices remaining range-bound during the autumn. Some support came from speculation that the European Commission would tighten caps for Phase III. In addition, there were concerns over trading confidentially. The Netherlands' allowance auction was cancelled after the confidential bids were leaked onto the exchange.
EUAs moved higher in the latter part of the year supported by buying pressure from financial institutions. The expiry of the 2010 contract also dominated discussions as to whether it would breach €15/tCO2e beforehand. Participants began to roll forward positions from 2010 to 2011, with selling by utilities prompting further falls.
EUA and CER swaps
As part of the EU Linking Directive, organisations are able to surrender part of their annual emissions reconciliation in Certified Emissions Reductions (CERs) to cover their emissions. These are generated by the Clean Development Mechanism (CDM). In the UK, companies are able to use up to eight per cent of their annual allocation as CERs in Phase II. This makes the spread between EUAs and CERs of significant importance to many businesses.
In August 2010, an investigation was launched into a number of CER projects. Allowances were suspended from some HFC-23 projects in China followed by a delay in the issuing of further CER allowances. This resulted in increased trading activity in the CER market, as well as higher prices and interest. It was alleged that a number of projects were deliberately generating greater levels of greenhouse gases so that they could create saleable credits. The projects that were under review represented almost a quarter of the CDM-based projects dealing with the reduction of HFCs.
CERs in Phase III
Given concerns over the use of some types of CERs, the European Commission has amended the rules for Phase III. Access to project credits under the Kyoto Protocol from outside the EU will be limited, with some types being excluded. It is proposed that credits generated from the destruction of HFC-23 and N2O greenhouse gases will not be eligible for compliance after 2012. This will effectively create a two-tier market for CERs. Concerns over what credits will be eligible for EU ETS compliance in Phase III led the forward curve for CER prices to fall during the autumn of 2010.
Some participants may feel unsettled by the change in the rules which could raise concerns that there will be further alterations to the scheme ahead of Phase III going live in 2013. In addition, any further changes could limit investment in CDM projects due to uncertainty over whether they will be allowed in future phases of the EU ETS. The reduction in availability may also support EUA prices, as there will be fewer CERs to use for compliance. As a result, the participants in the scheme should pay close attention to any announcements from the European Commission, as there are still two years to go before Phase III goes live.
If you are interested in receiving support or advice contact theenergyexperts@eic.co.uk or call 01527 511 757.