March 1, 2009

Carbon Goes Subprime

Dr. Robert Peltier, PE, Editor-in-Chief

European Union (EU) carbon trading proponents are finding support for their market-based emission trading scheme (ETS) in freefall like the market price of carbon in the EU. This unanticipated consequence of the ETS really should not have come as a surprise.

Free Allowances

The ETS, often described by EU regulators as the world’s most advanced market-based approach to reducing carbon emissions, liberally distributed carbon emissions allowances to industries proportional to their pre-ETS emission inventory when the EU economy was in full swing. Subsequently ratcheting down the number of allowances will, in theory, increase the value of those allowances, and their market price should rise. The anticipated effect is to increase the cost of coal-fired generation, for example, and to subsidize less-carbon-intensive, yet more expensive, renewable energy.

This free-market approach to managing an unpredictable power supply market may work well in a rising market when the thirst for power can’t be satisfied. What the ETS designers failed to consider is that during a recession, the demand for power slows, leaving a glut of allowances on the market and quickly falling prices. Allowances that were highly prized last year might as well be sold on eBay as just another depressed asset.

Vincent de Rivaz, CEO of the UK arm of Électricité de France, the French-owned utility, suggested at the January World Economic Forum in Davos, Switzerland, that politicians and regulators need to reexamine the ETS and confirm that the system is working as designed. "We like certainty about a carbon price, [but] the carbon price has to become simple and not become a new type of sub-prime tool which will be diverted from what is its initial purpose: to encourage real investment in real low-carbon technology," he said.