"Carbon emitters’ free ride is about to end"
By Kevin Parker Published: July 16 2008 19:02
(Copyright notice )
While rising commodity prices have attracted the glare of public attention, carbon has remained in the shadows. The price of European carbon allowances (known as European unit allowances, or EUAs) has risen only modestly this year, to about €27 ($43, £21) a tonne. But market pressures are building that could take the price to €100 a tonne or higher.
EUAs permit companies to emit a specified amount of carbon. These allowances are traded: companies have fixed emissions limits imposed on them by the European Commission but can offset their excesses by buying allowances in the market. However, the levels of demand and supply are severely out of balance. This may lead to a radical repricing of carbon that will fundamentally change the political, business and financial landscape forever.
The astonishing truth about the carbon market is that nearly everyone is short carbon: companies will breach their emissions limits and do not own allowances to make up the difference. When I ask market participants: "who has surplus allowances to sell?" I get back blank stares. It cannot be long before the market recognises this fundamental supply/demand imbalance.
The carbon market, in addition to allowing offsets, should also encourage the switching away from pollution-intensive fossil fuels such as coal to less carbon-intensive gas and renewables. Carbon pricing should be correlated with oil and natural gas prices, which are soaring. A recent report by my colleague Mark Lewis at Deutsche Bank ("It takes CO2 to contango", May 30 2008) argues that carbon's market clearing price with oil at $85 (€55) a barrel and coal at $90 (€58) a tonne is about €40 a tonne. However, with the actual oil price at about $135 (€87) and coal at $200 (€127), the market clearing price for carbon is €75 to €80 a tonne – nearly three times its current level.
The markets have an uncanny ability to find the weak hand. Those emitters with too few allowances to cover their carbon output are going to get squeezed by the lack of supply, and a rise to at least €100 looks inevitable.
Another trigger for a rise to more realistic levels is the €100-per-tonne fine that comes into force this year with phase two of the European Union's Emissions Trading Scheme. It will be imposed on companies breaching their emissions limits, who will also have to purchase enough allowances to bring them back into line. The EU is right that enforcement is essential to ensure industry takes the carbon policy seriously. However, a possible short-term effect will be a scramble to cover EUAs, triggering the squeeze.
The effects of a repricing of carbon will be profound. Carbon will take its place alongside oil, coal and gas as one of the most closely followed commodities in the world. This will mark the beginning of externalities at last being priced into the cost of production. It will signal that carbon emitters have had a free ride for long enough. Governments – the US's in particular – will have to join Europe to create a global market for pricing carbon and businesses around the world will have to accept the price the market sets.
A higher carbon price will force companies to make radical changes to their business models (this has already begun in the European utility sector). Early movers are likely to be winners. It will be an economic imperative for corporate boards and managements to take into account carbon pricing in their business and strategic planning.
This adjustment will allow for a more efficient allocation of capital. Landmark decisions are already being taken in the US, where coal-fired power projects have been abandoned owing to the future cost of emissions. Citibank, JPMorgan, Morgan Stanley and Bank of America this year signed up to a set of "carbon principles" that include a refusal to lend to high carbon emitters whose financial statements do not account for the future cost of their pollution. The US government reached the same conclusion. Insurers are reconsidering insurance for big polluters and moving to price the risk accordingly.
The rising cost of carbon will also drive the need for, and the viability of, alternative technologies. Capital will start to flow to new areas of investment: existing technologies to conserve power and mitigate carbon emissions, developing technologies for carbon capture and alternative energy. Like many turning points, the carbon price rise will be fraught with risk. However, that is worth the enormous opportunities and benefits it will create.
The writer is global head of Deutsche Asset Management
We have reproduced this article for scientific reasons only because of the volatility of the internet. Copyright guardian.co.uk © Guardian News and Media Limited 25 May 2008
Billions wasted on UN climate programme - www.guardian.co.uk
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