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Thursday, October 23, 2008

Carbon price hits eight month low

According to Point Carbon, carbon prices for permits traded within the EU Emissions Trading Scheme (EUAs) have "crashed", and are now priced at less than €20/tonne. The chart below illustrates how far the price has come down over the course of just one month.

We have made the point repeatedly that price volatility is a major flaw in carbon markets, and acts as a serious disincentive to large-scale capital investments designed to cut carbon emissions. Decisions on this scale of investment take place over a timeframe of years, possibly decades, making it very difficult for big polluters to make plans on the basis of an erratic carbon price signal.

Carbon prices are driven by scarcity in carbon permits, which in turn is determined by a number of complex and unpredictable factors - including weather patterns, fossil fuel prices and expected economic growth. The latter two factors in particular are behind the current slump in prices in Europe.

The judgement of bureaucracies (in this case the Commission) - who need to determine the final number of permits to be issued - is of course a key driver of carbon value in cap-and-trade schemes such as the ETS. And it is apparent that these officials were unable to predict a big slump in oil prices and recession in Europe. If winter turns out to be unusually warm, this could push prices down even further...

This illustrates the intrinsic problem of the ETS and systems like it: bureaucrats cannot predict the future, and can never have the knowledge or resources to be able to set the allocation of carbon permits at the "right" level for a five or seven year trading period.

When things don't go the way the officials expected, the result is volatility in the price of carbon. That's why we think it's time for emissions trading to be replaced with a solid, long-term carbon price mechanism such as a tax.

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