Emissions trading isn't working

Sorry to keep coming back to the subject, but it is becoming increasingly apparent that the EU's Emissions Trading Scheme really is in trouble.

Heavy industry, especially steel, is slashing production, meaning lower emissions, less scarcity of carbon permits, and hence lower carbon prices.

Point Carbon reports that prices for carbon permits within the EU ETS slumped 8 per cent yesterday, falling to 16 euros a tonne. The price will hit a floor between 12 and 14 euros per tonne, according to "several traders". This is less than half what the price of carbon was just five months ago.

It is probably true that carbon prices will not totally crash in the current phase of the ETS, as they did during the first phase of the scheme when a huge oversupply of permits meant they became worthless. But that is not really the issue any more. As we've argued again and again and again, price volatility such as what we're seeing now undermines incentives to channel long-term investment towards large-scale (often very capital-intensive) carbon saving projects and technologies.

Especially in the current climate, there is no way that the Chief Financial Officer of a large emitter can approach a bank asking for credit lines to fund new low carbon investment with any realistic expectation of what the price of carbon will be when the investment comes to be realised in 3, 5 or 10 years time.

Speaking to industry practitioners, this is the major structural failure in the EU Emissions Trading Scheme. It won't get any better in the next phase of the scheme (running from 2013 to 2020), even if all the political issues surrounding the basic structure of that trading phase are resolved soon (very unlikely).

As we've learned over the past few months, EU policymakers did not (and could not) predict economic slowdown and slumping carbon prices. And economic trends are only one element amongst many others (weather, politics, technological change) which drive carbon prices. The managing authorities of cap and trade schemes like the ETS will never have the knowledge to be able to allocate the right number of permits in order to create a stable carbon price. So there's no telling what could be happening in carbon markets in ten years time - and that is the fundamental problem.