The first phase of the European Union’s Emissions Trading Scheme (ETS), which comes to an end this year, may not have delivered the hoped-for cuts in carbon dioxide emissions, but it has triggered the development of a huge new energy market in emissions — not only in Europe but increasingly in the US, where individual states are setting up unilateral trading schemes. Trading volumes in the EU’s ETS, which currently accounts for 80% of global emissions trading, have risen from 276 mn tonnes CO2 equivalent in 2005 to 756 mn tonnes in 2006 and 634 mn tonnes in the first half of this year.
After a bullish start to trading in 2005, the price of European Union Allowances (EUAs) in Phase 1 has plummeted and is now less than €1/tonne. Verified (actual) emissions data for 2005 and 2006 have revealed that the emission caps set by the EU’s member-state governments were too high and that there is therefore a large surplus of allowances on the market. Since Phase 1 EUAs cannot be carried forward into Phase 2, which begins next year, these surplus allowances are effectively now worthless, assuming that all operators who were short have covered their compliance requirements. Prices for Phase 2 allowances, however, have been much more robust, trading this year in a range of €18- €30/tonne. This reflects market expectations that supply will be much tighter in the period 2008-2012 following a stricter approach by the EU Commission to the emissions caps set by member-states in their national allocation plans.
The second phase of the EU scheme is timed to coincide with the five-year implementation period of the Kyoto Protocol, which will open up trading opportunities for all the industrialised countries that have ratified the Protocol. While Western Europe, Japan and Canada will be short of allowances to meet their Kyoto obligations, the countries of the former Soviet Bloc, where economic growth plummeted in the early 1990s, will have allowances to spare. Project credits from the Clean Development Mechanism will also be flooding on to the market after 2008, raising concerns that the price of emissions allowances could crash. Evolving longer-term energy policies, however, suggest a much tighter carbon market after 2012, especially in the EU. This should encourage countries and companies to bank allowances for future use rather than sell them and depress prices. For their part, Russia and the Ukraine could act like OPEC in the oil market, keeping back reserves of allowances to support the price.
