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What price carbon?

Uncertainty about how the European Union emissions trading scheme will work after 2012 is creating a headache, reports Ed Owen and John McKenna.

Not knowing what prices will be from one year to the next is an accepted reality of living in a market economy. So why has French cement manufacturer Lafarge got its knickers in a twist and suspended £755M of investment in plant because of the uncertainty surrounding carbon pricing post-2012 (News last week)?

It is because in Europe, the price of carbon released into the atmosphere by industry is far from being truly open to market forces; rather it is dictated by Brussels via the European Union Emissions Trading Scheme (EU ETS). As things stand, a decision on how this works after 2012 is unlikely to come before 2010.

As a result, industries covered by the current scheme including cement, steel and energy are wary of making investments that could affect their carbon outputs until they know how cheap or expensive carbon is likely to be.

To understand why the price of carbon post-2012 is such a headache for many industries, one must understand the complex EU ETS and its history.

If you cast your mind back to 1997, the Kyoto treaty saw countries signing-up to reduce CO2 outputs to 1990 levels before the end of 2012.
The major problem was that the world's greatest producer of CO2 – the United States – decided to opt out, and some groups thought the targets could have been firmer. But for those countries which did sign up, the measures took hold in 2005.

The Kyoto Treaty also introduced the idea of trading emissions. With emissions trading, companies are given a CO2 allowance. If they produce less than their allowance, they can sell the remainder to another producer which is likely to exceed its allowance. If they produce too much CO2, then they can buy credits from a company whose production falls short of its allowance. Spare CO2 allowances are held on digital registries, and can be traded like shares. Overall allowances fall over time, with the aim of reducing overall CO2 emissions.

By far the largest and most complex emissions trading scheme is in Europe. The first full EU scheme began in 2005, for large industrial producers such as energy companies, accounting for 40% of all emissions. EU member states were each given set allowances, which they in turn allocated as CO2 limits to companies that fell under the terms of the scheme. This was seen as a failure, as caps on emissions were too generous, forcing the price of carbon to drop to almost nothing.

The second round of trading started this year, with tighter controls and tighter caps. From 2010 emissions from aviation will be brought into the scheme, with allocations made from Brussels, not by individual countries. This is significant because it will increase demand for tradable carbon, which will drive the price up.

The third round will begin in 2012, and the draft legislation is aiming to achieve at least a 20% reduction in global CO2 emissions between 1990 and 2020. This could even rise to 30% if other developed countries commit to similar reductions.

The third round will be considerably tighter, as legislation will cover CO2 emissions not covered in the trading scheme so far, such as those from buildings, transport and from the waste sector. A second target aims to increase the proportion of electricity from renewable sources to 20% across the EU by 2020.

Post-2012, the EU plans to centrally allocate carbon allowances, and businesses in any country will be able to trade these EU wide. This is expected to dramatically increase the quantity of carbon traded.

Today, the price of CO2 is €21.65 (£16.31) per tonne. Prime Minister Gordon Brown last week said he favoured, "the creation of an independent European carbon market bank to set caps on carbon permits and establish how the carbon market should operate in the future".

This carbon bank, not the EU or individual countries, would hand out allocations, and then the market would set the price. The idea seems sensible, but is unlikely to get off the ground as the EU will be reluctant to have control of its flagship green measures wrested from it.

All of this debate is unlikely to be resolved until 2010 and carbon allowances for cement, glass and paper manufacturing are unlikely to be determined until the following year.

With no certainty about which companies will be handed credits or whether they will be able to buy enough of them after 2012, it is understandable that Lafarge has decided to suspend investment in new cement plants.

The uncertainty could also cause a hiatus for investment in renewable technology and new nuclear power stations.

WHO's WORRIED ABOUT CARBON AND WHY?


Cement manufacturers

Lafarge's decision to suspend investment in new cement plants puts into action the words of British Cement Association (BCA) chief executive Mike Gilbert. Last month he warned that waiting until 2010 for an EU report on the competitiveness of carbon trading to determine how the ETS will work between 2013 and 2020 creates uncertainty over investment decisions.

This in turn will have a effect for construction as materials supply slows. Gilbert expressed dismay that current EU proposals for the trading period post-2012 failed to exempt the cement industry from the auctioning of allowances. The current system of caps being set by home governments had by 2006 delivered a 29% drop in CO2 emissions from cement manufacture on 1990 levels. He argued that auctioning would simply reduce the funds available for investment in new and carbon efficient plant.

Power generators

With gas and coal-fired power plants already included in the trading schemes, many generators will have similar concerns to those in the cement industry. Discouraging investment in fossil fuel technologies may be a good thing in terms of driving down carbon emissions, but the uncertainty could also have a negative impact on the development of alternative technologies such as new nuclear, carbon capture storage (CCS), and to a lesser extent renewables.

If generators think the price of carbon is likely to be high, it will make the investment in nuclear and CCS more financially
attractive. If it is low, the opposite will be true. However, development of renewables in the UK is likely to insulated from ructions in the EU ETS due the government subsidy of Renewable Obligations certificates.

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