Carbon Market Collapse

The world-wide carbon market has collapsed. There is no price mechanism supporting the required move away from fossil fuels and so a total collapse of this required shift to renewables seems possible. Perhaps this is the end of climate change policies until the next crisis emerges?

In the last few weeks, the total collapse of the carbon market has come about as a very clear evidence of the lack of interest in the climate change policies by top political leaders.

The latest crisis has been triggered by the defeat in the European Parliament of proposals to postpone the auctioning of new permits under the European Emissions Trading Scheme. The aim of the proposal was to keep the markets alive and functioning. The effect of the defeat, which does nothing for the reputation of the Parliament as a serious policy making body, was a 30 per cent collapse in prices which in any case had fallen to so low as to be ineffective.

Europe’s climate policy has been predicated on correcting the market failure which leaves carbon untaxed, despite all the costs it imposes. With a carbon price in place emissions would carry an added cost and it would therefore be advantageous for energy users, including power generators to switch to lower emission sources.

Two problems have broken the system. Low growth has meant that too many permits were being issued. Secondly the pre-tax prices of hydrocarbons have fallen. The shale gas revolution in the US may not have led as yet to any shale gas exports but it has diverted coal which has lost some of its US market. Since the first quarter of 2012 coal prices have fallen by over $20 per ton. In the simplest terms it is cheaper for power generators to burn coal and to pay the carbon tax than to switch into other fuels.

The collapse of the carbon market also effectively kills conservation schemes around the world which have been designed based on the market price of their carbon credits. The recent examples of RDD schemes to combat deforestation in Cambodia, Loa, PDR and the Amazon normally rely on the price of the carbon credits they can generate and sell into the developed country markets for carbon. These projects are all now jeopardized by the European Parliament’s decision. If the credits are valueless their business model is undermined.

In economic terms a carbon tax is clearly the most effective and simplest way of encouraging the shift to a low carbon economy. Of course the level of the tax matters. Nick Butler in the Financial Times recommends a Stephen Tindale paper which he appropriately lables as  an excellent paper for the Centre for European Reform, in which a floor price of 30 Euros a ton is recommended. This level of carbon pricing may well be enough to gradually induce people to shift to non-fossil fuels and it is certainly more effective than the current price of 3 Euros. Unfortunately Tindale’s proposals have little chance of success. European politics in particular seem to be working against any rational solution.

A system of tax and trade is fundamental to the concept of a global deal to reduce emissions. The reality though is that there is no global deal and the mechanisms which exist to underpin what might have been a consensus to combat climate change is coming apart. There is a serious chance now of the Australian system of carbon pricing will be abolished or stripped back if Labor loses the upcoming election. Elaborate structures such as the international carbon market were only ever going to be effective if they had a broad base grounding in a common effort. That has not materialized, leaving Europe facing far higher energy costs because of the carbon tax, while others including specifically the US and China do little. That was always going to be unsustainable. Talk of a trade war in which Europe imposes tariffs on trading partners who don’t do the right thing on climate change  has never been credible.

Real change in the carbon intensity of the global economy looks unlikely to come through with  international agreements that impose costs on unwilling consumers. The only solution is intensification of basic research on renewables to develop competitive prices for renewables without Government subsidies. That is now the only practical way forward.


See: Nick Butler, The collapse of the carbon market, Financial Times, May 23, 2013