Flexible CO2 supply option sparks mixed market views

A dynamic supply-side mechanism to fix the EU emissions trading system’s (ETS) oversupply still sparks mixed views from market participants and experts, despite being hailed as the most politically viable option on the table.

The European Commission proposed six options to structurally reform the carbon market. A seventh option – introducing a flexible supply mechanism – emerged from replies participants submitted to a public consultation on the issue (see EDCM 8 March 2013).

Split opinions

“Making supply flexible by linking to GDP is the easiest, most transparent and promising way to structurally reform the carbon market, to which I think it would be difficult to object,” said Ingo Tschach, head of market analysis of German analytics firm Tschach Solutions – now part of ICIS. He added that if this option gained support, a specific GDP indicator would still have to be considered.

Tschach explained how the mechanism could work: If a given year’s GDP is significantly below the forecast used to set that year’s cap, the EU could adjust the subsequent year’s cap downward accordingly. If GDP then exceeded forecasts, reserved set-aside allowances could be used to increase the cap.

But others disagree that it is the best way out of the oversupply for the ETS.

The head of natural gas, coal and carbon at consultancy Energy Aspects, Trevor Sikorski, said making supply flexible poses problems. “On the conceptual level it is problematic as it mistakes what this market is about, which is the volume of emissions and not the price,” he said.

One analyst at a utility said that, if implemented, macro-economic data would play a much bigger role in carbon trading and tie the CO2 price more closely to what is happening in other markets – such as actual and estimated GDP figures.

Similarly, Sikorski said that basing ex-post carbon supply changes on real emissions would make it difficult to grasp the market. This could impact trading negatively, he added. “[Such mechanism] makes it harder to trade, as future scarcity is harder to judge, and could well reduce the volumes in the market or alternatively increase the price.”

A source at a broker also warned that linking supply to GDP could “kill the market” and that the choice of indicator could add further challenges for carbon.

Industry

Stakeholders, including trading associations, utilities and industrials have already expressed interest in making the supply side more flexible – a state of affairs which would make more likely to attract political backing than other suggestions, such as the cancellation of cheap surplus offsets, from EU countries and sectors.

“Any other structural measure idea, such as permanent cancellation, [won’t] fly under back-loading text,” the broker source said.

“I understand why this reform option is looked at since it would make certain industries that are currently perhaps opposing carbon markets more willing to be on board,” the utility analyst said.

Companies and lobbies that have previously backed the idea of making supply flexible include steel major Tata Steel and cement producer Holcim.

European power company lobby Eurelectric said it was “in principle interested in a supply adjustment mechanism”, but added two “caveats” to its position: firstly, the lobby’s preferred option for fixing the ETS is still an increase in the linear reduction factor (see EDCM 5 February 2013); secondly, it continued to analyse and had no final view yet on supply adjustment options.

Eurelectric wants a reduction factor of around 2.3% before 2020, depending on emissions and sectors included in the ETS, in line with the 2030 target.

Italian power incumbent Enel, for instance, agreed in the past with a flexible supply mechanism, proposing a link between future caps and the allowance surplus.

The International Emissions Trading Association is also examining different options. A representative said that it was in discussions with its members on what a supply-side mechanism could look like and is hoping to publish a document on this in September. Silvia Molteni and Marie-Louise du Bois