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Matthew Gray

25 April 2013
Matthew Gray

On Tuesday, the European Parliament voted down a plan to withhold 900 million emission allowances from the EU Emissions Trading Scheme (ETS) until 2020, in order to boost short-term prices. The price fix, known as “backloading,” was rejected 334 to 315, with over 60 abstentions. Following the vote, carbon prices plunged to eight-year lows.

The Climate Group’s Damian Ryan and Evan Juska spoke with Matthew Gray of Jefferies about the near-term impact on the EU ETS, and what it means for carbon markets in general going forward.

Why do you think the “backloading” plan was rejected?

The main reason is EU deindustrialization. The deindustrialization trend goes to the heart of the EU’s body politic and explains why ETS reform faced such strong resistance. Although industry is playing a less important role in driving economic growth, the EU’s political economy is skewed in favor of the manufacturing sector because 1) it remains one of the biggest employers across the continent and 2) those assiduous and fiscally conservative German households – who are currently underwriting the EU project – are disproportionally employed by Germany’s dominant manufacturing sector.

What will the near-term impacts be on the market?

After it became evident that the proposal had been rejected, the price of EUAs collapsed to reach an all-time low of €2.63. Going forward, we expect the average price for Phase 3 (2013-20) to stay down at about €2.50, assuming there is no regulatory intervention. That’s much lower than our initial price forecast of €13.

Unfortunately, the EUA market is essentially finished until further notice. Speculators and industrials will exit the market, which only leaves utilities who will continue to cover power hedges. Volatility should naturally decline, leaving the ETS operating more like a tax, than a market.

What does all this do to investor confidence in the EU ETS and carbon markets in general? Can the damage be repaired?

Over the long-term, this outcome is not as morbid as it appears. Backloading was never going to do much other than keep speculators interested and prevent compliance buyers from aggressively selling off their excess inventory. The reality is EU energy policy is at a crossroads. A dramatic rethink is required to prevent continued deindustrialization and the Bloc becoming the global dumping ground for cheap coal. These reforms will take time, because they will likely define Europe’s future. Climate policy, specifically structural reforms and the 2030 debate, will be coalesced into this strategy.

The backloading proposal now goes back to the Parliament’s environment committee for further review. Will it survive or will there be another proposal? 

I’m not optimistic that the Commission can engender meaningful reform over the short-term. The EU, much like the US, governs by crisis these days, while eurozone instability and energy costs swell within the heart of the body politic.

What about reforms in the long-term?

Our long-term outlook for domestic policy remains resolutely optimistic. This optimism looks beyond Phase 3 and is dependent on adequate regulation. If carbon wants to be considered a serious asset class, it needs to be seriously regulated. This will not occur without political independence.

Read more about the EU ETS decision.

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