Can We Put a Price on Solving Climate Change?

Earlier this week, Lisa Zelljadt from Point Carbon wrote of her company’s new “Carbon 2010” report, which is a worthy attempt at covering the complex set of variables involved in creating and sustaining markets for carbon allowances. The report quantifies the responses from their proprietary data and marketing survey of approximately 1,500 carbon professionals who are all involved in some way in carbon markets/ resource finance (and who are disproportionately carbon traders).

It looks at the success of market-based carbon initiatives, with particular focus on the EU Emission Trading System, where problems may be used as case studies for the eventual U.S. carbon market (as sixty percent of the respondents still think will happen by 2015).

Thus far, most people involved in the day-to-day of carbon markets come from regulated organizations (output sources) and dealers—aggregators or middlemen between governments distributing allowances and the firms that need them for compliance. Europe is suffering from an EUA (EU Emission Allowance) oversupply, and illustrates some of the problems that can occur with mispriced carbon.

The economic downturn resulted in decreased manufacturing, and thus decreased carbon output, despite the fact that firms have enough EUAs for a boom year. Half of Point Carbon’s polling sample had surplus EUAs, which drive down their current and future value.

EU firms also revealed, varying by sector, differences in carbon price tolerance; some industries (like metals, or heat and power) were more likely to buy allowances or invest in mitigating technology at a certain “price” for carbon. Oil and gas’ behavior, however, was unaffected despite the price of carbon, perhaps speaking to the scale of the working capital in these industries.

The report also notes an interesting outcome: because the ETS is a market made by governments, the returns must be politically sound.

In other words, carbon markets are bullish when they work—when firms reduce their CO2 output. Paradoxically, however, CO2 reduction diminishes the demand for the commodity market in general. For this reason, governments with carbon markets must, unlike Europe, consistently maintain scarcity of allowances to drive up their cost and stoke investments in them. Carbon is currently suffering through a bear market. Returns are uncertain, price signals are obscured, and so investment (allowance purchases) is lagging.

This is why many argue that action from the Obama administration is so necessary. In the carbon economy, governments set prices that drive firms either to invest in mitigating technology or buy their way into compliance with allowances. When governments don’t set prices, markets don’t function efficiently. As it is, some markets have prices and other don’t, creating arbitrage opportunities that shouldn’t exist.

Respondents’ universal confidence about the eventuality of a U.S. carbon market is present but restrained. It is no wonder that the respondents of Point Carbon’s report reflect so much ambivalence towards the industry, which perhaps is an interesting barometer for the overall perception of the efficacy of carbon markets in mitigating climate change.

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