Carbon Market Analysis: Can the EU ETS be fixed?

2011 was characterized by global torment in global capital markets mainly during the second semester. The main causes were the debt crisis and the increasing fear of the Euro zone being dismantled. These facts put a very pessimistic perspective on global growth, thereby pushing the main markets into negative territory. Nevertheless, both carbon underlyings EUA and CER plunged deeper than other commodities or equities. Meanwhile, crude oil remained in a stable range over the past 12 months. The overreaction of the carbon prices was also augmented by the regulatory framework’s lack of stability and by the uncertainty of the market after 2012. The negative returns/high volatility couple was also supported by the fundamental decline of carbon prices and by the increased technical trading compared to the physical demand. The historically low prices only 12 months before the beginning of the more penalizing phase III showed, in fact, the weakness of the ETS designs. A price decreasing exponentially, even if theoretically the phase III has a higher deficit, underlines the fact that the cap and trade framework is not stable and needs to be revisited. In fact under the fixed allocation established in 2005 the decreasing price is completely inappropriate for the actual conditions (continued after graph).

EUA/CER vs. commodities, clean dark German spread (right axis)

What is a cap-and-trade framework if not an option on the abatement of carbon? Obviously the allocation of the cap-and-trade system determines the value of this option and should be revisited dynamically depending on some macro-economic factors. Thus, as long as the allocations are fixed, then the installation will always have an option to create a surplus, thereby putting pressure on the ETS prices. A dynamic allocation reviewed periodically would be in the actual state the best solution in order to give EUAs momentum.

Spot EUA and CER price forecasts

 

 

 

 

 

– Dr. Marius-Cristian Frunza is eCO2market’s Head of Research. This article originally appeared in the 3 January, 2012 edition of eCO2abacus, our free weekly carbon market newsletter. Sign up to receive it by email each week or view old editions here.

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