Exchange-traded products (ETPs) linked to the price of carbon have plunged in value after members of the European parliament (MEPs) rejected a plan to revive the Emissions Trading System (ETS), the European Union’s carbon trading programme, by shoring up the price of emissions permits.
Carbon ETPs have plummeted after MEPs rejected the so-called “backloading” emissions permit plan.
MEPs rejected the European Commission’s so-called “backloading” proposal, which would have temporarily withheld carbon emissions permits due to come on to the market between 2013 and 2015.
There is currently a glut of permits, largely a consequence of miscalculation and weaker-than-expected economic growth, which has caused their price to drop substantially over the past few years.
At one point, permits were trading at a rate equivalent to more than €30 per tonne of carbon emissions, but had fallen to less than €5 on the eve of Tuesday’s vote. Following parliament’s rejection of the backloading proposal, the price of permits has slumped even further, with futures contracts linked to ETS permits down some 50% on the ICE Europe futures exchange.
The sell-off has been mirrored in ETPs indexed to the price of carbon, with the London Stock Exchange-listed ETFS Carbon ETC (CARP) down around 43% since the vote and the NYSE-listed iPath Global Carbon ETN (GRN) off some 46%.
These products are linked to ECX CFI EUA Futures and the Barclays Global Carbon Index, respectively, and essentially reflect the performance of carbon permits such as EU Allowances, Emissions Reductions Units and Carbon Emission Reductions.
The blocking of the backloading plan represents a major setback for the ETS, a cornerstone of the EU’s policy to combat climate change. The scheme works on the ‘cap and trade’ principle and covers more than 11,000 power stations and industrial plants in 31 countries, as well as airlines.
A cap, or limit, is set on the total amount of certain greenhouse gases that can be emitted by the factories, power plants and other installations in the system. The cap is reduced over time so that total emissions fall.
Within the cap, companies receive or buy emission allowances which they can trade with one another as needed. They can also buy limited amounts of international credits from emission-saving projects around the world. The limit on the total number of allowances available ensures that they have a value.
After each year a company must surrender enough allowances to cover all its emissions, otherwise heavy fines are imposed. If a company reduces its emissions, it can keep the spare allowances to cover its future needs or else sell them to another company that is short of allowances.
By putting a price on carbon and thereby giving a financial value to each tonne of emissions saved, the scheme is designed to put climate change on the agenda of company boards and promote investment in clean, low-carbon technologies.
However, with permit prices so low, the incentive to cut carbon emissions and undertake investment in the clean energy sector is, from a commercial perspective at least, much reduced. Therefore, it appears unlikely that the price of carbon-related ETPs, such as those issued by Barclays iPath and ETF Securities, will rebound anytime soon.
And while advocates of carbon trading are not going to roll over and suspend their efforts to tackle climate change – indeed, alternative ways to inject life into the price of carbon are already being considered – it is unlikely that anything, bar a major pick-up in economic growth, will make much difference soon. All this means that carbon ETPs could continue to drift lower as new emissions permits are released, attracting the attention of short sellers.