In Europe, Paid Permits for Pollution Are Fizzling

April 21, 2013

In Europe, Paid Permits for Pollution Are Fizzling


LONDON — On a showery afternoon last week in West London, a ripple of enthusiasm went through the trading floor of CF Partners, a privately owned financial company. The price of carbon allowances, shown in green lights on a board hanging from the ceiling, was creeping up toward three euros. That is pretty small change — $3.90, or only about 10 percent of what the price was in 2008. But to the traders it came as a relief after the market had gone into free fall to record lows two days earlier, after the European Parliament spurned an effort to shore up prices by shrinking the number of allowances. “The market still stands,” said Thomas Rassmuson, a native of Sweden who founded the company with Jonathan Navon, a Briton, in 2006.

Still, Europe’s carbon market, a pioneering effort to use markets to regulate greenhouse gases, is having a hard time staying upright. This year has been stomach-churning for the people who make their living in the arcane world of trading emissions permits. The most recent volatility comes on top of years of uncertainty during which prices have fluctuated from $40 to nearly zero for the right to emit one ton of carbon dioxide. More important, though, than lost jobs and diminished payouts for traders and bankers, the penny ante price of carbon credits means the market is not doing its job: pushing polluters to reduce carbon emissions, which most climate scientists believe contribute to global warming. The market for these credits, officially called European Union Allowances, or E.U.A.’s, has been both unstable and under sharp downward pressure this year because of a huge oversupply and a stream of bad political and economic news. On April 16, for instance, after the European Parliament voted down the proposed reduction in the number of credits, prices dropped about 50 percent, to 2.63 euros from nearly 5, in 10 minutes.“No one was going to buy” on the way down, said Fred Payne, a trader with CF Partners.

Europe’s troubled experience with carbon trading has also discouraged efforts to establish large-scale carbon trading systems in other countries, including the United States, although California and a group of Northeastern states have set up smaller regional markets.

Traders do not mind big price swings in any market — in fact, they can make a lot of money if they play them right.

But over time, the declining prices for the credits have sapped the European market of value, legitimacy and liquidity — the ease with which the allowances can be traded — making it less attractive for financial professionals.

A few years ago, analysts thought world carbon markets were heading for the $2 trillion mark by the end of this decade.

Today, the reality looks much more modest. Total trading last year was 62 billion euros, down from 96 billion in 2011, according to Thomson Reuters Point Carbon, a market research firm based in Oslo. Close to 90 percent of that activity was in Europe, while North American trading represented less than 1 percent of worldwide market value.

Financial institutions that had rushed to increase staff have shrunk their carbon desks. Companies have also laid off other professionals who helped set up greenhouse gas reduction projects in developing countries like China and India.

When the emissions trading system was started in 2005, the goal was to create a global model for raising the costs of emitting greenhouse gases and for prodding industrial polluters to switch from burning fossil fuels to using clean-energy alternatives like wind and solar.

When carbon prices hit their highs of more than 30 euros in 2008 and companies spent billions to invest in renewables, policy makers hailed the market as a success. But then prices began to fall. And at current levels, they are far too low to change companies’ behaviors, analysts say. Emitting a ton of carbon dioxide costs about the same as a hamburger.

“At the moment, the carbon price does not give any signal for investment,” said Hans Bünting, chief executive of RWE, one of the largest utilities in Germany and Europe.

This cap-and-trade system in Europe places a ceiling on emissions. At the end of each year, companies like electric utilities or steel manufacturers must hand over to the national authorities the permits equivalent to the amount gases emitted.

Until the end of 2012, these credits were given to companies free according to their estimated output of greenhouse gases. Policy makers wanted to jump-start the trading market and avoid higher costs for consumers.

Beginning this year, energy companies must buy an increasing proportion of their credits in national auctions. Industrial companies like steel plants will follow later this decade.

Companies and other financial players like banks and hedge funds can also acquire and trade the allowances on exchanges like the IntercontinentalExchange, based in Atlanta. Over time the number of credits is meant to fall gradually, theoretically raising prices and cutting pollution.

The reality has been far different because of serious flaws in the design of the system. To win over companies and skeptical countries like Poland, which burn a lot of coal, far too many credits have been handed out.

At the same time, Europe’s debilitating economic slowdown has sharply curtailed industrial activity and reduced the Continent’s overall carbon emissions.

Steel making in Europe, for instance, has fallen about 30 percent since 2007, while new car registrations were at their lowest level last year since 1995.

Big investments in renewable energy sources like wind and solar also reduced carbon emissions, which have fallen about 10 percent in Europe since 2007.

As a result, there is a vast surplus of permits — about 800 million tons’ worth, according to Point Carbon. That has caused prices to plunge.

The cost of carbon is far too low to force electric utilities in Europe to switch from burning coal, a major polluter, to much cleaner natural gas. Just the opposite: Britain increased coal burning for electricity more than 30 percent last year, while cutting back gas use a similar amount, and other West European nations increased their coal use as well.

“The European energy scene is not a good one,” said Andrew Brown, head of exploration and production at Royal Dutch Shell. “They haven’t got the right balance in terms of promoting gas.”

Fearing that prices might go to zero because of the huge oversupply, the European authorities proposed a short-term solution known as backloading, which would have delayed the scheduled auctioning of a large portion of the credits that were supposed to be sold over the next three years. But the European Parliament in Strasbourg voted the measure down on April 16.

Lawmakers were worried about tampering with the market as well as doing anything that might increase energy costs in the struggling economy.

“It was the worst possible moment to try to implement something like that,” said Francesco Starace, chief executive of Enel Green Power, one of the largest European green-energy companies, which is based in Rome.

The European authorities, led by Connie Hedegaard, the European commissioner for climate change, have not given up on fixing the system. But analysts like Stig Scholset, at Point Carbon, say that there is not much the authorities can do in the short term and that prices may slump for months, if not years.

That means more tough times for financial institutions. Particularly troubled is the business of investing in greenhouse gas abatement projects like wind farms or hydroelectric dams in developing countries like China. JPMorgan Chase paid more than $200 million for one of the largest investors in these projects, EcoSecurities, in 2009.

Financiers say these projects used to be gold mines, generating credits that industrial companies could use to offset their emissions elsewhere. But so many credits have been produced by these projects — on top of the existing oversupply of credits in Europe — that they are trading at about a third of a euro.

Market participants say they see many rivals pulling back from world carbon markets. Deutsche Bank, the largest bank in Germany, has cut back its carbon trading. Smaller outfits like Mabanaft, based in Rotterdam, have also left the business.

Anthony Hobley, a lawyer in London and president of the Climate Market and Investors Association, an industry group, estimates that among the traders, analysts and bankers who flocked to the carbon markets in the early days, half may now be gone.

But carbon trading is unlikely to fade completely.

For one thing, European utilities and other companies now must buy the credits to comply with the rules. And they can buy credits to save for later use, when their emissions increase and the price of credits rises.

Despite Europe’s sputters, carbon trading is beginning to gain traction in places like China, Australia and New Zealand.

In London, Mr. Rassmuson concedes that the business has turned out to be more up-and-down than he anticipated when he and his partner set up their firm in a tiny two-man office in 2006.

But he said his firm was benefiting from others’ dropping out. He is also branching out into trading electric power and natural gas.

Like many in the carbon markets, he says what he is doing is not just about money.

“Trying to make the world more sustainable is important to us,” he said. “It is a good business opportunity that makes us proud.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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