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MENAFN - Arab News - 10/09/2012

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(MENAFN - Arab News) A link between European Union and Australian cap and trade schemes could inject new life into emissions trading as long as regulators take into account risks such as the impact of market intervention in one region on energy prices in the other.

The European Union's executive Commission and Australian government recently proposed a link between their emissions trading schemes from July 2015, pending domestic approval.

The link would allow Australian polluters to meet half their emissions caps by buying allowances issued in the EU from 2015 and European polluters to do the reverse from 2018.

A wider carbon market would increase liquidity and trading efficiency and reduce the system-wide economic costs of carbon abatement through a bigger community of buyers and sellers.

International cooperation may also deflect opposition by industrial companies, which in isolated domestic schemes see themselves at a competitive disadvantage.

And against the background of failing UN climate talks, a European-Australian tie-up could be a focus for other cap and trade schemes that are proliferating.

Additional schemes already exist in New Zealand and some north-eastern US states. California and Quebec will launch markets in January 2013. South Korea plans to start a scheme in 2015, and China has said it will run pilot markets in various cities and regions.

A precedent has already been set by the link-up of the EU emissions trading scheme (ETS) and the UN's project-based clean development mechanism (CDM) under the Kyoto Protocol, and it shows the dangers of having an excessively influential trading partner.

Under the CDM, projects in uncapped developing countries can reduce emissions to earn tradable carbon offsets, which they can sell into capped schemes.

Companies and traders under the EU ETS buy the vast bulk of purchases of these certified emission reductions (CERs), and their prices have moved in lock-step with EU carbon allowances (EUAs). The two have shown a daily price correlation of 0.91 in the past 12 months.

That close dependence has made the CDM vulnerable to European regulatory intervention - such as the European Commission decision to ban credits from all new projects from Jan. 1 except those in least developed countries.

As a result, the value of the primary origination market in the CDM has shrunk to 40 percent of its peak, and existing projects are winding down.

When the link involves two capped markets, in which electricity generation includes the cost of carbon permits, intervention could have an even bigger economic impact.

Each regulator would have the scope to impact the other's carbon prices, and the costs would be passed on to industrial and domestic energy consumers.

The impact of cap and trade schemes on energy costs has already been a source of discontent among miners in Australia and steelmakers in Europe, not to mention opposition from world airlines against the extension of the EU scheme to aviation.

It is difficult to anticipate the impact of the Australian scheme on energy prices, because the carbon market will not enter fully into force until 2015.
But it is easy to illustrate the impact in Europe, where the scheme is in its eighth year and carbon prices are fully passed through to wholesale power prices.

Coal-fired power plants, the marginal electricity source in Germany, have to buy permits to cover emissions of about 0.82 tons of CO2 per megawatt hour (MWh). EUA prices are currently low at 8 euros per ton, and even then they still amount to about 13 percent of wholesale power prices around 50 euros per MWh.

Regulators in both the European bloc and Australia will have the power to set caps on emissions, but the larger EU scheme would have more weight.
For example, the European Commission later this year is to consider whether to withdraw hundreds of millions of EUAs to remove a glut caused by the region's financial crisis.

The commission then has a mandate to propose new, lower caps on carbon emissions after 2020.

Any such move would tend to boost carbon prices and indirectly raise the cost of doing business for Australian utilities and industries in a linked market.

On the Australian side, the regulator sets emissions caps every five years, which could affect European carbon prices.
The recent announcement of the European-Australian proposal bore the hallmarks of a half-baked plan, which neglected to explain such risks beyond a note to take account of "comparable market oversight arrangements."
If regulators can explicitly tackle such jurisdictional issues, then linking schemes makes sense.

- The author is a Reuters market analyst. The views expressed are his own.


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