With the carbon market in doldrums, emerging economies like India will have to announce bolder schemes for a low carbon future

The just-concluded Durban climate meet has been branded by many as a great saviour with even greater hopes being expressed for future. Reams have been written on how the summit had gone down to the wire, the famous huddle and how the twisting of semantics helped snatch victory from the jaws of defeat. But just a fortnight later, the carbon market price, a key incentive for future climate change mitigation efforts, resembled a punctured balloon.

The UN carbon credit price crashed to an all time low of €3 (Rs 200) per tonne carbon dioxide avoided. The credits are issued by the UN through its Clean Development Mechanism (CDM) scheme for projects involving greenhouse gas emissions reduction in developing countries.

At Durban, the parties to the conference were too divided—each faction having its own positioning and agenda—for any consensus to be achieved in the post-2012 regime. The major developing economies, China and India, fought principally for the continuation of the Kyoto Protocol, the international scheme under which the carbon credits are issued. The CDM market is worth US $2.5 billion a year and these countries did not want the funds tap to run dry.

Forget adaptation, forestry, real sustainable development commitment and other proposals tabled in Durban, the single measure of success for them was whether Kyoto Protocol would continue with no emission targets on the morning of  January 1, 2013.  The desperation of the major developing countries to maintain status quo on CDM, even when the scheme has apparent and inherent design flaws, and on occasions is at the expense of environmental protection, was mind boggling.

On the other hand, the EU, given its own entrenched carbon market investment and dream of a green, low-carbon world, wanted all major economies to commit to a future course of action before it loosened its purse strings; it will be the sole major buyer of UN credits from major developing economies post 2012. Other developed nations such as the US, Canada and Japan were mere reluctant bystanders at the climate summit.

So, the Durban deal could be clinched largely because of the EU and India-China, and parties returned home happily with a standing ovation to one and all. [EU is yet to clarify through its legislation whether it will accept post-2012 credits from major developing economies such as India and China, but it is assumed that the status quo would continue.]

But then just two weeks after the Durban meet, the price of UN carbon credit, the scheme for which all parties negotiated fiercely by spending many sleepless nights, has crashed.

Euro crisis and carbon trade

The reason: the European economic crisis, which is now in its fourth year, has led to a drastic fall in demand of its carbon permit certificate. The EU, through its 2008 directive, had announced a 20 per cent target reduction (with reference year 2005) under its flagship Emissions Trading Scheme (ETS) for industrial installations. The ETS is a cap and trade mechanism wherein the supply-demand of permits determine carbon price.

During the onset of the economic crisis in 2008, the fall in industrial output led to lower demand for the ETS permits. But by 2011, the crisis deepened to a full-blown sovereign debt crisis as many countries turned belly-up. With no recovery in sight in the foreseeable future, the declining economy-wide demand—primarily of housing and infrastructure—meant lower demand for energy intensive products and hence ETS carbon permits.

What’s more, given the carry over provision of permits from the 2012 commitment ETS phase to the next 2013-2020 phase, a huge transfer is expected of existing surplus permits (augmented by UN credit supply) to the 2020 phase. Hence, the 11,000 or so odd installations, which have been capped with declining CO₂ targets to 2020, need not move an inch to achieve their targets.

The result—the ETS carbon permit price has collapsed from a high of €29 (Rs 1,885) in July 2008 to just €6 (Rs 390) in early 2012.  The UN CDM credit price, which is dependent on and indexed to the ETS carbon permit, followed a similar trend and crashed to €3.

Meanwhile, all along, Europe continued to stick to its 20 per cent ETS target for 2020. Any talks to step-up to the 30 per cent target to bolster the ETS carbon permit price, is being banished by its poorer member states.

With no end in sight for the falling carbon prices, poor support to step up carbon targets and no other concrete solutions emerging, the EU desperately has announced holding back issuance of 1.4 billion tonnes of ETS carbon permits (or around 10 per cent of the total) from the 2013–2020 phase, hoping that it would help push up prices. EU reasons that the artificial shortage would imply a 25 per cent reduction target for 2020. A legislation is to be passed by the European parliament in March 2012 in this regard.

But market participants know these allowances are in the kitty, and hence may not be all that anxious to think of an impending shortage. Moreover, the continued high supply of UN credits means market flooding will continue on one-end, while on the other ETS permit demand from industries will be curtailed as governments implement forced austerity measures. The scenario of one or more member countries leaving the Euro currency block could also unravel the EU's entire economy, and hence even the carbon market.

Way forward

The most rational and perhaps inevitable step post-Durban, given EU’s commitment to a green world and its own investment stakes and jobs involved (never mind those of major emerging economies), would be to announce the move to a 30 per cent ETS target with radical measures to reform CDM to ensure purging of unwanted dirty offsets from projects such as coal-based power. Other measures to overhaul ETS and the international carbon pricing mechanism for 2020 should also be welcome.

Limited by its large diversity and the scale of complexity, the EU has already shown poor judgement in handling the economic crisis, and now even for climate markets it continues to bury its head in sand, hoping that things would automatically improve one fine day. With no firm action forthcoming from the EU, it’s time China and India realise Durban was indeed a big raw deal.

The $2.5 billion (Rs 12,500 crores) global handout under CDM is a drop in the ocean considering the size of the large emerging economies. In fact, if the low UN credit price situation continues, these countries should go ahead and announce their own solid domestic carbon markets (such as a tax) to leap frog into low carbon path of their individual growth patterns, without waiting for the reluctant and illusive handouts.