Is the EU carbon trading market oversupplied?

published 25 May 2006

Any fledgling market is prone to nasty shocks, but the EU's emissions trading system was hit exceptionally hard last week. Shortly after reaching a record price of €31 a tonne, the price of carbon-emission permits plummeted by more than 50% to €14 a tonne.

The collapse was caused by news that several EU countries had emitted less carbon than expected last year. Traders now fear the market is oversupplied with permits and that the price could fall further as other countries report their emissions over the next week.

The crash comes after long-running concerns about the way the permit system operates. Permits are allocated on a national basis and given without charge to carbon emitters, such as factories and power stations. If a firm produces less carbon than it has permits, it can trade its excess permits with companies that have exceeded their allowance (and would otherwise be fined €40 a tonne).

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As the FT points out, "supply of these permits should be less than demand for them; otherwise there will be no reduction in carbon pollution". The EU has got its sums wrong and handed out too many permits for this year and next, which will undermine the market.

"But it is not too late to tighten the system for 2008-2012", when the market widens to include Japan, Canada and Russia. There are also calls to auction the permits instead of initially handing them out free after a report from IPA Consulting found power firms may make a £1bn windfall profit from overgenerous allocations.

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.