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Increased utility demand and a supply squeeze will see carbon hit €20 in 2011, analysts say.
But how soon prices rise from current levels of €14 will depend on when power companies start to sell electricity in bulk for 2013 delivery and buy carbon allowances to cover their emissions.
All eyes will be on the second quarter of the year, as in each of the last three years carbon prices have peaked in the “hedging season” of May or June.
But while carbon has proven this year to be more anaemic than most analyst predictions, some of which said the contract would average €18 over the course of the year, all forecasters once again expect prices to surge.
Nine carbon analysts polled last month predicted that European carbon will outpace interest rates in 2011 with the mean of all predictions suggesting carbon could average €20 over the 12 months.
Most analysts cited stable supply and surging demand as a catalyst that could drive prices higher by 50 per cent or more in the first six months of the year.
Power companies in Germany and the UK are expected to buy around 30-50 per cent of their 2013 carbon needs by the end of 2011, meaning additional demand of up to 340 million could hit the market from Europe’s two biggest emitting countries alone.
At the same time fresh supply at best is expected to seep through following a November announcement by the EU that suggested it would not auction any 2013 allowances until 2012.
“In light of recent EC statements on early auctions, we have revised our assumption on 2011 early auctions from 200 million tonnes to nothing,” said Barclays Capital analyst Trevor Sikorski in a report this month.
“As a result, our forecast average 2011 price has increased from €18.50… to €20,” he said.
It is also unclear when the European Investment Bank will start to sell 300 million allowances from a pool of phase two allowances set aside for new entrants.
Other factors impacting EUA prices next year include whether Europe will face a double dip recession and whether industrials will stockpile EUAs for the third phase of the EU emissions trading scheme, which is just two years away.
Industrial output in the EU has grown throughout 2010, but on the bearish side the pace of recovery since the 2008-2009 economic downturn has shown signs of slowing and is mixed for individual countries.
The latest official EU production data for October showed a 6.7 per cent rise on the previous year, but the bloc is still around 10 per cent below its pre-recession output level.
Eurozone economic growth this year is expected to average 1.7 per cent, but slow to 1.5 per cent in 2011 before picking up to 1.8 per cent in 2012, according to 50 analysts polled by Reuters earlier this month.
But in key sectors, such as steel, a recovery will likely curb the EUA selling by industries as their surplus of permits dwindles.
Steel production, which is allocated around 13 per cent of the annual ETS allocation, rose around 26 per cent in 2010, clawing back much of the 30 per cent drop from the previous year.
Carbon analysts expect selling by industrial companies to subside by the second quarter, although the publication of verified emissions data for 2010 in early April could alter traders’ views.
Point Carbon forecasts that those figures will show emissions will rise to 1.973 billion from 1.880 billion for 2009, leaving the market long for 2010 by around 100 million allowances, compared to last year’s surplus of 160 million.
20 or 30
The policy decision with the biggest market-moving potential is whether EU leaders opt to deepen the bloc’s overall emissions target from 20 to 30 per cent below 1990 levels by 2020.
Hungary, which will take over the rotating six-month EU presidency from 1 January has vowed to hold talks to discuss the target in early March, shortly after the commission is expected to publish a study on the impact of a deeper goal.
However, some analysts are sceptical about the will of member states to make further cuts while post-2012 global climate agreement hangs in the balance, and a decision to limit the types of offsets companies can use to meet targets could also add to the debate.
A decision to ban industrial gas offset credits from 2013 could make “some member states more wary of the further costs to be incurred by raising the 2020 emission-reduction target to 30 per cent”, Mark Lewis, a Deutsche Bank analyst said in a report.
In January, officials from all the member states are expected to vote on the proposal.
Point Carbon analysts have forecast 253 million CERs will be issued in 2011, an 89 per cent increase from the 132.4 million CERs issued this year.
The coming year is expected to deliver improvements to how the Kyoto protocol’s clean development mechanism (CDM) operates as the UN moves to implement changes agreed at climate talks in Cancun earlier this month.
But these measures – such as standardisation of baselines and improved communications with offset project participants – are not expected to have a major impact on supply.
Rather, tighter deadlines for regulators and simplified procedures are expected to speed up the CER issuance rate next year.
With only two years of the current commitment period left, the flow of carbon finance through the CDM is likely to head increasingly towards least developing countries and sectors that score better on issues such as environmental credibility.
But whether investors agree to pay more than the current €6-10 per credit for post-2012 projects is likely to depend greatly on the wider policy framework that governs the CDM.
In particular, investors want to see that a clearer future for the Kyoto protocol is agreed at UN climate talks in South Africa at the end of next year and will also be watching out for signs of progress on designing new market mechanisms.
Financiers will have a keen eye on work towards new markets for developing countries, with interested parties given until late-February to submit proposals ahead of four interim UN meetings ahead of the South Africa summit.
But no matter how volatile and unpredictable 2011 might be, most analysts expect European carbon to go on its biggest bull run since 2005 and, if the UN meets its ambitious timetable, new market mechanisms could emerge before 2012.
Sceptre Group Limited is a specialist investment firm focused in low carbon financial investments such as sustainable biofuel plantations, agricultural farmland and green technologies. For more information on Biofuel Investments, please visit Sceptre Group’s website at www.sceptreinternational.com.