The complex world of climate politics

The carbon market is on an exponential development curve characterised by increasing confidence in the reality of international trading well before the end of the next decade, progressively rising carbon prices and pricing becoming increasingly influenced by politics. These are some of the key conclusions of a recent survey conducted by Point Carbon.

March has proved to be a busy month for the carbon/climate market, with Europe determined to play a major role in the market’s evolution. The EU Spring Council at the beginning of the month saw agreement on a 20% reduction below 1990 levels of greenhouse gas emissions and a minimum renewable energy share of 20% also by the end of the next decade.

Angela Merkel, the German chancellor, who has seemingly taken the climate change relay baton from Tony Blair and who not only chaired the Spring Council but will also chair this summer’s G8 summit, proclaimed “The member states have said ‘Yes. We want to go down this road. We are proud to hoist our colours to the mast [on climate change].” And Commission president Jose Manuel Barroso was similarly bullish about the EU’s climate role. “At the G8 meeting in June we can say to the world ‘Europe is taking the lead. You should join us.’”

But will other nations share this apparent EU jingoism? The Point Carbon survey believes the international market will follow Europe over the next decade with the company outlining its main political scenario post-2012 as follows: a new Kyoto-like Protocol will be signed by 2010 for the 2013-17 period; the US will not ratify in time for 2013, but will begin by linking to the global trading system and become a full member from 2018; during the 2013-17 period the US will enact domestic climate policy in parallel with the global regime and a US ETS will link with the EU ETS and spur certified emission reduction (CER) demand; and, China will join around 2018 with targets, probably along with a few other rapidly industrialising developing countries.

There is a wonderful simplicity and convenience to this scenario. The next US presidential term runs from January 2009 to January 2013 with the aforementioned scenario assuming US ETS legislation is planned and passed in this first presidency and then developed in the second presidential term from 2013 to 2017 and then implemented in a third term from January 2018. Conveniently, this coincides with the start of a third Kyoto phase on the assumption that each phase runs for a period of five years.

But what if this scenario is not followed? What then becomes of an international market? After all, Point Carbon says there is only a 72% likelihood of the next US president having a strong climate change position. It is conceivable that either Rudy Giuliani, ex-Mayor of New York, or Mitt Romney will be elected next year, with neither having strong views on climate change. And what of China? While it is committed to energy efficiency in the current five-year plan in the first year of the plan it achieved only a quarter of its annual efficiency target. Will Beijing feel suitably confident to impose carbon caps in its next five-year plan from 2011 or indeed the following five-year plan from 2016?

If the embryonic carbon market has taught us anything it is that there are considerably more uncertainties than certainties. A look at the pricing history is sufficient to bear this out. Who would have expected carbon prices to peak above h30 in 2006 or fall below one euro in 2007? And looking to the future, survey respondents, of which government and NGOs accounted for barely a tenth, expect the EU allowance price to average h17.50/t in 2010 and h23.10/t in 2020, against a current (as of mid-March) December 2010 price of h16.15/t. But EU energy commissioner Andris Piebalgs wants a price of nearer h30/t. Both can’t be right.

Survey respondents believe EUA prices will largely reflect fuel switching and not the price of Kyoto project credits (ie CERs), with there being a good correlation between fuel and carbon prices during 2006. Yet when asked what will be the main short-term price driver in the EU ETS around two-thirds cited political decisions, a more than two-fold increase compared to the 2006 survey. Political factors are also expected to be the main driver of long-term EU ETS prices according to around three-quarters of respondents.

The perceived importance of political decisions in the pricing development of the emissions market confirms, if confirmation were needed, that climate change is first and foremost a political market. It was conceived through politics, is being developed through politics, and numerous politicians now want to be associated with a climate legacy.

The political capital to be extracted from the climate market is both significant and growing. Leading Democrat and Republican US presidential candidates have placed climate change at the top of their manifestos for next November’s election, investment in the emerging Asian economies is increasingly being determined by the political acceptance and mitigation of climate change, while EU member states are becoming ever more proficient in the new art of climate politics.

Some of the most intense carbon politics have been seen in the UK, which is trying to position itself as the world’s “carbon capital”. Last month the government published its consultation on a Climate Change Bill, which it hopes to place before parliament in the autumn to achieve Royal Assent by the spring of 2008, and ahead of the Budget statement the chancellor (and likely prime minister-in-waiting) and the leader of the opposition set out their respective positions on addressing emissions. Both want to seize the environmental vote at the next general election, which could be as early as this autumn or as late as spring 2010.

There is little doubt that the carbon market will continue to grow in both size and value through the remainder of this decade, nor that it will become increasingly international during the next decade or two. And with now less than nine months to go before the start of the first Kyoto commitment period there is a growing sense of climate bravado, with most of this being politically driven. But market size, scope and political will do not necessarily correlate to market health and prosperity. For all the bullish political rhetoric being spouted on both sides of the Atlantic it is best to be no more than cautiously optimistic on the future health of the global climate market. And, hopefully, be proved wrong for being cautious.