Brady Yauch
Probe International
February 22, 2010

After political leaders failed at December’s climate summit in Copenhagen to agree to a successor to the Kyoto Protocol, the price of carbon has been slowly deflating. Many investors are now wary of pouring more money into a scheme that depends on political will, rather than economic fundamentals.

According to The Economist, prices [PDF] in the largest market for carbon-dioxide emissions, the European Emissions Trading Scheme (ETS), have fallen from 14.70 Euros at the start of the Copenhagen conference to a low of 12.40 Euros in the two months following the gathering. Yet, this decline over the past two months is part of a much larger trend, with price of carbon emissions falling more than 50 percent from their peak price of 30 Euros in 2008.

The cause? Real market forces are making the “political” carbon market redundant.

CO2 regulators had originally hoped to encourage investments in “cleaner fuels” by reducing the supply of emission credits, forcing up their price and making conservation and fuel switching (from dirty to cleaner) more attractive. But the strong arm of government has become unnecessary.

Due to the recession, industrial output has fallen across the European continent—causing a decline in the demand for energy. Carbon allowances that industry once needed to carry on their businesses—and that were initially doled out, mostly for free, to CO2 producers in 2005 and again in 2008—are now in surplus.

Moreover, says Sabine Schels of Bank of America Merrill Lynch, as the price of natural gas has dropped and coal has inched upwards, investors are switching from coal to gas—a cleaner burning fuel—naturally, without carbon credits to encourage them to do so.

The effect of these market forces is, ironically, putting carbon markets under a “big dark cloud” according to Merrill Lynch [PDF] . They expect emission volumes to rise 5.6 percent this year because of the economic recovery, but don’t expect they will return to last decade’s peak levels until 2013.

Adding to the carbon market woes is the all-but-certain death of a cap and trade system in the United States in the wake of the recent election of Republican Senator Scott Brown in Massachusetts and the growing criticism of a cap-and-trade plan in Australia.

The growing scandal at the University of East Anglia [PDF] , where hacked emails showed scientists allegedly manipulating climate data—all in the effort to promote the theory of global warming, dubbed “Climategate”—isn’t helping the cause either. Now, a number of investigations into the leaked emails are underway [PDF] and the science behind global warming looks decidedly unsettled.

One part of the carbon market that still seems to be standing, is the UN administered Clean Development Mechanism (CDM)—that allows parties in the developed world to offset their carbon emissions by investing in “green” projects in the developing world. But its future, too, looks subject to wild swings in confidence. According to Abyd Karmali of the Carbon Markets and Investors Association “the CDM will either be consigned to the dustbin for quaint market-based approaches that couldn’t attract sufficient political will, or it will scramble to scale up massively.”

If nothing else is certain about the carbon markets, at least this is—their survival depends on political will and not economic forces.

And in the world of political markets, anything is possible. As The Economist says, carbon markets “are entirely political creations—even the most inventive financial engineers would not, on their own, have come up with the idea of a difference in value between the air people breathe in and the air they breathe out.”