Carbon Markets:

Former U.K. climate director Derwent discusses price volatility, offsets debate

With Senate Majority Leader Harry Reid pushing for a global warming bill to hit the floor by the end of summer, Congress is moving quickly to develop and debate climate legislation. During today's OnPoint, Henry Derwent, president of the International Emissions Trading Association and the former climate change director for the United Kingdom, takes a look at the state of international and domestic carbon markets and discusses how markets would be affected by a U.S. cap-and-trade law. Derwent explains why there has been so much volatility in the price of carbon recently and talks about the price assurances that are needed in order to drive investment and innovation.

Transcript

Monica Trauzzi: Welcome to the show. I'm Monica Trauzzi. With us today is Henry Derwent, president of the International Emissions Trading Association. Henry previously served as the U.K.'s international and domestic climate change director. Henry, thanks for coming on the show.

Henry Derwent: Thanks for inviting me.

Monica Trauzzi: Henry, the price of carbon has been very volatile in recent months and we've seen some pretty dramatic falls in the price. What's contributing to these big fluctuations that we've been seeing?

Henry Derwent: Well, I think you're basically seeing a market do what a market is supposed to do, which is reflect the balance of supply and demand. Essentially the position is that, and I don't wish to sound as though I can't see the downside of this, but the position from the atmosphere's point of view is that there is less carbon going into the atmosphere because there is less burning of fossil fuels particularly for energy purposes and because there is less demand from a slowing economy in Europe and elsewhere. And that is immediately reflected in the balance of supply and demand for essentially permits to emit carbon. And the market is essentially saying, okay, well, if there's less demand for it, then it's cheaper and that's just the way it should be. It's not a wonderful position from the perspective of the industry obviously because along with lower prices come tougher conditions in the debt markets and so forth. And so many of the participants in the carbon market like other markets across the world are having to tighten their belts at the moment. But I don't think it's an indication that there's something wrong with the market approach to carbon.

Monica Trauzzi: What role are speculators playing in all of this and what do you see as sort of the short-term outlook for the price of carbon?

Henry Derwent: I always worry about the use of the word speculators because there is a very important distinction to be made, I think, between activities which amount to manipulation of a market for personal profit if you like, against the fundamental objectives of the market and activity where people actually take risks and hedge risks which are speculative in the true sense of the word, but are the way that markets actually operate. If you don't have people prepared to speculate, prepared to take risks, then you don't have any opportunities for people to use the markets to hedge risks either. But having got that out of the way, let me say that I think that there is no indication then I've seen that there is anything in the European markets at the moment that indicates market manipulation or anything that you would not expect to be happening at this point in time. Different levels of price are being tested by the markets. I haven't seen what's happened today, but yesterday they were going back up.

Monica Trauzzi: There are many people that are concerned that this type of volatility sort of undercuts long-term success. What kind of assurances need to exist in order to assure that we have investment and innovation?

Henry Derwent: The first thing I'd say is that the purpose of the market is price discovery and we don't know an awful lot yet about the cheapest and best ways of reducing emissions across the whole economy. The European market has shown that there is a great deal to be gained from fuel switching. The CDM market has shown there's a great deal to be gained from the suppression of industrial gases. These were not outcomes that were expected, but I don't think there's any reason why you should say that that's wrong and that a change in investment would be right. Nevertheless, over the longer term, clearly we have to find means of financing investment and stimulating investment in low-carbon technology. And there, obviously, a low price of carbon, if sustained, would not be a good market signal. But the emphasis should be on the words if sustained. We're talking here about investments which should be for sort of 40 or 50 year lives and what really is important is the viewpoint that will be taken by investment committees within major public sector utilities or major steel builders or whatever. The decisions that they'll be taking there about what they think the long-term price of carbon will be. In the European system, of course, essentially the supply is fixed. The supply is fixed through 2020. That's the decision that's been made. At the moment people are trying to deal with immediate difficult economic circumstances by selling, but with the price fixed and the expectation that the economy will come back to normal, they're going to be buying again so you'll see those prices go up.

Monica Trauzzi: Have you seen evidence of countries sort of shying away from forcing companies to pay for their emissions as a result of the economic downturn?

Henry Derwent: Yeah, very much so. Understandably, the economic downturn has affected the discussion in Europe about the impact of Phase 3 of the European system on the economics of in particular trade exposed industries. And the way that that has been sorted out has not, in fact, been to look again at the level of ambition that Europe has undertaken, it's been to look at the balance between free allocation and auctioning. There was always intended to be a balance there, and expectation that you could introduce auctioning sooner for some industries than others. Well, in the light of economic circumstances being tougher, the deal that was come to actually included more free allocation than was the original proposal. It's not the end of the world.

Monica Trauzzi: Heading into the UN's Copenhagen meeting in December, how badly do you think this economic situation is going to affect what's discussed at that meeting, the outcome of that meeting? Does it have an impact?

Henry Derwent: It does have an impact to a degree, but I don't think there will be many participants in that discussion who will be saying we need to, if you like, take our foot off the gas because of the immediate economic downturn. There will be plenty of national and international discussions of government ministers where that might be the line to take. But when the UNFCCC comes together they're focused on the climate issue and it's very, very clear that just because we have a little local difficulty with the world's economic markets that really doesn't make any difference to the size of the problem we've got with the climate and with the buildup of greenhouse gases in the atmosphere. It may be getting a little bit slower at the moment, as I've said before, but the issue is really, really still very bad and I think everybody will be going to Copenhagen strongly focusing on that.

Monica Trauzzi: Both the House and Senate here in the U.S. have very aggressive goals for getting legislation to the floors of their chambers at some point this year, three Copenhagen. What does the U.S. have to come to the Copenhagen meeting with in order for the international community to be happy?

Henry Derwent: The best answer to your question that I can give is I'm afraid something that I don't think the U.S. can give, which is an absolutely clear and firm proposal for a set of emission reductions in the U.S. economy over the period probably to 2020, which will be probably greater than the indications that President Obama gave a little while ago, but which will be firm and be supported by a willingness to sign up to binding international law on that subject. And I think that's all a little bit too much to expect from the U.S. right now. Of course, at the very least, the U.S. must come, if they're to be respected in the international negotiations with a clear indication of domestic progress and a clear indication of a willingness to engage and a clear respect for the UN process rather than saying, oh, this is a pain. Let's go somewhere else. I see indications that all three of those things are going to be there, but I think that is if you like the ante. What happens afterwards may take longer than Copenhagen, certainly if it's to get to a point where the U.S. is able to say, look, this is exactly what we are doing. We can promise this and you can see that we've got agreement for it.

Monica Trauzzi: There's been some discussion recently about Canada, the U.S., and Mexico sort of joining forces and creating this North American cap and trade, rather than the U.S. acting alone. Does a plan like that make sense considering the amount of overlap we have with these two countries in terms of trade and manufacturing?

Henry Derwent: Yeah, I think it makes a lot of sense. I think, well, you would expect somebody from the International Emissions Trading Association to be favorable to international in emissions trading. There's no doubt about it, the wider the market that you can create the more likely you are to find emission reduction possibilities which can serve people's needs and reduce costs. So I think it's a great idea and I hope that it gets pursued and, similarly, that the U.S. administration will look carefully at the possibility of making leaps across the Atlantic as well.

Monica Trauzzi: There's a big debate here in the U.S. about offset and concerns about how offsets impact the environmental benefits of a cap-and-trade plan, should they be allowed and to what degree?

Henry Derwent: You've got to allow them. What is the point of having a trading system which after all is a mean of identifying who can do stuff cheaper than somebody else in coming to a deal? Where's the point of doing that without actually allowing access to some of the cheapest and most available emission reductions across the economy and I would say internationally as well. You look at all the figures that have been done to identify the economic cost to a country or more particularly to a world of achieving a given level of emissions reduction. You can come up with numbers which in percentage of GDP are really not all that frightening, 1 or 2 percent over a period where you would expect that, say through to 2050 that GDP would increase by 200 or 300 percent. But the only way that works and the basis for all those figures is on a basis of the maximum of international emissions trading. In other words, the ability for the rich countries to be able to say I need to take responsibility for emissions reduction. I can see places across the world where I can do that without having to damage my own economy.

Monica Trauzzi: All right, we'll end it right there on that note. Thank you for coming on the show.

Henry Derwent: Not at all.

Monica Trauzzi: And thanks for watching. We'll see you back here tomorrow.

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