2 December 2011

The 2011 United Nations Climate Change Conference is now underway in Durban, South Africa. The likelihood of parties managing to make progress on a successor or extension to the current Kyoto protocol appears slim to zero.

This year, expectations have further dwindled and it's now thought that even achieving this by 2015 will be a difficult task, and that 2020 is a more realistic target.

This isn't a make or break for the carbon market. In fact, most agree that hopes for the future of the carbon market are better pinned on constructive, regional developments (such as Australia's recently passed legislation). But, post 2012, global demand for offsets will be less clear-cut.

For New Zealand carbon market participants, however, the more immediate problem is the relative size and supply-demand balance of the emissions trading schemes which exist to date. And this is where the really bad news lies.

It's the economy, stupid

As we mentioned last week, the ongoing failure of European politicians to agree and implement a credible plan to deal with the current debt crisis now looks likely to send the entire Euro zone into a deep recession, and could potentially drive a break up of the single currency.

This fallout will result in economic contraction, reduced manufacturing and industrial production, and hence reduced demand for carbon credits.

This week, a very respected team of carbon market analysts released a particularly bearish report, announcing that after recalibrating their modelling to take account of wider macroeconomic forecast downgrades, they are now of the view that no further abatement in Europe is necessary; surplus supply could persist until 2020; and the primary driver of value for European carbon now simply stems from the chance that targets could be tightened up at some point in the future.

Where does this leave NZU holders?

A number of gloomy reports have been released in the last couple of weeks, but generally speaking, if analysts are right, EUA prices could fall as low as, or even below, 5 euros. CERs (which are able to be used in the NZ scheme on an unlimited basis) would follow - to even lower levels.

Against this backdrop our fear is that NZU prices could fall lower than their current $11s and languish indefinitely.

Two things could possibly improve the situation. The first would be if the EU were to act on their already signalled willingness to increase their emissions reductions target to 30% by 2020. However to date, this has been conditional on other countries making similar efforts, and as we noted above, progress is poor.

The second would be if our own government sought to better align the NZ scheme with that of Australia and the EU, by adopting some sort of limits on CERs / minimum requirement to surrender NZUs.

It's not clear whether the new government intends to address this situation, but if ever there was a case for action it's now.

Source: Carbon Match Weekly