UK’s carbon allowance auction raises £54m

The first CO2 emissions allowance auction has been judged a success despite challenging carbon market conditions, and concern over the government’s refusal to hypothecate funds. There are plans to modify future auctions to allow smaller players to participate.

The Department for Energy and Climate Change (DECC) has auctioned four million CO2 emissions allowances for Phase II of the EU’s Emissions Trading Scheme (EUETS), which runs from 2008-12.

The auction, on November 19, was the first by any EU nation; there has been serious slippage in auctioning plans across the rest of the bloc. It raised £54 million. Exclusive of VAT, this worked out at just £13.60 (€16.15) per EU allowance (EUA), well below the market peak of over €29 in July, and a price level unlikely to make a significant difference to investment flows for low-carbon technologies. Each allowance covers one tonne of CO2 emissions.

Despite this, the UK’s pioneering auction was oversubscribed more than four times, according to the UK Debt Management Office (DMO), the body appointed to run the EUETS auctions. Four per year are now planned from spring 2009.

The sums raised could contribute substantially to energy efficiency initiatives. Yet critics, including the Institute for Public Policy Research (IPPR), are unhappy at DECC’s refusal to follow Austria, the Netherlands and Hungary in planning to hypothecate the funds received for energy efficiency and fuel poverty.

But in reality, no other EU state is yet in a position to auction EUAs in this way, with the Netherlands facing legal objections from energy companies to its national allocation plan (NAP), though Austria hopes to do so in spring 2009.

Germany still lacks the necessary legislation, and is now putting off auction plans until 2010, but it has been selling small portions of its total allocation of EUAs at the market price on a regular basis since January 2008.

For its part, DECC says it will continue funding low-carbon activities from central government coffers and is opposed to the principle of hypothecation.

The participants placed bids through intermediaries, or ‘primary participants’, into a competitive bidding facility using an electronic auction system developed by Bloomberg.

Four primary participants - Barclays Capital, JP Morgan, BNP Paribas and Morgan Stanley - have been approved by the government to facilitate the competitive stage of the auctions. They take bids from other parties registered by the government, resulting in a clearing price for EUA credits held by the Environment Agency, and deal directly with the DMO.

DECC says auctioning "reduces the potential for windfall profits and strengthens incentives for companies to cut emissions". The UK’s Phase II NAP reserves 86 million allowances for auction over the five-year period, equivalent to 7% of its total allocation under the EUETS. The power companies will need to bid for some 30% of these allowances or cut their emissions.

The government aims to auction a further 25 million allowances during 2009 and 100% of allowances in the power industry from 2013 under Phase III of the EUETS.

Speaking at the Institute of Economic Affairs and Marketforce second annual conference in London on the future of the carbon market, International Emissions Trading Association president Henry Derwent pointed out that auctions across the EU could ultimately raise €60 billion per annum, assuming 100% auctioning, but the proportions to be reserved for programmes tackling climate change remain hotly disputed.

There are further changes ahead. Subsequent auctions "will include a ‘non-competitive’ component, accounting for up to 30% of EUAs, to facilitate broader access to the auctions", DECC says. Full details will be published early in 2009.

While bids are now placed only through the four registered intermediaries, the UK is looking to permit companies wishing to buy smaller quantities of EUETS allowances, possibly up to 10,000, to bid ahead of the auction. Bids would then be amalgamated and treated as a single buyer, reducing the cost and complexity of participation for smaller firms.

The government also plans to increase the number of registered intermediaries.

One major concern for the future is the extent to which major emitters covered by EUETS will be able to use offsets bought from greenhouse gas emission-reduction projects in developing countries under the Kyoto Protocol’s Clean Development Mechanism.

Carbon Trust chief economist Professor Michael Grubb has warned that without tight import limits, these offsets from the developing world could suppress carbon prices. That would reduce funds for low-carbon investment in the EU. A report by the trust proposes a ‘price floor’ through a reserve auction price as one solution to provide investor confidence.1 In the UK auction, only bids above a clearing price, not disclosed, were accepted.

DECC declined to provide a breakdown of buyers on grounds of commercial sensitivity. But ENDS understands most buyers of auctioned EUAs were major emitters such as the power and chemicals sectors, with speculative buyers playing a minor role.

International Emissions Trading Association programme assistant Cedric Ammann said prices achieved were consistent with the current "flattening market" following a sharp decline (ENDS Report 406, pp 15-16 ). He believes auctions will continue to play a key role, but cautioned "we are still in a very young market".

Adam Nathan of the Carbon Markets and Investors Association said: "We were happy with the auction results. All the allowances were sold, and it achieved a price close to that of the secondary market."

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