UK carbon mountain piles higher

The 31 "direct participants" in the UK emissions trading scheme again notched up huge over-compliance against their targets in 2003.1 The Environment Department (DEFRA) is now trying to find a way to limit the surplus from a handful of key regulated sources.

In 2003, the second year of the domestic trading scheme, direct participants were expected to reduce their greenhouse gas emissions by 1.5mtCO2e from their collective baseline (million tonnes of carbon equivalent). In practice, they overshot this figure by a massive 3.7mtCO2e.

The first year of the trading scheme saw a similar net over-achievement of 3.85mtCO2e (ENDS Report 340, pp 4-5 ). Direct participants were collectively well below the eventual target for 2006 in both of the scheme's first two years.

The oversupply in the UK carbon market is compounded by huge net over-compliance among the 6,000 companies with climate change agreement (CCA) targets (ENDS Report 339, pp 23-26 ).

Just four direct participants - Ineos Fluor, Invista (formerly DuPont), Rhodia and BP - accounted for 88% and 82% of the over-achievement in 2002 and 2003, respectively. These companies - whose emissions are already controlled under environmental legislation - will receive more than half of the £215 million incentive money being paid out by DEFRA.

The surplus is set to grow further in coming years, not least because Rhodia has commissioned an incinerator to destroy most of the HFC releases from its Avonmouth site.

In May, DEFRA admitted to the House of Commons Public Accounts Committee that flaws in its methodology had given over-generous allocations to the four companies (ENDS Report 352, p 34 ). Officials revealed that they are trying to renegotiate the companies' targets in order to drain some of the surplus.

The move followed a National Audit Office investigation which confirmed several of the scheme's flaws (ENDS Report 351, pp 27-30 ). However, ENDS remains concerned that the NAO painted too rosy a picture of the scheme - and dealt inadequately, or not at all, with several key aspects. Our coverage has prompted an exchange of letters with the NAO.2In 2003, 10 of the 31 direct participants needed to buy allowances to comply with their targets. Almost all were small players which needed to buy a few thousand tonnes to comply. Participants relying on improved building energy efficiency - such as Dalkia and Battle McCarthy Carbon Club - appear to be struggling to meet their targets in-house.

Shell is the only big player to miss its target in-house. It is a sophisticated player in emissions markets, and appears to be one of the few to have joined the scheme on a speculative basis. Even so, its annual incentive payment of £4.7 million massively outweighed the cost of buying allowances to meet its target.

Despite the massive surplus, the market price has risen from £2 to £3.5-4/tCO2e in recent months. This apparent defiance of the laws of supply and demand appears to be driven by low market liquidity and by companies under CCAs buying up allowances in advance of possible action by DEFRA to drain the surplus.