Emission allowance auction to be held as price crashes

The second auction in Phase II of the European Union's Emissions Trading System will be held on behalf of the government on 24th March.

But the scheme has come under attack again, as the owners of registered installations - large energy generators, cement manufacturers, chemical plants and the like - have been selling off credits which they are not using on account of the recession - to the tune of 75 to 150 million euros a day - to raise funds to balance their books.

Big polluters must purchase allowances corresponding to the tonnes of carbon they expect to emit. 7% of the UK's allowance cap is auctioned - about 86 million allowances over Phase II.

West European iron and steel output is expected to fall by at least 14% this year compared to 2008, and EU cement production by 20-25%, meaning there will be a surplus of carbon allowances of 66 million tons for those two sectors alone. This is worth about 750 million euros. But the sell-off is causing a glut and a price collapse - by up to a third in January. Analysts said it could drop as low as 5 euros from a peak of 31 euros last summer.

"This was not designed as a scheme to give corporates cheap short-term funding options in a credit crunch meltdown," said Mark Lewis, Deutsche Bank carbon analyst. "But that appears to be what's happening."

A low price undermines incentives for companies to cut emissions. "It demonstrates that the targets after 2012 (to 2020) are too lax, especially in combination with a large use of carbon offsets," said Cambridge University's Karsten Neuhoff. But Barbara Helfferich, EU Commission environment spokeswoman brushed off criticism, saying "If those companies were smart they would take those profits and invest them in greener technology". But will they?

The allowances are one of the worst investments so far in 2009, falling more than almost any other energy commodity or index of global stocks. Only the energy guzzlers have benefited - so it looks as if this auction won't raise nearly as much cash for the government as the first one.

This is yet another reason why the ETS needs a complete overhaul - it is just not fit for purpose.