What a slump in carbon prices means for the future

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It is getting progressively cheaper to pollute the atmosphere. The price of permits to emit carbon dioxide has crashed, falling to 9.30 euros ($12) per tonne of CO₂ on Tuesday, close to the all-time low of 8 euros.

In the medium to long term, this might affect the European Union’s ability to meet its ambitious targets for reducing emissions by 20% by 2020 relative to 1990 levels. A low price is bound to have more immediate effects too.

Will it affect the Kyoto targets?

Unlikely. Put simply, this is because the Kyoto targets are already built into the European carbon trading scheme – they contribute to determining how many permits are issued for trading. But because the emissions trading scheme works in phases, and the current phase ends in 2012, there is no guarantee beyond that.

So why do we care what happens to the price?

According to Andreas Arvanitakis, senior analyst at the trading consultancy Point Carbon, the greatest risk is that companies lose interest in investing in low-carbon technologies such as ways of generating renewable energies.

Investors in future technologies don’t have a financial crystal ball, so the decisions they make today are based mainly on the current market. The low and volatile price of carbon today is likely to affect investments in renewable energy technologies.

How much money a company makes from carbon capture and storage (CCS), for instance, depends on how expensive it is to put carbon in the atmosphere. If it’s cheap and CCS is expensive, the company won’t get a worthwhile return on its investment. The upshot is that companies may postpone any decision to invest.

Can’t we just leave green energy for a little later?

Not unless we’re prepared for an even bigger problem. Every year that green technologies are delayed is a year during which fossil fuels are burned and greenhouse gases build up in the atmosphere.

Low-carbon technologies such as solar power and CCS will take a long time to develop. To achieve the ambitious emissions reductions that many analysts say are needed, these technologies need investment now.

For how long will it be cheap to pollute?

Point Carbon projects that carbon prices will stabilise in the middle of 2009. Over the year, they expect an average price of 12 euros per tonne of CO₂, rising to 18 or 19 euros on average for 2010. Both are low relative to the long-term projected average of 24 euros for 2009-12.

It’s likely that governments will need to step in to encourage green investments (see “$400 billion: The price of our future”).

Why have prices dropped?

There are two main drivers. First, the economic downturn has slowed industrial activity. Companies are therefore emitting less CO₂ and selling emissions permits they no longer need.

Second, as natural gas becomes cheaper, electricity generators switch to using natural gas instead of coal. Burning gas emits less carbon than coal, so electricity companies emit less and need fewer emiss