By Jeff Coelho
LONDON (Reuters) - Any one-off European Union intervention to clear the massive glut of permits now clogging its emissions trading scheme is likely to lead to a ‘central bank' or other policy tool to manage future imbalances in the world's biggest carbon market.
If it does act, the European Commission, the bloc's executive, is cautious about entrenching such a mechanism in the scheme, the bloc's chief weapon to fight climate change.
Analysts and observers say a new tool is needed to fix an oversupply estimated at several hundreds of millions of carbon permits, because EU carbon prices - now trading below 8 euros ($10.61) a metric ton (1.1023 tins)- are way too low to drive green investment.
EU officials, member states and lawmakers are debating if and how to intervene, and a one-off move to withhold a certain number of carbon permits for the period 2013-2020 is possible. Many in the market expecting a decision this year or next.
"The ETS was designed to provide a price signal that drives future investment and a low carbon pathway. It is clearly not doing that at the moment," said Miles Austin, director of Climate Markets & Investment Association (CMIA), a lobby group.
Europe's recession and fiscal crisis have slowed industrial output and growth, making it easier for heavy polluters to limit their carbon dioxide emissions in accordance with an EU-wide cap that covers around half of the 27-nation bloc's emissions.
Around 12,000 industrial and power plants are given a certain number of carbon permits each year - mostly for free - which they can sell to or buy from one another as needed.
As the flagging economy has choked demand for carbon permits, many analysts predict the market will be oversupplied until at least 2020. Carbon prices have fallen some 60 percent in 12 months and recently hit a record low of just under 6 euros a tonne at the start of April.
Last month, EU Climate Commissioner Connie Hedegaard said the European Commission will review its auctioning rules for the EU carbon scheme by the end of the year as part of efforts to boost the market.
"The idea that we won't have another recession is unlikely, so you need a mechanism that is in place that can respond to it (recession) as it happens," Austin said.
CMIA has proposed that if a certain number of surplus permits have not been used after a period of three years, an equal number of permits should be removed from later supply - but only from among the permits that will be auctioned.
Starting next year, EU member states aim to auction around half, or about 1 billion emissions allowances per year, as the bloc moves towards charging all companies for them.
As critics of market intervention argue deliberately altering the price would make the ETS into a tax, the Commission has repeatedly said any intervention would be a one-off, made necessary by the depth of recession.
Companies and analysts doubt a political intervention in the carbon market would be a one-time event, however, suggesting the need for some kind of automatic intervention system.
"Once you allow a politically-motivated manipulation of the market, it is going to happen on a regular basis because there will be other events or problems that will be used to justify intervention" said Russel Mills, global director of energy and climate policy at Dow Chemical.
"If the political forces are so strong that there is no other option than to have some kind of political interference in the market, then as a minimum this should be via some kind of independent carbon central bank that has a very clearly defined and predictable mandate to manage excessive price swings."
A carbon central bank is one of many measures that could come into force over the next few years, said Scott McGregor, chief executive of Camco, a developer of emissions reductions and clean technology projects.
"There are a number of options that could provide the market with the long term certainty it needs and these should be considered before the best and most sustainable intervention can be identified that will ensure this market can continue to encourage emission reductions at least cost," he said.
A source at the European Commission said the idea of a central bank for the carbon market "is not on the table."
The problem with a carbon central bank is getting the EU to agree to allow an institution to set a carbon price range that allows it to intervene when the carbon price moves outside the limits, said Bas Eickhout, a Dutch Green member of the European Parliament.
On the other hand, the emissions trading scheme needs more flexibility to manage supply swings, rather than relying on ad hoc and unjustified market interventions.
The CMIA approach could be the solution. "This stimulates emission reductions in times of a recession, since companies want to hedge against the risk of a sudden carbon price spike in times of economic recovery," Eickhout said.
However, he added: "I do want to stress that I have not seen the perfect recipe yet."
(Additional reporting by Barbara Lewis in Brussels; Editing by Anthony Barker)