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The carbon price has dipped a bit recently and the main reason appears to be oil (and therefore gas) prices softening. This lead a Deutsche Bank analyst to recently declare it a ‘phantom market’ trading on sentiment rather than the underlying market fundamentals.

The fundamentals that should effect the price of carbon are quite complicated – understanding the number of permits created relative to recent emissions levels is crucial – but as we have found, not all the data necessary to calculate this is available yet….
How many permits German installations will each receive is not yet know (and they are the biggest players in the market) nor is data availale for Poland who were one of the biggest sellers of credits in 2005-07. Weather also plays a big part – dry, hot summers reduce output from hydro power schemes and increase use of air conditioning, meaning more fossil fuels get burnt, warm winters mean the opposite. The state of the economy matters – if manufacturing is down and people are spending less then emissions will also go down – though in many cases the emissions associated with what we consume may now be overseas. And finally oil and more importantly gas prices matter. If coal is cheap relative to gas then more coal gets burnt to make electricity creating higher emissions. According to Deutsche the carbon price needs to reach €35 to cause fuel switching back to gas. And to make it sensible to capture and store the CO2 from coal stations most people believe the price needs to climb to around €75.

But perhaps the most important thing affecting the price is the fact that in this phase of trading, unlike the last, it is possible to carry over spare credits to the next trading period. This is good for traders since it guards against any sudden price crash should we discover that the market fundamentals are not looking good for a high carbon price. It is not so good for the environment, however, since it could mask the fact that yet again we have handed out too many allowances to have any meaningful impact on emissions levels – meaning we remain way out of step with what the science is telling us it is necessary to do.
My personal opinion, unlike Deutsche’s, is that prices are artificially high at the moment. It will be interesting to see if the fundamentals ever over take the sentiment and what that does to the price.