RioPlus Business Focus: Carbon Price Floors – a vital tool but no silver bullet

Politicians make the policy. But it’s often left to business to implement it. For this reason RioPlus Business is featuring submissions from the private sector across the globe in the lead up to Rio+20.

The aim is to demonstrate how Sustainable Development is becoming a reality in every continent, country and city.

By Charles Purshouse

Charles Purshouse, Vice President, Carbon Services, Camco North America explains why it is vital the price for carbon is managed effectively if it is to incentivize green growth.

The oversupply of allowances in the EU Emissions Trading Scheme (EU-ETS) and the recession has resulted in a significant reduction in the market price for carbon allowances and carbon credits. Project developers, and governments within Europe, who were hoping to see a steadily rising price of carbon incentivize the adoption of new technologies are looking at other policy approaches to encourage the development of clean energy and low-emissions projects.

While creating a degree of certainty, price floors can also add risks. For example, will they be changed in the future? (Source: Flickr/TheWritingZone)

A carbon floor price mechanism – either enforced by setting a floor price for the auction of allowances or by some kind of central carbon bank removing allowances from the market when prices drop below a certain level – is in place in the Regional Greenhouse Gas Initiative (RGGI) in the U.S. and is proposed for California’s and Quebec’s cap-and-trade programs due to start in 2013, and for Australia’s in 2015. As a project developer, Camco see floor prices, particularly in the early years of a program, as helpful in underpinning forward price discovery and greater confidence to project investors that carbon revenues will be able to provide investment returns.

Investor certainty

Many projects in the energy space have a two to three year development horizon (or longer) and rely on long term offtake agreements for the energy and other attributes they generate to demonstrate to investors and debt providers that their funds will be repaid. Price floors have the potential to allow investors to have greater certainty over the carbon revenue stream, helping the development of projects and technologies which are strongly reliant on a price on carbon to be viable. In the early stages of a market, this is particularly important.

There are some caveats: Whilst creating a degree of price certainty, price floors can also add additional risks; i.e., will they be changed at a later date? For example, discussions are underway within RGGI on whether to increase the auction price floor. If a price floor is not transparently fixed and subject to a clear review process its benefit to developers will be limited and could create additional confusion, adding further political risk into any investment appraisal. Once created, the likelihood that politicians will want to adjust the level of a price floor should not be underestimated.

Further, price floors should not be seen as the silver bullet that will suddenly support prices and galvanize investment. As carbon credits from offset projects are not auctioned and are generated outside of a capped system a price floor would only have an indirect effect on the market. An oversupply of carbon credits could, for example, result in prices for credits dropping below the price floor.

No substitute for ambition

Allowance price floors provide a measure of certainty for developers of low-carbon projects. With a number of cap-and-trade schemes currently pending implementation they should encourage the initial development and roll-out of new technologies and projects to meet the demand for reductions in the early phases of a program. With many investors cautious of the returns provided through carbon markets they can help to underwrite future carbon revenue streams. However, price floors can create additional risks. Ultimately, price floors should not be a substitute for the real driver for investment into low-emissions technology: the level of ambition of the emissions cap.

This article is part of a series commissioned by the Rio Conventions for their RioPlus Business project.


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