Reflecting on Carbon: Why Invest now in Efficiency

I’ll admit it. I read some dismay the stories about the collapsing market for European carbon dioxide emissions allowances, as covered in the New York Times.

Without going into great detail, I feel the most economically efficient way to reduce the deferred costs of carbon emissions is to simply set a price for them today. Does buying roses grown in Africa produce more or less carbon than those grown in the Holland?  I’d say a carbon analysis of that supply chain borders on too complex. But if carbon impacts were fairly encumbered at each point of use with a cost, an efficient market would prefer the lower impact source to the extent that carbon futures affect the price of the commodity.

Sadly it appears we have taken a step away not only from that efficiency, but also from addressing the carbon problem.

So are the carbon credits DOA? After some digging, I think not. Here's why - carbon futures are traded on a market like any other commodity and are affected by the same supply and demand economics that affect the price of everything else. So let’s look at both.

The first data I looked at was to compare the fluctuating price of carbon with economic data in this case the changes in combined GDP of four major European economies (Germany, France, UK, and Italy). This shows an important correlation in the demand side. The amount of money available to chase EUA credits is limited.


Another correlation is with electricity generation, which is a reasonable proxy for the demand to use credits. Here I just looked at France and Germany together. Although Europe uses multiple sources for electricity, the majority source is from fossil fuels.


Again, the trend (at least of available data) shows a pretty good correlation. This is yet another way to look at the demand side of the equation. With lower economic output driving lower demand for electricity in turn diving lower demand for carbon allocations, the drop in price seems natural.

On the supply side, of course, the decision by the commission to not limit the number of allocations guaranteed an abundant supply of credits.

So do I think the carbon market idea is dead? No, I don’t. The data “behind the curtain” support the idea that the falling price of carbon allocations is just a simple matter of supply and demand.

Will demand rise and EUA prices rise in the future? Of course they will. Hence, while there may not be any short term imperative to oinvenst in low carbon and efficient technolgies, smart industries should be, I believe, investing now, in the down turn, to gain advantages from efficiency in the longer term.