LONDON, July 12 — European pollution permit prices are poised to rise as lawmakers work on a proposal to permanently cut a record supply in their system.

Carbon allowances will climb 28 per cent to €7.50 (RM32.52) a metric ton by December after jumping 18 per cent in the first six months of the year, according to the median of 11 estimates compiled by Bloomberg. UBS AG in Zurich says prices will rise 71 per cent, while Paris-based Societe Generale SA expects gains of about 11 per cent. They slumped to as low as €2.46 in 2013.

Rule-makers are debating whether to remove about 60 per cent of the 2.1 billion tons of spare permits in the US$54 billion (RM 172 billion) market and put them in a reserve. A key challenge is agreeing on the levels of supply at which allowances would be withdrawn from the market and then returned for use by power stations, factories and airlines as the economy expands.

“They’ve shot an arrow in the right direction,” Henry Derwent, chief executive officer at Climate Strategies in London, who also worked as an adviser to former UK Prime Minister Tony Blair, said by phone July 9. “There needs to be more modeling and simulation to make sure it’s headed for a bull’s-eye.”

Each allowance gives the owner the right to emit a ton of carbon dioxide. The surplus adds up to more than a year’s worth of European pollution, according to European Union data.

Carbon gains

All of the traders and analysts responding in this month’s survey said carbon prices would rise through December because of efforts to trim the surplus. EU carbon allowances for December rose 0.9 per cent to €5.75 a ton on the ICE Futures Europe exchange in London today.

The EU’s emissions trading system allocates for free or by auction allowances to more than 13,000 factories and utilities which must surrender enough permits to match their discharges of carbon dioxide or pay fines.

The credits slumped to a record low last year after too many were handed out in response to requests by industry groups and as the financial crisis slowed manufacturing.

Under the European Commission’s reserve plan, the supply sold at auction would be cut by 12 per cent annually until the accumulated surplus falls below 833 million tons, according to the draft law. If the excess supply drops below 400 million tons, the EU will return 100 million tons of allowances to the market each year.

Trigger points

It’s those trigger points that the commission needs to spend more time modeling, says Derwent. Take too many allowances out, prices may rise too far and hurt the economy. Take too few out, the market fails to discourage coal burning.

“It’s quite a good tool to use against this oversupply,” Janne Ploeen Mortensen, a carbon sales trader at Danske Commodities in Aarhus, Denmark, said July 8 by phone. The bloc can more easily control volumes sold at almost-daily carbon— permit auctions than win political support for tighter emission limits, she said.

The plan, proposed January 22, would be the bloc’s second effort to curb the oversupply. After three years of debate, lawmakers agreed January 8 on a temporary fix, known as backloading, which removes 900 million permits from the market through 2016 and returns them in 2019 and 2020.

Emissions output

Allowances traded as high as €7.41 in March before those initial withdrawals began, only to plunge to €3.71 a month later on speculation the bloc’s output of greenhouse gases for 2013 was lower than expected. Emissions from manufacturers and generators covered by the market fell about 3 per cent compared with expectations for a 3.8 per cent drop in a survey of analysts at the time.

In the five years through 2012, greenhouse-gas output from the EU’s power industry dropped 14per cent, or 186 million tons, according to CDC Climat, the climate-research unit of French state-owned bank Caisse des Depots et Consignations. Most of the decline was probably due to the region’s economic downturn, the Paris-based lender said in the December report.

EU governments and the European Parliament probably won’t finish work on the reserve proposal before the end of the year, though they may do so by July 2015, Jos Delbeke, director general for climate at the commission, said last month.

The reserve wouldn’t start until 2021. The timing has caused disagreement, with Germany pushing for a 2017 start, while Poland and Greece are among those against an earlier introduction.

Germany is seeking a fast beginning to prevent the 900 million backloaded allowances from returning to the market, Environment Minister Barbara Hendricks said June 12.

Poland, whose coal plants generate about 84 per cent of the nation’s electricity, said an early start would break a deal struck by EU nations in 2008 for 2020 limits.

Climate trust

“This is not the way you build trust before important decisions on climate and energy toward 2030,” Marcin Korolec, Poland’s climate negotiator, said July 3 by e-mail. “Early start of the market stability reserve is impossible.”

France has suggested the triggers be tightened, speeding injections into the reserve and boosting the pace of withdrawals. That could increase prices faster, while preventing them from rising as much in later years, according London-based Bloomberg New Energy Finance.

Carbon prices will continue to show “huge volatility” while details are ironed out, said Nick Eagle, a trader at Clean Energy Group Ltd in London.

“The market stability reserve is going to be so difficult to put in place, it may not happen before 2021,” Eagle said July 2 by phone. In the survey, the range of forecasts for the end of the year was from €5.93 to €10.

Early start

Without any reserve, carbon prices may fall to €3 in 2019 to 2020 because return of the backloaded permits, equivalent to about half a year’s supply, will add to the glut, New Energy Finance said last month in a report.

Permits may surge to €54 by 2026 if the reserve starts in 2018, according to New Energy.

“I doubt any government wants a carbon price at €50 at the moment, but above €10 the market starts to matter again,” Patrick Hummel, a utilities analyst for UBS, said by phone from London on July 2. “By year end, it will be more visible if there’s political support for the reserve.” — Bloomberg