The Allure of Dirty Carbon

Europe's main weapon against climate change, which makes industry buy rights to emit carbon dioxide, has not stopped power generators from using dirty coal because they can still make plenty of money from burning it.

The European Union launched a carbon market to try to make low-carbon sources of energy like gas, wind, biomass and nuclear more competitive against high carbon coal.

The problem is that soaring oil prices have dragged up gas prices in much of Europe too, making coal cheap by comparison and overwhelming the penalty that a carbon price imposes on burning coal.

Energy price rises have driven more investment into coal and coal to liquids than into renewables, and have swamped carbon prices, said Nick Mabey, chief executive of the environmental and sustainable development group E3G.

The EU market has given utilities most of the emissions rights they need for free and allowed them to pass on these non-existent carbon costs to the power consumer, further diluting the effect of the carbon price on dirty generation.

You could have carbon at 50 euros ($67.15), but as long as the power price makes it worthwhile to burn the coal and buy the emissions, then that will happen, a trader at a utility said.

Carbon emissions rights for 2008 delivery are now trading at around 21 euros per tonne.

Only a collapse in natural gas prices, not carbon, during the peak demand winter months last year led British power firms to burn all the gas they could, relegating coal plants to a supporting role.

Generators will not face the full carbon cost of burning fossil fuels under the EU scheme until 2013.

And coal could still be the cheapest option unless gas prices collapse again. Following the opening of the Langeled pipeline from Norway, there was so much gas in the system last winter that big consumers were briefly paid to use the fuel.

Otherwise, they would have used coal for baseload electricity while topping up supply with gas at peak times.

Last winter everybody should have been running baseload coal. But because the gas came crashing off, things changed round, said one trader with a utility that has both types of power plant, adding that there was plenty of time for the economics of power generation to shift before autumn.

Things can and will change many times before the winter.

COAL TO BURN

Coal still produced more of Britain's power last year because gas prices were relatively high in the first half of the year due to supply concerns over the two previous winters.

According to government figures, in Britain last year 37 percent of power was still generated by coal, compared with 36 percent by gas and 18 percent by nuclear.

The profits generated by producing power from gas are referred to as spark spreads and from coal as dark spreads.

Because gas-fired generation emits 0.40 tonnes of CO2 per megawatt of generation, compared to coal fired's 0.90 tonnes, the cost of carbon per megawatt hour will always be less for gas, said Nikki Wilson, analyst at John Hall Associates.

However, the dark spread can be more attractive to generators if the price of coal is low enough or gas high enough to compensate.

Nuclear power produces very little of the carbon that is blamed for global-warming and can be generated without requiring carbon allowances under the European Union's trading scheme.

But nuclear plants cannot be switched on and off easily, so it is not practical to shift to or away from nuclear power depending on economics. Generators' room for maneuver is between gas and coal.

KYOTO TARGETS

The European Union introduced carbon pricing in 2005 to help it meet its targets under the Kyoto Protocol on global warming and cut emissions of planet-warming carbon dioxide (CO2).

Continued consumption of high-carbon coal could jeopardize that, especially as many of the 15 longest standing EU members are still far exceeding their emissions limits.

While the planet will have to pay the price, utilities with diversified portfolios stand to profit from whatever they burn.

They have all been handed free carbon permits and although the biggest carbon emitters have to buy additional rights to pollute, they can pass on the extra costs to customers.

Those with permits to spare can sell them on, meaning the carbon trading scheme has given them windfall profits.

The first phase of the EU's scheme collapsed after the EU handed out too many allowances. Carbon prices are much higher in phase 2, which begins in 2008, but still not high enough, at current gas and coal prices, to shut down coal plants and switch on the gas.

The sure way to prevent utilities from burning whatever is most economic is government regulation, analysts say.

The Large Combustion Plant Directive, which takes effect from 2008, will make gas-fired generation the first choice for investors, as well as promoting clean coal technology, Wilson said.

But it will be some time before investments result in new generation. For now any switch between gas and coal-fired plants could become academic as capacity becomes more and more strained by closures of ageing plant and insufficient new building.

The UK is not massively oversupplied on generation and it's going to get worse as plants shut and are not replaced fast enough, one trader said.

(additional reporting by Gerard Wynn)