London (Platts)--23Jan2013/1053 am EST/1553 GMT

Barclays Capital has slashed by 35% its forecast for the price of EU carbon dioxide allowances to Eur5.50/mt ($7.34/mt) from Eur8.50/mt previously, on slower-than-expected progress by the regulator to curb a long-running oversupply.

However, the bank raised its longer-term carbon price forecasts on expectations that regulatory efforts to cut the surplus will eventually go ahead.

"The European Commission is now on a slower pathway to implement its proposal to move 900 million mt of EU allowances from 2013-15 to 2019-20, having failed to find enough support for the proposal last December as Germany struggled to find an internal consensus on the issue," said Barclays director of environmental products research Trevor Sikorski.

"Without German support, the proposals are unlikely to pass -- so this begs the question of whether the German economic or environment ministry holds the upper hand," he said in a research note Wednesday.

"This makes it a hard one to call, but we think the EC's proposal is marginally more likely to pass," he said.

At stake is the price of EU Allowances under the EU Emissions Trading System, which regulates CO2 emissions from about 12,000 power plants and factories, as well as airlines, across the EU, in a market worth $148 billion in 2011.

Due to falling CO2 emissions in Europe, the system has flipped into a surplus of allowances instead of a scarcity as originally intended.

With more than enough allowances in the system to match industry's actual CO2 emissions, companies have needed to buy fewer permits, pushing prices to new lows of Eur4.95/mt this year, from as high as Eur19.00/mt in 2011.

The EC wants to temporarily curb the flow of new supply from auctions in 2013-15, without altering the overall CO2 cap to 2020, although it is mulling other structural reforms that could reduce the cap.

Since agreement has been delayed on the EC's "backloading" proposal, its implementation is also likely to be delayed, said Sikorski.

"Therefore, we do not expect a reduction in auction volumes until Q4 2013 and even then, it is likely that only 100 million mt or so is removed from the 2013 cap," he said.

"This change to our base-case assumptions means that our forecast prices for EUAs in 2013 have been revised downwards from Eur8.50/mt to Eur5.50/mt," he said.

"However, we now assume 900 million mt, rather than 700 million mt, are back-ended from the first three years, increasing our average Phase III price forecast from Eur9.00/mt to Eur10.80/mt," he said.

"We stress that these forecasts are very sensitive to the fate of the back-ending proposal and a rejection of this by EU legislators will see average EUA prices fall lower, with Eur3.00/mt a likely possibility," said Sikorski.

The EU Parliament's environment committee is set to vote on the EC's backloading proposal on February 19, followed by a plenary vote April 15.

Overall CO2 emissions from the EU ETS are likely to fall by 10 million mt or 0.5% in 2012 from the previous year, excluding aviation, Sikorski said.

Power sector emissions are expected to rise 14 million mt, due to significant fuel switching from natural gas to coal in the UK and Spain, partly offset by low economic activity and renewable generation, he said.

Non-energy industrial emissions were expected to drop by 24 million mt in 2012, he added.

The EC is due to release verified CO2 emissions data for 2012 from EU ETS-regulated installations on April 1.

EUA futures contracts for December 2013 delivery on the ICE Futures Europe exchange in London were quoted at Eur5.02/mt at 1418 GMT Wednesday, down 43 euro cent from the previous close.

--Frank Watson, frank_watson@platts.com

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