Europe loses credit as carbon trading scheme dwindles away

Launched in 2005, the European Union's emissions trading system represented a huge step forward in the fight to curb global warming.

Under the scheme, some 5,000 companies generating half of the EU's greenhouse gas emissions must surrender a carbon permit for each tonne of carbon dioxide (CO2) they emit.

Some factories receive permits for free, while most power firms buy them from companies with a surplus or from state-backed auctions held almost every day. The higher the price of the permits, the higher the cost of polluting.

The EU hoped the system would force power companies and industrial companies to reduce emissions and invest in clean technologies. But prices in the market have dropped so low they now have little impact on investment plans.

The permits, traded by manufacturers and banks, have plummeted to less than €3 a tonne of CO2, compared with €7 a tonne a year ago and around €30 per tonne in 2008, because of Europe's economic slowdown, which has reduced both power generation and manufacturing, thereby causing an oversupply of permits.

The impact is evident. European investment in clean energy fell 25 per cent in the first quarter of this year from the same quarter last year, according to Bloomberg New Energy Finance. The slump in permit prices has also prompted European power companies to burn more coal, which is a big source of CO2.

Analysts say carbon permit prices should be at more than €35 a tonne to encourage electricity generators to switch from coal to gas.

After months of debate among ministers, policymakers and industry chiefs, the European Commission, the executive body of the EU, came up with a plan to boost the permit prices artificially through "backloading" - temporarily cutting the supply of permits by 15 per cent in the hope prices would rise.

But the European Parliament rejected the plan last month because many conservative policymakers feared higher carbon prices would cost jobs and harm economic growth in Europe, much of which is plagued by unemployment and recession as a result of the debt crisis.

"This is a black day for climate protection in Europe," said the leader of Germany's opposition centre-left Social Democrats, Sigmar Gabriel, after the vote.

Critics says policymakers have sounded the death knell of Europe's main instrument in the fight against global warming. The proposal will now go back to a parliamentary committee for further debate. Permit prices tumbled 40 per cent to below €3 after the vote. Banks and trading houses may now abandon Europe's carbon market altogether, making government auctions of permits more likely to fail.

Campaigners and traders warn the carbon price could now fall below €2 or even to near zero.

Despite the price fall to just €3 from €30 five years ago, speculators remain in the market to profit from price volatility. But they might quit because it seems likely prices will remain low. Some big players have already left or cut trading staff.

"Europe needs a robust CO2 market to reach our climate goals and spur innovation," says the EU climate commissioner Connie Hedegaard.

Whether it will get one is now highly uncertain.