Clouds gather over EU carbon market

EU Carbon Trading

In London's finance epicentre, some of the world's largest companies trade the world's newest commodity - carbon dioxide.

Trading in carbon permits allows polluting companies to pay for emissions cuts made elsewhere and the market potential for this type of trading is huge, but its future remains uncertain as long as how governments decide to tackle climate change beyond 2012 remains a mystery.

Carbon emissions trading was created in 1997 by the Kyoto protocol and was nicknamed "cap and trade". In a report by the BBC Abyd Karmali, then an energy and climate change officer with the UNEP, explains the thinking behind the scheme: "A market mechanism was likely to lead to lower overall cost for entities that had obligations [to reduce their emissions]."

Polluters are forced to reduce carbon emissions

The idea was originally based around emissions in developing countries, where they are first capped at a quantity equal to or below their historical levels and the polluters in these capped industries are then given credits for each tonne of carbon dioxide they emit.

Therefore polluters are forced to reduce carbon emissions when, for example, a coal power company receives credits under the European Trading System for only 80 percent of its emissions.

Europe's cap and trade system encourages the development of renewable energy to replace traditional sources, such as coal-fired plants, in developing countries where caps are yet to be set. These "offsets" can be purchased by companies every year.

As the BBC reports, the system helped to create a global market worth US$126 billion in 2008 - mostly within the EU emissions trading scheme. In 2008 investors put around US$6.5 billion into developing country projects designed to offset their own emissions.

European emissions dropped by roughly 3 percent in 2008

The system received a further boost in February this year when a prominent research company, New Carbon Finance, said its calculations showed the largest cause of a reduction in emissions in the EU itself in 2008 was attributable to the trading system - because it had encouraged greater use of natural gas in power generation rather than dirtier fuels like coal.

European emissions dropped by roughly 3 percent in 2008.

But the Kyoto protocol that governs these offsets expires in 2012, and as of yet there is no indication of the future beyond the expiry date.

Carbon trading also has somewhat of a damaged reputation with the US still without a system of its own, not to mention the absence of developing economies. Some analysts even suggest that using the markets is far from the best way to reduce carbon emissions, especially when there are concerns that the EU are over-issuing credits.

For carbon trading to have any kind of future, the involvement of the US will be vital. Their version of a cap and trade bill has just past its first legislative stage, so hopeful with the arguably the world's only super power on board, cap and trade in Europe can continue to help to reduce carbon emissions until other alternatives are capable of taking its place.

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