The market for carbon trading is broken. We must fix it before it's too late.

As things stand polluters can buy up permits that allow them to emit as much carbon dioxide as they like.

Fumes emit from factories of Keihin Industrial Area on December 1, 2009 in Kawasaki, Japan. (Getty Images News)

As the European Commission prepares to publish its first report on the EU Emissions Trading Scheme (ETS), the future of the world’s largest “cap and trade” system for forcing down carbon emissions hangs in the balance. As it stands today, emitters are running rings around policymakers and exploiting the scheme’s many weaknesses. The time has come to fix it, or shut it down for good.

Major emitters have lobbied hard against reform of the carbon market - a sure sign they fear significant intervention is a serious possibility. For the sake of all European economies and their citizens, we should hope their fears are warranted.

The Emissions Trading Scheme was designed help the EU meet ambitious emissions targets and build a new energy infrastructure for the 21 Century. But it cannot do so in its current form. Riddled with perverse incentives, it feeds the carbon dependencies it was intended to eliminate.

In theory, the system should make polluters pay through the nose if their emissions exceed a certain level, whilst offering significant savings if they come in below it. The price of permits to emit carbon serves as both stick and carrot, in that it determines how much polluters pay to pollute, and how much they can make from finding alternatives. 

At present, the carrot has wilted and the stick has been snapped.

The carbon price is too low to make investment in green technology a commercially attractive alternative. At less than ten euros per tonne of carbon emitted, it is peanuts compared to the €25 to €40/tCO2 first projected. At this price, pollution comes cheap.

Emitters are the only winners under this broken system, but losers are legion.

The central problem here is that the EU has overestimated the number of permits to be supplied to European emitters, meaning major polluters are given easily enough to cover their emissions – especially against a backdrop of plummeting global demand. At present, the EU has no way of reducing this oversupply, leaving emitters sitting on heaps of free permits they do not need to use. These permits are worth hundreds of millions of euros and can all be sold for cash.

The idea that excess permits can be traded is a core principle of the scheme. But thanks to lazy regulation, it’s not just unused permits that are sold off. The EU treats emissions permits from emerging markets as equivalent to its own, even though they cost significantly less. This means European emitters can sell their own expensive permits off and buy up cheaper international ones to demonstrate compliance. Polluters are the only parties benefiting from this price difference, as it allows them to pocket a tidy profit. This difference, therefore, needs to be eliminated.

Emitters are the only winners under this broken system, but losers are legion.

The EU loses out on billions of euros in revenue that could be made from auctioning off appropriately valued permits. Europe loses out on the green infrastructure these lost billions would have been spent on. Citizens lose out in the form of higher energy bills. And the planet loses out on a chance to significantly cut emissions.

A fixed minimum price for emissions could finally give governments a serious revenue stream from the sale of carbon permits – potentially driving billions into energy infrastructure in Europe, improving energy efficiency and sustainable resources management, creating jobs, reducing energy consumption and helping clean up Europe’s environment. 

Effective reform of the Emissions Trading Scheme could also show how a sensibly-structured cap-and-trade system can help achieve aggressive emissions targets. Kyoto is gasping at its last breath, and the records of the various international task forces involved in the forthcoming Durban Platform negotiations do not bode well for a replacement. The EU-Emissions Trading Scheme has the potential to link with similar schemes in Australia, Korea and China, and this cooperation could fill the gap left by a lack of progress in stalled multilateral talks; but only if the EU-ETS sets a price which drives change.

As things stand, the EU-ETS sends money to polluters and banks, at the expense of EU citizens, their governments, the global community and the cause of greenhouse gas abatement. The cure is straightforward.  The market is largely under the control of its regulator; this regulator therefore needs to intervene forcefully and decisively, setting a minimum price for all auctions of emission permits.

The EU Emissions Trading Scheme may be broken - but it can be fixed. The EU should grasp the opportunity to do so with both hands.

Assaad W. Razzouk is the CEO of Sindicatum Sustainable Resources.