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E.U.'s carbon trading system remains in peril, but a rescue attempt is launched

LONDON -- The European Union's carbon emissions trading system has literally been brought low by a combination of politics and economics, but with some controversial alterations it can remain a major tool in the bloc's battle against climate change, analysts believe.

Yesterday, E.U. politicians announced a rescue attempt, but it will be a difficult process due to a mixture of poor initial design, Europe's lingering recession and electoral politics.

The market's problem began with an oversupply of emissions allowances due to high emission caps and the recession that slashed industrial activity to the point where earlier this year the carbon dropped to a record low of €2.8 ($3.66) per metric ton. Last month the European Parliament rejected a proposed cure: to delay for five years the issuance of 900 million metric tons of carbon permits initially supposed to come to market between 2013 and 2015.

The Parliament's wafer-thin majority decision to send the so-called backloading proposal back for further consideration prompted a renewed price decline and much speculation that it was the death knell of the trading system that has been at the heart of the European Union's climate policy since it came into effect in 2005.

Experts say that for it to attract major investment in low-carbon technologies, the price of carbon must be at least €30 a metric ton -- around 10 times the current level.

"The implications of the vote are quite significant. It won't kill the scheme altogether, but it will make it completely inefficient and useless, which is more or less the same thing," said Benny Peiser of the climate skeptic Global Warming Policy Foundation.

Others have less funereal, but not terribly sanguine, views. "While there remains the possibility that the proposal may come back to plenary for a new vote before summer, it remains unlikely that backloading will ever be implemented," said analyst Haege Fjellheim at Thomson Reuters Point Carbon, which cut its 2013 carbon price forecast by 45 percent to an average of €3 a metric ton.

Help is on the way, E.U. ministers say

Yesterday, the European Parliament's environment committee announced that it would vote again next month on backloading and that the full Parliament would vote again in July.

At the same time, energy and environment ministers from nine of the European Union's 27 members -- including France, Germany and the United Kingdom -- declared a timetable for action to rescue the trading system.

They called for E.U. member states -- deeply divided on the issue -- to make up their minds and for the E.U. Parliament to take a new vote by July at the latest. They also urged the European Commission to come up with legal proposals for a structural reform of the system by the end of the year.

"We are firmly committed to the E.U. Emissions Trading System as being at the heart of the E.U.'s climate change and low carbon investment policies up to and well beyond 2020," the joint statement said.

"Although we are clear that market interference should be kept to a minimum, a one-off and targeted intervention now would minimise market uncertainty and distortions and also promote investment in low carbon technologies," it added.

Many parliamentarians who voted against the proposal said they did so out of fear a higher carbon price would damage their domestic industries that were already struggling, while others said they did so out of the principle of free markets.

For Tom Burke of influential think tank E3G, the vote was a serious setback to attempts to mend the flawed system, but not a fatal one.

"This is not the death of carbon trading. That is just wishful thinking by the skeptics. It delayed action, but it is not yet defeat. There was an attempt to try to make an in-course adjustment -- backloading. The reason for that is they designed a learning device with no opportunity to change when they learned," he said.

"There are deeper problems which were design flaws in the original proposal which the European Union is going to have to address. If you have any recovery in economic growth, guess what, prices will go up," he added.

Georg Zachmann of Brussels-based think tank Bruegel was also confident that the trading system would survive. "The solution is to give the system long-term credibility. We have to make market actors today believe that even in 2030 or 2040 the political framework around the allowances that they buy today doesn't change," he said.

A German election and the need for French prestige

The quest for long-term credibility is not helped by the fact that the German government is deeply divided on backloading and likely to remain so at least until after elections in late September -- with the components of the resulting coalition set to determine the issue.

Although Chancellor Angela Merkel's CDU/CSU coalition is likely to again emerge as the dominant force, it is far from clear whether it will form a government with current partner the liberal FDP -- which opposes backloading -- or the greens who support it.

Further complicating the picture is the fact that the current European Parliament is in its last year before elections in 2014, and positions have steadily become entrenched -- although the International Emissions Trading Association says newly elected members tend to be enthusiastically pro-European Union initially, which might augur well for the future salvage of the trading system.

But the climate and carbon turmoil in the European Union is not just an internal problem; the trading system is by far the biggest and best established in the world and is closely watched by other countries either trying or thinking about establishing one of their own.

Against this backdrop, international climate change negotiations are making scant progress despite confirmation from the International Energy Agency that the world's energy systems have made almost no progress overall in decarbonizing, with average emissions 2.37 metric tons of carbon dioxide per metric ton of oil equivalent in 2010 compared with 2.39 in 1990.

This fact prompted IEA chief Maria Van der Hoeven to accuse governments last month of "20 years of listlessness" at the same time that it was reported by the Mauna Loa Observatory in Hawaii that atmospheric concentrations of CO2 were heading rapidly to and past 400 parts per million.

But for E3G's Burke, hope lies in the 2015 deadline set by the international climate negotiations for agreement on a new climate pact, with that crunch meeting to be held in Paris.

"France will want Europe to have a 2030 carbon emissions target by then. They will want to make it a platform for [President Francois] Hollande. It is all about French prestige. One reason why the price has fallen so low is the absence of a 2030 target. You need one to drive prices. People buy forward. There is no substitute for a 2030 target," he said.