THE future of Europe’s Emissions Trading System (ETS) hangs in the balance as officials in Brussels prepare to do battle this month with member states to uphold the credibility of a market in permits to pollute. The market stands accused of generating billions of euros in windfall profits for utilities at the expense of consumers.

The European Commission needs to clamp down hard on member states, market analysts say, if it is to rescue the ETS, which has fallen into disrepute over lax carbon emission targets set for the first phase of the scheme from 2005-07.

The ETS was devised to create a market incentive to cut greenhouse gas emissions that cause climate change, but the market was undermined from the beginning by weak-willed governments. The system imposes a cap on emissions of carbon dioxide, forcing companies that exceed their allowance to buy “permits to pollute” from companies that manage to cut emissions. European governments were too generous with the caps, causing the price of permits to collapse in May. Lack of confidence in the market encouraged power generators to switch from cleaner gas to dirty coal.

The cap in the first phase was 100 million tonnes more than actual emissions in the first year and the Commission’s authority is again at stake, according to Mark Lewis, an analyst at Deutsche Bank in Paris. “The question is: does the Commission insist on much tougher allocations in Phase II that create genuine scarcity?” he said.

Nineteen national allocation plans have been submitted for the second phase, 2008-12, but Deutsche Bank reckons that only five states — Germany, Italy, Portugal, Slovenia and Britain — have acceptable carbon caps, compliant with their respective Kyoto targets.

Austria, Finland, Greece, Ireland, Luxembourg, the Netherlands, Sweden and Spain are out of line, as are Estonia, France, Latvia, Lithuania and Slovakia. Poland has proposed a hugely extravagant plan that permits 70 million tonnes more CO2 than it emitted last year. Overall, 130 million tonnes of carbon need to be cut from the national plans so far submitted.

“If they get the numbers wrong again, the credibility of the trading system is undermined,” Mr Lewis said.

Without rigorous national plans, the ETS will be exposed to even more criticism that the scheme is not just a failure but a licence for polluters to extort money from consumers. Under the present scheme, permits are issued free by national authorities, but each pollution permit has a carbon “cost” priced by the market. That price has been passed on to consumers in the cost of electricity in the first year of the ETS, with nil gain to the environment.

Franck Schuttellar, an analyst at Gaselys, the energy trading firm, estimates that UK firms earned a collective windfall of €1.4 billion (£940 million) in the scheme’s first year.

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