The Europe-wide carbon trading market suffered a severe blow yesterday when a European court issued a ruling that will weaken carbon prices and undermine efforts by the European Commission to curb carbon emissions further.

In a landmark decision, the European Court of First Instance ruled in favour of an appeal by Poland and Estonia for the right to be more generous in granting carbon emission allowances. In its surprise annulment of a Commission decision to cut the carbon quotas of the two countries, the court said: “The Commission exceeded its powers.”

The decision is expected to weaken prices in Europe’s troubled carbon market and undermine efforts by the Commission to impose a stricter regime on carbon polluters.

The court said that the Commission had no right to impose a lower cap on the emissions of Estonia and Poland when it rejected the national allocation plans (NAPs) submitted by the two countries.

Under Europe’s Emissions Trading System (ETS), each state submits a plan setting out how many carbon allowances (EUAs) it will issue to industry each year.

The court’s ruling astounded carbon traders in Europe yesterday and the price of EUAs traded on the ETS fell 60 cents a tonne before recovering to €13.40 a tonne.

Carbon traders said that there was a risk of a further 50 million tonnes in EUAs coming on to the market as the two countries exploited the court’s ruling against the Commission’s authority.

“It means two things — possibly more allowances in the market and more uncertainty,” Emmanuel Fages, a carbon analyst with Société Générale, the investment bank, said. “It’s another blow because people will say the market doesn’t work.”

The ETS was set up to create a market incentive for businesses to reduce CO2 emissions by enabling companies to sell surplus carbon allowances for cash in the market. In its first phase, governments gave away too many allowances, depressing the price of EUAs and reducing incentives. In an effort to boost the ETS in its second phase, the Commission sought to rein in the volume of EUAs distributed by governments.

The ruling is a victory for Central and Eastern European states that fought against the Commission’s attempts to cut carbon emission quotas. Poland argued that its dependence on a Soviet-era coal and power industry deserved special treatment when it submitted its NAP to the Commission for approval. The Commission rejected the NAPs of several states, including Poland and Estonia, and ordered those two countries to reduce the number of EUAs by 27 per cent and 48 per cent, respectively.

However, the European Union’s court said that the Commission’s power of review was “very restricted”. The Commission could reject an NAP only if it failed to conform with criteria set out in the EU directive concerning greenhouse gas emissions. By imposing a different quota ceiling, the Commission was “encroaching on the exclusive competence which the directive confers on the member states”, the court said.

The Commission said that it was “extremely disappointed” and hinted that it would appeal against the ruling.

Other EU states that suffered cuts in their NAPs in the second phase may now challenge the Commission. The Polish and Estonian cases were supported by Hungary, Lithuania and Slovakia. The ruling will raise further questions about the effectiveness of market-based carbon trading systems in bringing about reductions in greenhouse gas emissions.

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