Business is getting acclimatised to trading in carbon emissions

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The Independent Online

"We have begun a chain reaction which is changing business culture.... Carbon dioxide has moved out of the domain of the environmental officer at a company to the boardroom and the chief financial officer and the chief executive officer," Ms Day, the European Commission's director-general for environment, said.

The system is clearly just the first step in Brussels' ambitious plans. It covers heavy industry at the moment, but the Commission has said it wants to extend the scheme to aviation. It obviously wants to see other parts of the world join Europe's trading mechanism or set up a similar ones of their own. This is, after all, the ultimate global problem.

In time, the emissions of cars, buses and trains could fall within our ETS and maybe one day this kind of scheme will be applied to individual households. So, some decades from now, a parent may have to go online to buy a carbon credit before cooking the family dinner.

For now, most households are blissfully unaware of the logic of the "cap and trade" solution to rising global temperatures.

Europe and much of the industrialised world - though famously not the United States - signed and ratified the Kyoto Protocol. This obliges signatories to reduce their emissions of greenhouse gases to 12.5 per cent below 1990 levels, by 2012.

The response of Europe to this challenge was the market-based ETS. This mechanism allocates emissions allowances to industry at a level deliberately below the requirement under a "business as usual" scenario. These allowances, each the equivalent of emitting one tonne of carbon dioxide - the main greenhouse gas - can then be traded.

So a company can either buy more allowances if it cannot meet its cap. Alternatively, it can put in new technology or change its working methods, reduce its level of emissions and sell the spare credits it then has on the market.

In the current system, which covers the period to 2007, the burden falls heavily on the power generation sector. Other energy-intensive industries, such as steel plants and paper makers, are also in the scheme.

The idea comes, ironically, from the US, which has used this mechanism to control the emission of gases that cause visible air pollution - smog. So far this year, Europe's ETS has seen 150 million allowances traded, with a financial value of nearly €2.5bn (£1.7bn), which is tiny compared with, say, the market for crude oil, but carbon trading is new and the launch of the system has been remarkably smooth. All the big brokers such as Goldman Sachs and Morgan Stanley are involved.

A total of 2.2 billion tradeable allowances will be put into circulation annually between this year and 2007. "We have put a price on carbon and brought into being a new currency," Ms Day said. That new currency has proved to be stronger than anyone imagined. The price of a tonne of carbon hit a high of €29.50 in July and it is now trading at about €23. It started the year at less than €10.

The reason for the strong price is not to do with demand for carbon credits, but is the result of demand for gas and coal. As the price of gas has soared this year, it has become less attractive to burn gas, rather than coal, in power stations. Burning coal means greater emissions of carbon dioxide, and so more credits have to be purchased.

The volatility seen in the price of carbon is such that one major player, E.ON, called yesterday for an absolute cap to be put on the price, to act as a "safety valve". A runaway price for carbon could be disastrous for European business.

Simon Skillings, the director of strategy and energy policy at E.ON UK, said: "It would be a very inefficient outcome if the costs to the economy are far greater than any benefit to the environment." The group, which owns Powergen in this country, worries firstly about unexpected events sending carbon shooting up in price. It cited the events of two years ago, when a drought in Scandinavia forced the region to shut down its zero-emission hydroelectric plants, while the same extreme weather in France meant that its zero-emission nuclear power stations had to close.

As big a concern for E.ON and other business is the political risk. The number of carbon credits in circulation is decided by politicians and bureaucrats. There are no "fundamentals" determining the supply of allowances.

Those politicians have already fought over the allowances for their countries for the current 2005-07 period. British industry believes that it lost out after the Government went for too stringent an allocation. Next year, EU countries must submit bids for allocations to cover 2008-12, the period which actually comes under the Kyoto Protocol. But beyond 2012, we do not know whether the ETS will survive, or whether countries such as the US, China and India will be in.

Building a power station is hugely costly and requires years of planning and building. A huge number of Britain's power stations - including most of our nuclear plants - are coming to the end of their working lives. "In order to keep the lights on, we need to build an awful lot of power stations over the next 10 years," Mr Skillings said.

If there is no cap and trade beyond 2012, it may make sense to replace the stations with coal-fired plants. Or if there is to be a bigger crackdown on emissions for the 2008-12 period, or beyond, it could make sense to fit carbon capture and storage technology, or build nuclear.

Business is clamouring for clarity for the post-Kyoto period and a more level playing field, internationally and in terms of bringing more sectors under the ETS. Tony Blair recently made it clear there would be no new treaty for many years.

Next time, the US must be in and for negotiations to start properly on that, we will have to wait for the Bush administration to go in 2008. Some US states are planning to set up their own carbon trading system in the meantime. The Commission's Ms Day said yesterday that Europe would be willing to rewrite its rules to include these states in the ETS, even though the US as a country is not within Kyoto. As for bringing aviation and other industries into Europe's ETS, that can probably happen only after 2012, Ms Day admitted.

Business has embraced emissions trading but it will not get the answers on the future it needs from politicians for years to come. The road beyond Kyoto is long and winding.