Carbon trading chaos as Brussels gets numbers wrong

Europe's flagship carbon trading system was struggling to restore its battered credibility yesterday as figures for 2005 showed that industry was given too much leeway to pollute last year.

Statistics from all but four of the EU's 25 member states showed an embarrassingly large surplus of 64 million tonnes of carbon credits after the scheme's first year of operation. That is likely to lower costs to polluters and could undermine Europe's drive to cut greenhouse gas emissions.

Under the scheme, 9,000 industrial installations are allocated a CO2 emission allowance by their government each year. Those that fall under that ceiling can sell their surplus to less energy-efficient companies.

Yesterday the price of a credit, which began at €5 (now £3.41) per tonne in January last year and rose to €30, slumped to just over €12, then rose to €17.25 when Germany announced plans to cut its allocation.

The European Commission, which has to approve national schemes, was studying the reasons behind the 2005 overshoot and promised tougher targets for 2008-12. "The allocation will be stricter if it is found out that installations in member states could have lower projected emissions," said Barbara Helfferich, the spokeswoman for Stavros Dimas, the European Environment commissioner.

Underlining the scheme's teething troubles, some of the figures released yesterday were accidentally placed on the Commission's website last Friday. That caused the price of credits to drop to €8. In six countries, the UK, Spain, Ireland, Slovenia, Austria and Italy, allocations were all below actual emissions indicating that the scheme was working reasonably efficiently.

But overall emissions last year were 63.7 million tonnes below a total industry permit quota of 1.8486 billion tonnes. Critics say several countries succumbed to industry lobbying and allocated more credits than required.

Lithuania's allocation was 70 per cent above real emissions with Estonia, Latvia and Finland all between 30 and 50 per cent above. That is a large enough mismatch to raise serious questions over the operation of a scheme, which is the centrepiece of the EU's Kyoto strategy to tackle climate change.

In approving allocations granted by EU member states, the Commission has a difficult balancing act to perform. Targets that are too tough could choke off economic growth, but failing to set sufficiently stringent levels will undermine the scheme's effectiveness. There are several legitimate potential explanations for surplus allocations. The rise in energy prices in 2005 may have been steep enough to persuade firms to implement energy efficiency measures. Or warmer-than-average winters may have reduced demand for energy, and some installations may have closed temporarily.

The case of Lithuania, the most extreme over-allocation, was based on assumptions of what would happen after the closure of the Ignalina nuclear reactor. Fears over the use of more coal plants appear to have been exaggerated.