Two years ago on Friday, the Kyoto Protocol for cutting greenhouse gases was born after an agonising gestation, but there will be few birthday celebrations in the carbon market created by the UN pact. As US states mull setting up their own market to trade in carbon dioxide (CO2) emissions, they are casting a worried eye on the almighty crash in the European Union's Emissions Trading System (ETS), the first and so far only significant market in carbon.

A year ago, CO2 was changing hands in the ETS at 30 euros (33 dollars) a tonne, triple that at the market's launch in January 2005.

Today, a tonne of CO2 can be bought for little more than one euro.

To outsiders, a market in a gas that is colourless, odourless, tasteless, and crosses borders seems a daft way of trying to cope with a global pollution problem.

To its defenders, the market is a smart way of accelerating the cleanup of carbon emissions that stoke climate-changing global warming.

The ETS works under a cap-and-trade approach. It comprises 11,500 big industrial firms that account for about half of the 25-nation bloc's CO2 output.

Each firm is given a quota. They face a penalty of 40 euros (52 dollars) for every excess tonne of CO2 for 2007 (and also for 2006), a punishment that will rise to 100 euros (130 dollars) a tonne from 2008.

Companies that are under quota can sell off any surplus to those over their quota, thus providing a financial carrot to everyone to clean up his act.

Jean-Francois Conil-Lacoste, chief executive of the French bourse Powernext, where 70 percent of spot CO2 is traded in Europe, explains what went wrong.

In 2005 and half of 2006, the price of CO2 went from strength to strength, as electricity producers — the big emitters — provided the demand while industrial firms sat on their hands, reluctant to sell.

Then, in mid-2006, came a big whammy.

In monitoring this initial phase of the ETS, the EU's executive commission discovered that the quotas issued to the firms by national governments and based on preliminary estimates were generally far higher than the pollution actually emitted.

As a result, the market became flooded with CO2.

"The fall reflects the quota surplus in relation to the actual emissions," said Conil-Lacoste in an interview with AFP.

"In the short term, there isn't much ground for believing that things will change," he added.

The European Commission has embarked on an offensive to tighten up quotas for the so-called second phase of the ETS, the commitment period running from 2008 to 2012.

If the futures market for CO2 is any guide, the price will rise. Carbon "for delivery" in 2008 is trading at around 14 to 15 euros a tonne.

"The European Commission was too lax in allowing the national quota plans for the first phase," says Morgane Creach, of the French branch of Climate Action Network, a green group.

"But it has decided not to fall into the same trap for 2008-2012 and to be tougher on member states."

A power struggle is unfolding on this issue, with the Commission and Germany wrangling over Germany's second phase quota.

Even though the market is still reeling from the slump, it is maturing in some important ways. Spot prices are showing sensitivity, for instance, to such short-term factors as weather, economic growth and the price of carbon fuels.

In the longer term, though, political uncertainty weighs upon the market.

Negotiations for the future of the Kyoto Protocol are due to start in earnest this year, with no guarantee as to the shape of the treaty after it runs out in 2012.

The world's biggest single polluter, the United States, has abandoned Kyoto and President George W. Bush strongly opposes any federal cap-and-trade approach to carbon pollution.

Developing countries, meanwhile, lie outside its constraints for targeted emissions curbs, even though the biggest emerging economies, especially China, have become huge polluters in their own right.

Source: Agence France-Presse