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Carbon trading is over in Europe and the EU's policy on climate change is in complete disarray. The European Parliament on Tuesday killed a proposal to rescue the moribund EU carbon trading system (ETS) by refusing to postpone the issue of a further 900 million allowances. The news that nothing would be done to stop the flood of additional permits to issue greenhouse gases caused the price of EU allowances (EUAs) to fall to below €3 ($4.04) per tonne, a level at which it makes little sense to do anything except buy wagonloads of cheap coal and burn it.

It's a huge blow to Connie Hedegaard, the EU Environment Commissioner who wanted to delay the issue of further allowances and thereby clear a glut of the permits, each of which allows the emission of a tonne of CO2. Launched eight years ago, the ETS was intended to give industry an incentive to convert to lower carbon technology by putting a price on their carbon emissions. However, national governments have been reluctant to sufficiently restrict the issue of allowances and the price of EUAs only briefly reached €30 per tonne, a level at which it might make sense to switch out of oil and coal into "cleaner" technologies. Recession has compounded political failure: a fall in industrial output left many large energy-intensive companies holding surplus EUAs. Ms. Hedegaard now fears that the failure to mend the ETS will lead to a collapse of EU climate policy and "a patchwork of 27 different national regulations."

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The unpalatable truth is that the political will was never really there to maintain a tight monetary policy on carbon and the market took revenge, as it does on all attempts at inflationary "money" printing. The ETS carbon allowances were destined to become a banana republic currency as soon as it became clear that their issuance was subject to the whims of 27 quasi central bankers who, predictably, were more interested in ensuring that their domestic industries had enough EUAs to remain competitive than they were in promoting EU climate policy. It is telling that Philip Roesler, the German economy minister, took the opposite view to the Environment Commissioner, arguing that more expensive carbon allowances would be bad for EU competitiveness. He even suggested that delaying the introduction of the extra permits would distort the ETS. "Reducing the number of emissions certificates would be an intervention in a functioning market system," he said.

Arguably, Mr. Roesler is right. The ETS is simply responding to markets forces, one of those forces being the political power of Europe's uncompetitive heavy industries, which have lobbied effectively to ensure that a potential cost burden has been emasculated. Ironically, Ms. Hedegaard's climate policy is also being undermined by market forces, as well as a lower-carbon technology that is making big advances across the Atlantic. Cheap shale gas in America has reduced demand for U.S. coal and American mining companies have been quick to export their product to grateful European power companies. It is no accident that North Sea gas producers such as Shell have been unexpected supporters of the Commission's drive for higher carbon prices; the cheap coal is making expensive European gas, too, look rather uncompetitive.

Carl Mortished is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights.

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