Carbon emissions: to trade, or not to trade? With emissions falling amid the economic downturn, the price of carbon in Europe recently dipped below [euro]10/tonne. Falling prices prove that carbon markets function on one level, but can they reduce carbon emissions in the long run?(ANALYSIS)

In the long run, said the rehabilitated economist John Maynard Keynes, we are all dead. If the consensus among scientific experts is correct, then collective 'death' is accelerating, via climate change. So, if we accept climate change is the mother of all problems facing planet Earth, then action is needed now to curb harmful emissions. This much we know.

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However, a major mechanism for taking this action--emissions trading--has come under attack after the price of a tonne of carbon in Phase II of the European Union Emissions Trading Scheme (EU ETS) fell to a new low of around [euro]8 ($10) last month, down from around [euro]31/tonne in July 2008.

The fall in price reflects falling emissions and a rush in the selling of permits, raising around [euro]1bn for cash-strapped, credit-crunched firms. So, as a price mechanism, the market appears to be functional; demand for permits has fallen, the supply has risen and -more importantly--carbon emissions are down.

So why is the power industry not entirely happy? Well, critics of the EU ETS argue that pollution is now too cheap, making renewable generation such as wind and solar power even less cost-competitive than the burning of fossil fuels.

We have seen this before, of course, following the collapse of the carbon price during Phase I of the EU ETS. In Phase II of the scheme, however, some of the permits have been auctioned, rather than 'grandfathered', i.e. given free to polluters.

What we are now seeing is the market reacting in part to falling emissions, rather than merely a heavy sell-off of permits, and the subsequent price plunge has exposed some of the flaws inherent within this particular market-based approach to carbon mitigation. The main criticism leveled at the EU ETS by power generators is that it does not offer any certainty, and without a clear long-term carbon price, they cannot accurately measure the payback time of an investment in a low carbon technology.