Hot Planet, Cold Market

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Patrick Pleu / EPA /Corbis

Offsets Carbon trading aims to compensate for dirty energy with investment in clean power

The idea was simple enough: establish a limit on greenhouse gases — the emissions from power plants, transport and factories that cause global warming. Then force industries to meet that cap by either reducing their emissions or purchasing carbon credits — investments in projects that will reduce greenhouse-gas emissions somewhere else. Such carbon trading seemed like an ideal way to reduce greenhouse gases, better than having governments simply slap on politically unpopular energy taxes. Once the Kyoto Protocol went into effect in 2005, mandating greenhouse-gas reductions in nearly every developed nation (with the notable exception of the U.S., which refused to sign on), rich countries could fund carbon-reduction projects in developing nations. The climate — and the market — would win.

Except that's not quite how it's worked out. The fact that the U.S. — historically, the world's biggest emitter — opted out of the Kyoto Protocol meant that the deal was lopsided, with nearly all the action taking place in greener Europe. But even there, carbon trading has run into problems stemming from the financial crisis and uncertainty over international climate policy. At the end of November, the price of U.N.-backed carbon permits fell to an all-time low of less than $8 a ton, down more than 50% since June. And with little hope for a breakthrough at the U.N. climate-change summit under way in the South African city of Durban, that uncertainty will likely only deepen, with depressing effects for the financial market that was supposed to save the planet. "The global carbon market is at a crossroads," World Bank climate-change envoy Andrew Steer said earlier this year. "If we take the wrong turn, we risk losing billions of dollars in lower-cost private investment and new technology solutions in developing nations."

The future of the Kyoto Protocol is the biggest issue facing the international delegates at Durban, and it's also the biggest question facing the global carbon market. Kyoto's commitment period for carbon reductions ends in 2012, and right now it's not clear what, if anything, will follow it. Developing countries, which are currently exempt from any mandated greenhouse-gas reductions under Kyoto, want to see rich nations take on additional cuts under the existing Kyoto framework.

Canada, Japan and Russia — all signatories to Kyoto — have said they won't accept additional commitments under the current system, and the U.S. is handcuffed by domestic opposition to any climate action. For its part, the European Union — which has agreed on its own to cut carbon emissions at least 20% by 2020 — is open to further reduction commitments, but the bloc accounts for just 11% of global emissions, outpaced by rapidly growing developing nations like China. "We've seen things going in completely the wrong direction from where they need to be," says Jennifer Morgan, director of the climate and energy program at the Washington-based World Resources Institute.

Nor does it help that the European market was hit earlier this year by cyberthieves who stole more than $60 million worth of carbon permits or that greens have raised doubts about the climate benefits of some carbon-trading projects. As the European economy slows down, greenhouse-gas emissions from industry will drop, reducing demand for carbon credits. A report last month by the Swiss bank UBS forecast that the price of carbon credits in the European market would average less than $7 a ton and could fall to as low as $4, with a carbon-credit surplus that could persist until as late as 2025. "There is a huge amount of mistrust, and the chilling effect that it will exercise over Durban could be extremely damaging," Henry Derwent, head of the International Emissions Trading Association, said recently.

Still, the news isn't all bad. Last month, Australia — one of the biggest per capita carbon emitters in the world — passed a landmark law to reduce greenhouse-gas emissions, and California is establishing its own carbon cap-and-trade system. But the future of the global carbon market may well come down to what happens in Durban. Too bad you can't trade on hope.