As the centerpiece of Europe’s pledge to lead the global battle against climate change, the region’s market for carbon emissions effectively turned pollution into a commodity that could be traded like gold or oil. But the once-thriving pollution trade here has turned into a carbon bust.

Under the system, 31 nations slapped emission limits on more than 11,000 companies and issued carbon credits that could be traded by firms to meet their new pollution caps. More efficient ones could sell excess carbon credits, while less efficient ones were compelled to buy more. By August 2008, the price for carbon emission credits had soared above $40 per ton — high enough to become an added incentive for some companies to increase their use of cleaner fuels, upgrade equipment and take other steps to reduce carbon footprints.

That system, however, is in deep trouble. A drastic drop in industrial activity has sharply reduced the need for companies to buy emission rights, causing a gradual fall in the price of carbon allowances since the region slipped into a multi-year economic crisis in the latter half of 2008. In recent weeks, however, the price has appeared to have entirely collapsed — falling below $4 as bickering European nations failed to agree on measures to shore up the program.

The collapsing price of carbon in Europe is darkening the outlook for a greener future in a part of the world that was long the bright spot in the struggle against climate change. It is also presenting new challenges for those who once saw Europe’s program as the natural anchor for what would eventually be a linked network of cap-and-trade systems worldwide.

Carbon “started as the commodity of the future, but it has now deteriorated,” said Matthew Gray, a trader at Jefferies Bache in London and one of a diminishing breed of carbon dealers in Europe. “Its future is uncertain.”

Europe's carbon-trading market

The problems plaguing Europe’s cap-and-trade system underscore the uphill battle for international cooperation in the global-warming fight. After middling progress at various summits, officials from more than 190 countries have been charged with forging a global accord by 2015 aimed at cutting carbon emissions. But critics point to the inability of even the European Union — a largely progressive region bound by open borders and a shared bureaucracy — to come together on a fix for its cap-and-trade system as evidence of how difficult consensus building on climate change has become.

Negotiations to launch a similar system across the United States collapsed in 2010, replaced with a regional approach in which California, for instance, moved forward with its own program. Aided by a boom in cheaper and cleaner shale gas as well as the spread of more renewable energies, including wind and solar, the United States has — like Europe — nevertheless seen a continuing drop in its overall emission levels.

But there are also signs that years of increasing investment in clean energies are ebbing on both sides of the Atlantic. In 2012, overall clean-energy investment in the United States fell 37 percent,to $35.6 billion, compared with a year earlier, according to a new report by the Pew Charitable Trusts. European countries, including green leaders such as Germany, also saw declines, leading analysts to call the problems with the region’s cap-and-trade system that much more troubling.

“Obviously, what’s happening now is very disheartening for people who have been involved in trying to cut carbon emissions,” said Agustin Silvani, managing director of carbon finance at Conservation International in Arlington, Va. “The European system was at the center of the global fight, and the fact that it is collapsing is definitely a blow. Maybe a moral one more than anything else.”

Lost incentive

The cap-and-trade program is based on a system of carbon allowances for large emitters such as utilities and manufacturers, with some bought and others awarded for free. Companies are allowed to draw on global mitigation projects — such as planting trees in tropical rain forests — to offset a small portion of their emissions. But for the most part, they must meet targets through carbon credits issued by European authorities.

A number of other factors, including mandates and subsidies for renewable energy, have coaxed European companies to reduce their emissions in recent years. But in the early stages of the cap-and-trade program, “higher carbon prices were a big incentive for companies to take action,” said Marcus Ferdinand, senior market analyst for Thomson Reuters Point Carbon. “Now, they’ve lost that incentive.”

At the core of the problem is a massive oversupply of carbon allowances. Demand for carbon began to fade in the late 2000s as a recession set in and factories across Europe dramatically curbed production. But there were also built-in flaws. Unlike newer cap-and-trade programs such as the one in California, Europe’s system never established a price floor that could have prevented a market collapse. In addition, too many free allowances were given to too many companies. Some, in fact, never had to pay for allowances at all, allowing them to hoard them or even sell their carbon credits at a profit.

On April 16, the European Parliament was on the verge of temporarily tightening the supply of allowances to boost the price of carbon and shore up the ailing market. But opposition by countries led by Poland — a nation strongly dependent on heavy-emitting coal power plants — defeated the measure. The rejection sent the price of carbon plummeting to a historic low of roughly $3.60.

Shoring up prices

A bright future for cap-and-trade systems may yet exist. Promising new programs, for instance, are being rolled out in California, Australia, Quebec and a few provinces in China, with officials in some areas setting a minimum price for carbon credits to prevent the kind of market collapse seen in Europe.

But if Europe is unable to shore up the price for carbon credits here, observers say, it could complicate hopes down the line of linking various programs together. The price per ton in California, for instance, is above $10 — about two and half times the price in Europe.

Large emitters such as the steel industry, however, say the system is working just fine. With a price determined by supply and demand, industry groups say, it is only fitting for the price to be low now. Also, given the region’s weaker economic activity, they note that the European Union is still virtually assured of meeting its pledge to cut carbon emissions — a reduction of 20 percent by 2020 compared with 1990 levels — even with the cap-and-trade system faltering.

Yet critics argue that the low price of carbon has removed the incentive for European companies to reduce their carbon footprints. They point to a boom in the use of cheap imported American coal in European power plants. In addition, many fear that the lack of an incentive to make more green upgrades will create a boom in emissions if and when European economies recover.

As the regional plan falters, some countries are going it alone on domestic initiatives. This year, for instance, Britain introduced a carbon tax on emissions that British manufacturers say has put them at a competitive disadvantage with their counterparts on the continent. It suggests the potential pitfalls ahead as countries and even smaller jurisdictions such as states, provinces and cities introduce a disparate patchwork of climate-change measures.

Optimists point to hope that the European Parliament will once again vote on a measure to tighten the supply of carbon credits in the coming months, thus shoring up the price. They also note that the European Commission is studying more ambitious proposals for a bigger overhaul of the region’s cap-and-trade system.

But given the growing resistance in some European countries to anything that might drive energy costs up further, others wonder whether Europe’s leaders still have the political will to take aggressive action.

“We’re risking the credibility of European politicians by not fixing this system,” said Johannes Teyssen, chief executive of German energy giant E.ON. “How can they travel to world climate-change conferences claiming others should do more when our own system is on its deathbed and they do nothing?”

Eliza Mackintosh contributed to this report.