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COLOGNE, Germany (Reuters) - Major changes proposed to the European Union's emissions market could dramatically alter the landscape for traders, who are increasingly frustrated by regulatory uncertainty and political stalemate.
A deeper 2020 EU greenhouse gas reduction commitment, qualitative and quantitative restrictions on carbon offset eligibility and details on carbon permit auctioning in the scheme's third phase are among the decisions expected to be made this year by the 27-nation bloc's executive.
But policymakers at this week's annual Carbon Expo conference in Cologne were tight-lipped, and the uncertainty caused gloom among traders.
"Obviously the mood would be better with more regulatory certainty," Emmanuel Fages, carbon analyst at Societe Generale/orbeo, told Reuters on the sidelines of the conference.
"Firms for whom carbon is a core activity remain resilient but they are experiencing a difficult context post-Copenhagen."
The market's momentum has already been stalled by failed U.N. climate talks in Copenhagen last year, delays to a U.S. climate bill and scandals including tax fraud and permit theft that rattled the $118 billion EU scheme in 2009.
Carbon prices have also dropped from 2008 highs due to lower European industrial output as a result of the global downturn.
Despite the uncertain investment climate, organizers said attendance at the conference was strong again this year at around 3,000 people.
The EU Commission said on Wednesday it would consider deepening its 2020 target to 30 percent below 1990 levels, from a 20 percent currently, if other nations adopt deep cuts themselves.
A decision will likely be made before this year's U.N. climate talks in Mexico. If approved, it would mean the EU carbon permit supply would be slashed, and that could push prices up to between 30-50 euros, from around 15 euros now.
The move, expected to cost around 81 billion euros ($99.2 billion) annually by 2020, could have grave implications for EU industry, especially the top emitting power generators which get most of their emissions permits for free.
In the scheme's third phase (2013-2020), most utilities will be required to buy their permits at auction, but details about the auctions or the total number of permits on offer have also not yet been decided, meaning utilities that forward sell power are limited from hedging their positions with Phase 3 credits.
"The one positive thing about auctioning should serve to lift the gloom because the market is going to get bigger," said Louis Redshaw, head of carbon markets at Barclays Capital.
More uncertainty surrounds the future of the Clean Development Mechanism, one of the carbon finance schemes under the Kyoto Protocol climate pact.
With Kyoto's first leg expiring in 2012 and no successor pact yet in place, the fate of the CDM and the carbon offsets, called Certified Emissions Reductions (CERs), it generates through clean energy project investment is in question.
"Investments are certainly slowing as a consequence. We don't necessarily know what types of CERs we can use, but there are plenty of clues," Redshaw said.
The EU has already committed to allowing a set quota of CERs, which serve as a cheaper alternative for participants to buying EU carbon permits, into its trading scheme through 2020.
But leaked EU documents show the Commission is considering several different proposals that could further shrink investment in the CDM, which fell to $2.7 billion in value last year from $6.5 billion in 2008, according to the World Bank.
One idea was to restrict CERs from certain types of projects from being used for compliance in the EU, for example from large, lucrative industrial gas cutting projects. A more recent one is to introduce a multiplier rate for using some CERs, for example two industrial gas credits would be equal to one renewable energy CER or one CER from a least developed country.
Traders say both are unrealistic and unfair, arguing that all tonnes of displaced CO2 are identical, whether they come from investing in cutting a chemical plant's emissions or from building a wind farm.
"The whole thing was sold to the European Parliament as being to do with CER quality issues, but now it seems to revolve around profitability," said Miles Austin of lobby group Carbon Markets and Investors Association.
U.S. climate legislation is one area outside the EU where, if progress were made, traders said could provide a boost to the stalled development of a global carbon market.
Two U.S. Senators unveiled their American Power Act earlier this month, which was quickly backed by President Barack Obama and aims to cut U.S. carbon emissions by 17 percent below 2005 levels by 2020.
The bill, similar to legislation passed in the House of Representatives last June, faces looming deadlines with mid-term elections set for November, and fierce opposition from Republicans and some Democrats.
"There's a mixed bag of views on the likelihood of U.S. cap and trade," Redshaw said. "We are relatively bullish, but 'relative' doesn't mean a great deal."
Additional reporting by Nina Chestney; Editing by William Hardy