The European Commission has questioned the effectiveness of the EU's emissions trading scheme, the cornerstone of its climate change policy.
The UK exceeded its quota of carbon permits in 2005
Under the scheme, governments set quotas for the carbon dioxide emissions produced by 9,400 large factories and power stations in 21 member states.
Carbon permits are issued to give firms a financial incentive to invest in clean technology and cut emissions.
But the commission's report showed that states have issued too many permits.
The permits effectively make the right to pollute a tradeable commodity - giving companies the ability to buy and sell permission to emit extra carbon dioxide.
Emissions of carbon dioxide - a greenhouse gas - are widely thought to be a key factor in global warming, increasing atmospheric temperatures around the world.
The Commission's reports showed a 2.5% surplus for 2005, with the 21 states granting 44.2 million metric tons more carbon dioxide permits than needed.
Unlike many other states, the UK kept a tight rein on the number of pollution permits it issued.
But as a result, it exceeded its quota of permits for 2005.
However, the UK has been in conflict with the EU over its level of permits, with Britain now arguing that it set itself too tight a target when the scheme was originally launched.
The EU has threatened to take legal action against the UK for exceeding its national quota, set in April 2004.
But the UK government is claiming that it should be measured against the revised quota it set in October 2004, which gave business more generous targets.
When it emerged that the number of permits exceeded demand, prices slumped.
The price of carbon credits traded in Europe has already fallen by around 60% over the past two weeks because some of the data from the report was released early.
"It's clear that most countries were too generous when handing out allowances," said David Foster, head of emissions and weather derivatives at Calyon, part of Credit Agricole.
"The dissemination of the information has been a farce."
The idea of the carbon-trading scheme was to raise the cost to firms of continuing to pollute while creating a market to give an incentive to become more environmentally efficient.