By Roger Harrabin
BBC News environment correspondent
Under Labour emissions have gone up by more than 2%
Power firms could make a £1bn windfall profit from the EU Carbon Emissions Trading Scheme, it is claimed.
The windfall is likely because many firms have benefited from increases in electricity prices brought about by the scheme without needing to make any extra investment in return.
Peter Bedson, from IPA Consulting, confirmed to BBC News that the profit could reach £1bn.
Environmental pressure groups have called the news a scandal.
Part of the problem, Mr Bedson said, was that firms had been given, free-of-charge, the carbon emissions permits on which the scheme is based. This, he explained, was like the government giving energy firms free money.
The WWF pressure group has demanded a windfall tax to re-direct the profits into energy conservation.
The Conservatives said it was an example of government incompetence.
Their environment spokesman Peter Ainsworth said: "MPs warned the Department of Trade and Industry (DTI) this would happen but they took no notice."
The windfall lies in the design of the EU Emissions Trading Scheme, which works by governments setting a limit for the total amount of carbon that can be emitted from its heavy industry and power sectors.
A true market scheme would see the permits auctioned, not given away by governments
Instead of banning firms from exceeding the limit, governments hand the firms free pollution allowances up to a certain level.
If a firm can cheaply cut its pollution by installing better technology, it will have carbon permits to spare.
If another firm is overshooting its pollution limit, it will need to get hold of extra allowances. The firms can then trade carbon permits on the EU market.
Economists like it because it gives maximum pollution savings at least cost; but a true market scheme would see the permits auctioned, not given away by governments.
The system means that generators using high-carbon fuels such as coal need to buy extra carbon permits.
That forces up the price of electricity overall, which benefits generators using low-carbon fuels such as nuclear and gas. This is where some power firms have made their windfall profit.
Mr Bedson did a report on the issue for the DTI earlier this year.
Since then the price of carbon has shot up and his revised estimates suggest that the resulting windfall will reach around £1bn.
It will depend in large part on the future price of carbon; the market has not been able to maintain its recent highs.
Green groups are particularly angry that despite knowing about the windfall, the government has been fighting the EU in the courts to try to get the carbon allocation for the firms increased.
Last week, it confirmed it would abandon the fight. But the DTI wants to compensate the generators by increasing their allocation under the next phase of the scheme.
WWF, the Conservatives and the Liberal Democrats all want the government to set much tougher limits on carbon emissions from the biggest polluters.
They all say the government should auction the permits.
Conservative environment spokesman Peter Ainsworth said: "All round Europe governments are in cahoots with the lowest common denominator of business.
"The problem will not be sorted out until the market is made to work properly by forcing firms to bid for their permits instead of being allowed to lobby government for them free of charge. The DTI aren't competent to decide on this."
Attention will now be focused on the government's carbon targets for big business under the next phase of the EUETS, which are due to be resolved shortly.
The government has said it will cut carbon emissions from big firms by between three and eight million tonnes. But experts note that the cuts are not real cuts - they are based on what industry is projecting it will emit in future.
So the three million tonnes cut is in fact an increase in pollution.
Government supporters will argue that there were bound to be problems when a large complex scheme like the scheme was set up, but that it was vital to design a scheme that would be supported by big business.
They will hope that problems will be ironed out in future years when the scheme beds down.
Problems are happening across Europe. The price of carbon crashed last week, and the market is in disarray.
It will come to a head in the next few days when governments reveal how many extra carbon permits need to be purchased.
The scheme is a mainstay of the EU's policy for meeting its Kyoto obligations. Critics of the Kyoto Protocol are already celebrating the problems in the market.
The UK government is failing in its carbon emissions targets. When it came to power in 1997, the administration planned to cut CO2 by 20% from 1990 levels by 2010. But under Labour emissions have gone up by more than 2%.
The DTI told the BBC that the emissions trading scheme was central to the†UK's strategy to tackle climate change.
"It is still not clear whether carbon costs are being passed through fully to retail customers in practice," it said.
"The free allocation of carbon allowances required under the EU European Trading Scheme Directive†is also a contributing factor and phase II of the Scheme, 2008-2012, provides an opportunity to reduce the amount of free allocation to generators by auctioning more allowances [up to 10%].
"The government continues to monitor the carbon market and the impact on electricity prices."
The UK is currently on track to meet its Kyoto commitment to reduce emissions of six different greenhouse gases by an average of 12.5% compared with 1990 levels over the years 2008 to 2012
The fall in emissions through the 1990s and early part of the 2000s was achieved at a time of strong growth in the UK economy
Carbon dioxide emissions have risen recently, largely due to increased burning of coal in power stations. This was prompted by a rise in the price of gas (gas is 'cleaner' than coal)
The Labour administration has stated in three election manifestos that it would like to see a 20% cut in CO2 emissions by 2010