The value dropped from €95bn in 2011 to a reported €61bn last year, representing the first annual contraction to be suffered by the sector since 2008, according to Bloomberg New Energy Finance.
However, trading across the world's carbon markets grew by 26% in 2012, to reach 10.7bn tonnes, which is equivalent to one third of the world's total emissions of carbon dioxide.
Activity particularly around UN offsets increased substantially towards the end of the year; in the last quarter it jumped by 70%, in a rush to issue and acquire these credits before the end of the year and to take advantage of record low prices.
Commenting on the fall in value of the market, Sarah Deblock, the EU policy director of the International Emissions Trading Association (IETA), said that it "reaffirms the importance of the proposal by the European Commission to backload 900 million allowances during phase III of the EU ETS”.
A report issued in November estimated that there was an oversupply of up to two billion allowances that is unlikely to decline before 2020. When it was announced, carbon prices rose slightly to over €9 in anticipation.
On 19 February the European Parliament's Environment Committee is to vote on a crucial one-line amendment to the legislation which would authorise the European Commission to postpone (or backload) the auctioning of 900 million allowances until 2019 and 2020, followed by a plenary vote in March by the European Parliament.
The IETA supports this measure as a way to avoid future routine interventions in the market, which could cause problems of predictability for market operators.
The rise in trading activity in the EU ETS was driven by the increased use of auctioning to distribute allowances, and heightened volatility due to the threat to withhold allowances from the market.
For most of the latter half of 2012 the price of emission allowances remained at €6 a tonne, well below the €30 expected in 2008. Short-term prices are defined by how much demand there is compared to supply, and demand has been sluggish due to the economic slowdown.
Guy Turner, Bloomberg New Energy Finance’s director of carbon markets, remains optimistic: “Given that the market has only been in existence since 2008 and hasn’t suffered a down year in terms of market size, I think it rode the global financial crisis pretty well,” he said.
"Even in the face of policy paralysis and depressed prices, trading activity in carbon markets has continued to grow in 2012. This shows how efficiently these markets work. Policy-makers now need to harness the energy of this market and create policies that will drive innovation, spur further reductions in emissions and reduce costs," he added.
He predicts that in 2013 the market will increase to around €80bn and the following year to €94bn, if the EC's backloading policy is successful.
Global markets will increase in size substantially over the next few years. On 14 November last year, California, whose economy is one eighth the size of Europe's, launched its first carbon allowances auction. Several regional schemes in China will begin this year, followed by Australia and South Korea in 2015.
In 2014 India will begin energy efficiency trading and Thailand will launch a voluntary emissions market.
The Australian carbon emission price is fixed at €18 a tonne until 2018, when it will merge with the European scheme.
The Californian scheme was oversubscribed, according to Derik Broekhoff of Climate Action Reserve, who says the price of carbon allowances is expected to increase in subsequent quarterly auctions.
“I think you’re going to see the highest prices in the world in California,″ agrees Turner, ″and although the schemes in Australia, South Korea and China aren’t actually trading yet, they are positive developments”.
Long viewed with scepticism by many as a means of tackling climate change, emission trading may be about to turn a corner. The UK government will certainly be hoping so, as it will make policies such as the Carbon Price Floor cheaper and more politically acceptable.
Story: David Thorpe, News Editor