* Deal supports carbon capture but unlikely to grow fast
* Kyoto Protocol renewal left for next year
* Lack of binding cuts and economy slow market development
By Timothy Gardner
CANCUN, Mexico, Dec 12 (Reuters) - Global carbon markets will struggle after the deal reached at annual U.N. climate talks did little to ensure mandatory emissions caps would be extended next year.
The modest deal forged after two weeks of talks in Cancun commits rich countries, from 2020, to finance ${esc.dollar}100 billion a year in climate aid for poor countries. It also sets a target to limit the rise in average world temperatures to less than 2 degrees Celsius (3.6 degrees Fahrenheit).
But it delayed the extremely difficult task of extending the 1997 Kyoto Protocol until next year's talks in South Africa. In Cancun, Japan, Canada and Russia said they would not support a second phase of Kyoto if it did not include caps on the United States and rapidly developing countries like China.
Kyoto, which expires in 2012, obliges all developed countries -- except the United States, which never ratified it -- to cut emissions blamed for warming the planet or face penalties.
It was the pact's binding emissions cuts, and expectations of tougher ones after a first phase, that gave birth to the European Union's Emissions Trading Scheme, the world's only carbon market that operates at national levels, as a way for businesses to meet mandatory caps.
"The outcome of Cancun does not change the fact that most of the important work of cutting emissions will be driven outside the U.N. process," said Michael Levi of the Council on Foreign Relations in New York.
But after a bleak year, carbon markets will not do that work either.
Banks let go many emissions traders even before the U.S. climate bill failed in July. Canada's Senate failed to pass a climate bill, Australia postponed legislation and Japan is struggling to set up a cap-and-trade market.
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The Cancun agreement locked into the U.N. process a pledge last year by China to reduce its emissions intensity, or amount of carbon released for every unit of economic output. But it paved no path for the world's largest coal producer and greenhouse gas emitter to embark on mandatory emissions targets.
Cancun also did little to cheer bankers and brokers trying to build a global carbon market who had hoped the world would now be on its way to a trillion dollars or more per year of emissions transactions.
If carbon markets remain weak and fragmented, they will do little to tackle global warming because they fail to push the price on carbon high enough to force emitters to make billion-dollar clean energy investments vast wind and solar farms, nuclear energy and carbon capture and sequestration (CCS).
BRIGHT SPOTS
The U.N. deal provided some bright spots for carbon markets, like taking steps to reform the Clean Development Mechanism, in which polluters in the EU market pay for emissions-cutting projects, known as offsets, in developing countries to get credit at home.
The deal also allowed CCS to be counted as an offset, which could lead to advances in the technology where carbon is siphoned from coal plants and factories and buried underground in hopes it will never reach the atmosphere.
And advances were made in reducing emissions from forest degradation and deforestation, or REDD, an U.N. offset program.
So far the program has generated only voluntary carbon credits as businesses look to enhance their green image and prepare for carbon pollution limits expected sometime in the future. But carbon traders and environmentalists believe it can slowly be turned into a mechanism to help save carbon-storing forests in the Amazon, Indonesia and the Congo basin.
But progress could be slow.
"Lack of specifics on finance, including future use of carbon markets, is a concern," Abyd Karmali, global head of carbon markets at Bank of America Merrill Lynch, said about the Cancun deal.
Carbon prices in the EU market, now hovering around 14.5 euros or ${esc.dollar}19.20 a tonne, were expected to react more to EU policies than anything that happened in Cancun. Those prices are less than half of what would be needed to drive polluters that burn coal to invest in nuclear energy and CCS at home.
"For the market, the expectations were low for Cancun, because the expectations of the negotiators were low," said Evan Ard, a spokesman for Evolution Markets, an emissions and energy brokerage. "The market is now focused on the sub-national and regional developments."
Developers in the United States, where emissions markets were invented, have much work to do.
California will launch a carbon market in 2012 but growth will be slow as the struggling economy has already pushed emissions down.
Prices in regional emissions market on the U.S. East Coast have sunk to a low below ${esc.dollar}2 per ton. Toughening the region's emissions cap would raise prices. But governors from the 10 states in the pact have showed no signs they can do that during hard economic times.
"Neither the United States nor China ... look willing to take leadership roles in tackling greenhouse gas emissions," Robert Johnston, director of energy and natural resources at the Eurasia Group, wrote in a research note.
"Ongoing disagreements between developed and developing countries ... on burden sharing are likely to impede progress at the next U.N. summit in South Africa." (Reporting by Timothy Gardner; Editing by John O'Callaghan)
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