Our planet is gradually but inexorably growing warmer under the blanket of carbon dioxide being pumped out by global industrialisation and modernisation.

It is, therefore, even more vital that clear opportunities to try to halt this trend are seized before the consequences become irreversible. Time is short and the decisions that must be made by policymakers at both national and international level are becoming increasingly critical.

The key to making companies and individuals reduce their output of highly damaging CO2 is to put a price on those emissions – and it needs to be a high enough one to change both consumer behaviour and future investment decisions. The polluter must be forced to pay.

The question is how to do this efficiently, in a way that is as market-orientated as possible and allows companies to continue competing in their own arenas on a level playing field. In Europe, we have already got the basic structure in place, at least until 2012, in the EU Emissions Trading Scheme (ETS). This “cap and trade” policy puts a price on carbon by allowing the trading of individual companies’ allowances to emit CO2 within an overall emissions limit that applies to the industries covered. The scheme, the world’s biggest of its kind, is on the right lines. But it has design flaws that need ironing out.

Hence the importance of the European Commission’s expected announcement next month of draft directives, with legislation to follow, detailing the structure of the third phase of the ETS from 2012 onwards.

One truth must be accepted: preserving planet Earth and cutting CO2 emissions is expensive. The longer we leave it the more it will eventually cost us all. The trick is to minimise this cost while maximising the outcome.

To do this, several myths must be debunked, many of them centering around power generation, which accounts for a third of all UK emissions, thanks partly to the raft of dirty coal plants owned by some of British Gas’s competitors.

The first myth is that somehow power prices can be protected from rising carbon prices. They can’t. From day one of the ETS, the actual and predicted price of carbon has been factored into power prices.

Why? Because unlike sectors such as steel or manufacturing, there is no competition from outside Europe in power, so the value of CO2 allowances has been passed straight into electricity prices.

This pass-through of carbon costs to prices applies to all allowances, whether handed out for free, as the vast majority will be until 2012, or purchased. It happens because allowances, free or bought, have an opportunity cost – generators can generate and use up the allowances or they can leave plant idle and sell the allowances.

The second myth is that removing free allocations to generators will push prices up. As explained, power prices already include the full opportunity cost of allowances and free handouts have simply resulted in massive windfalls for the highest-polluting generators; prices have risen without a corresponding increase in company costs.

For the second phase of the ETS, from 2008-12, where carbon prices are €22 (£16) per tonne, these windfalls are £1.5 billion a year in the UK and more than £13 billion a year across Europe.

This is a huge distortion in the market, and a disincentive to develop clean generation. From 2012, free handouts must end in favour of 100 per cent auctioning of allowances in the power sector or any other that can recover the costs through received prices. Auctioning forces the polluter to pay while giving an advantage to developers of the kind of low-emitting but expensive, £1 billion to £1.5 billion, clean coal plant that Centrica has considered building on Teesside. That cost is three times higher than an equivalent gas-fired plant but with a third of the emissions, or a sixth of the emissions of a traditional coal plant. If carbon prices rose to significantly more than €30 a tonne, such a plant might start to look economically viable, but it doesn’t at the moment.

Of course, other industry sectors competing internationally with low-cost Far East rivals would not be debarred from lobbying government for continued free allowances.

The third myth is that a carbon tax, set by government, could be better than a market-based cap and trade system such as the ETS.

Remember, a carbon tax would involve government setting the cost of carbon. This would inevitably result in it being either too high, meaning everyone overpays, or too low, in which case emissions reductions are not maximised.

By contrast, cap and trade gives a clear emissions cap and then allows the market to decide the price of carbon in order to deliver the prescribed reductions in emissions. This is far more effective.

Why is all this of particular importance now? One reason is the looming UK power gap, with around 11 gigawatts – a seventh of the UK’s generation fleet – due to be retired on environmental grounds by 2015. And that’s not including nuclear plants earmarked for decommissioning.

For companies to make decisions on replacing these plants with expensive but clean alternatives requires a clear view of the likely future carbon price.

We are already doing our bit – British Gas customers receive the lowest carbon-intensity electricity of any major supplier thanks to our lower-emitting gas-fired generation fleet. But we’d like to do more.

We would also like to see greater efforts to cut emissions in other industries, for example road transport, which accounts for 22 per cent of UK emissions, and aviation.

The outcome now lies in the hands of our politicians. Apart from getting the ETS structure right, we need all countries to be committed to it and to what will hopefully be a similar scheme established globally. Then we can all deliver steady reductions in CO2 output.

But one false step now, as the European Commission and European Parliament shape emissions policy over the coming months, will have dire results. Unless power sector investment objectives are rapidly aligned with environmental policy, the already high cost of salvaging the Earth’s environment will rise exponentially.

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