The town of Ludwigshafen, on the banks of the Rhine in central Germany, is home to the world's largest chemicals firm, BASF.

The company's factory here is truly vast.

It covers more than 10 square kilometres and contains no fewer than 250 manufacturing plants, all connected by a maze of roads, railways and pipelines.

It even has its own bakery and wine cellar.

The chemicals it produces are used in the manufacture of a bewildering range of consumer products, from car paints to credit cards.

The plant needs a massive amount of power to function. And like thousands of other energy-intensive industrial facilities across Europe, it is covered by the European Union's Emissions Trading Scheme.

Flawed scheme

The scheme is meant to provide a financial incentive for businesses to cut down on emissions of carbon dioxide, a "greenhouse gas" thought to play a key role in global warming.

Under the scheme, companies are given permits that allow them to emit a limited amount of carbon dioxide.

If they emit more than their allowance, they must buy extra permits, or face heavy fines.

In theory, this rewards efficiency and penalises companies that fail to reduce their emissions.

In effect, it makes the right to pollute a tradeable commodity.

Executives at BASF believe the system is flawed.

They are worried that it could end up hurting businesses that have already invested heavily in clean, energy-efficient technology.

By-product

The chemicals giant says it has done just that.

The company sets great store by what it calls its "Verbund" strategy.

The word literally means "group", but what it describes is a policy of complex integration.

In principle, it is designed to ensure that all the processes within the plant support one another wherever possible.

Waste products from one process are re-used in another, maximising efficiency and reducing consumption of energy and raw materials.

Two years ago, for example, BASF opened a new combined heat and power plant.

Its main purpose is to produce steam, one of the most important sources of energy for chemical reactions.

The gas-fired unit produces 20 million tonnes of steam every year.

But it also produces large amounts of electricity as a by-product.

This is used to power other processes within the plant.

Slight excess

Meanwhile, waste heat from chemical reactions is used to create yet more steam, while the residues that cannot be recycled are burned to produce yet more energy.

The company insists that it has no choice but to invest in the most efficient technology available, because otherwise it could not remain competitive in the global marketplace.

But when it comes to carbon trading, BASF has so far seen few benefits from its investments.

"The situation is about balanced", says company director Wolfgang Gerhard

"We have a slight excess of carbon permits, because of our energy-efficient power generation. But it's really very small."

So BASF is not making money from the scheme, but has not seen its costs rise either.

Fewer permits

Yet the carbon trading system in Europe is in its infancy - and European governments have been heavily criticised for issuing too many carbon permits.

That means companies have had little incentive to clean up their act, and the price of buying extra permits has fallen to a very low level.

But this situation is unlikely to last.

In 2008, the number of permits in circulation will be significantly reduced. And in 2012 it will go down again.

It is a prospect that Mr Gerhard finds deeply disturbing.

"It's right that the best technologies are supported by the trading system, and that companies which pollute too much have to pay a penalty," he says.

"But we are already on a very high efficiency level here. I do not see the technical means to increase our efficiency any further.

"We have already driven our energy demand down, and a greater incentive to cut our emissions won't give us the technical means to do it.

"Our costs will go up - or we will have to cut production."

No limits

The man in charge of the trading scheme has little sympathy with that view.

"Most of the companies that are covered by the scheme are highly energy-intensive businesses," says the European Union's environment commissioner, Stavros Dimas.

"Most of them do have the option of using technology to reduce their emissions.

"Technology is improving - technology is developing. There is no limit there."