Power price confusion as carbon policy is fiddled

Now the Government has added to the confusion by dropping the post-1 July 2015 carbon price floor of A$15, and seeking to 'link' emissions trading in Australia to the European emissions trading scheme. This 'link' still comes with access restrictions, both for Australian buyers of overseas permits, and overseas buyers of Australian permits, so it is partial, at best, for the foreseeable future. New limits also apply to purchases of cheap (and dodgy?) UN Clean Development Mechanism (CDM) permits.

This policy backflip highlights two crucial elements of so-called emissions trading schemes (ETS), and adds emphasis to the reality that they are, indeed, schemes, with all the implied rorting and abuse that label implies (and EU experience illustrates).

Taking these elements in reverse order, this policy backflip underscores the practical reality that the 'trading' part of ETS must lead to carbon price convergence within the trading market – unless governments try to prevent this by regulation. Such regulatory attempts only increase the incentives to rort the (government-created) system anyway.

Even partial attempts to 'link' an Australian ETS with the EU ETS creates the wrong trading market for Australia. Australia's main trade competitors don't have ETS systems, and siding with the EU ensures adverse effects on Australia's international competitiveness. Sure, aligning with a carbon price that may well be lower than under the previous version of Australia's carbon policy might be an improvement, but it still makes no sense in Australia's national interest – or indeed, from the perspective of trying to secure a genuinely global deal.

The second element is the most important – that is, if you believe that the purpose of ETS is to reduce greenhouse gas emissions. This is the process whereby governments impose 'caps' on the number of emissions permits issued. This is the mechanism that will drive permit prices up by making them scarce, thereby providing a signal to reduce emissions. (In contrast, the 'trading' part of such schemes just shuffles the given number of permits around. In total this number – and the emissions it allows – is unaffected by trading.)

Forecasts of increasing permit prices require governments in the relevant ETS markets to authorize increasingly scarce numbers of permits relative to those demanded under a 'business as usual' scenario.

The EU experience has been that, to date, this requirement has not been met. It seems highly unlikely that such discipline in issuing new permits will be met in the foreseeable future, given the diabolical economic mess in which the Eurozone (and Europe more generally) now finds itself. For Europe, any emissions reductions are likely to occur despite low permit prices, and because of recession. Ditto the global economy.

If, as is claimed, the 'linking' of Australia's ETS with the European ETS means that European decisions on permit issue will 'call the shots' for prices paid by Australian permit buyers, this suggests a lower Australian price trajectory than that underpinning Government forecasts. If so, less permit revenue is a Budget concern, and less incentive to reduce emissions is a climate policy concern.

I wouldn't bet my house, or even one dollar, that EU (or Australian) governments will restrict emissions permits sufficiently to produce a permit price of A$29, let alone one that would significantly change the economics of energy supply inputs, this side of 2020 (or beyond).

In this even more confused power pricing environment, Australia's carbon price is even more inefficient and ineffective. We should start again.