Any business that buys cheap European emissions permits now may find them worthless by the end of the year. Linking emissions trading schemes isn't as easy as the Gillard government makes it out to be.
On Tuesday, Climate Change Minister Greg Combet announced that the government was scrapping the floor price for carbon permits in a post-2015 emissions trading scheme.
The rationale is that it will remove the need for extra complex regulation for Australia's ETS now that it will be linked to Europe's. If the price floor were kept in place it would create a regulatory nightmare for our government as it chased companies to pay the gap between the cost of European permits and the Australian floor price.
With the European Climate Commissioner for Climate Action, Connie Hedegaard, Combet also announced that Australian companies could buy EU permits ''starting today''. The same doesn't apply to European companies, which won't be able to buy Australian permits for some time.
Combet's clear objective is to get business to forward-purchase permits and make it harder for Tony Abbott to repeal the government's carbon pricing scheme if he is elected to government.
The economic impact of this deal is particularly confusing. The government's carbon price modelling was always flawed.
For example, the Treasury's Strong Growth, Low Pollution modelling assumes nearly two-thirds of Australia's emissions cuts will be achieved by international permits by 2020. Yet the cap will allow only 50 per cent of permits to be sourced offshore. A European linking deal that might halve Australia's carbon price from about $25 to about $12 overnight provides no respite from the great known-unknowns of an ETS's impact, especially for carbon-tax paying businesses.
Ignoring domestic political risks, business should still be very wary of the ''benefits'' of cheaper European emissions permits.
Europe is playing hardball in international negotiations, making forward-purchased permits potentially worthless.
The Kyoto Protocol specifically stipulates how international permits can be traded and how they can be counted against national emissions targets. But at the end of this year the first commitment period to cut emissions under Kyoto will expire.
Negotiations on if, and how, Kyoto will be extended into a second commitment period, and how international rules over carbon trading will operate beyond this year, are ongoing. Until mid-next week countries are meeting in Bangkok in an attempt to finalise a deal for the future of Kyoto.
December's UN Climate Change conference in Qatar is the definitive deadline to avoid a gap between a first and second commitment period under Kyoto.
Few think a comprehensive Kyoto agreement will be ratified.
A survey last year by the World Bank's carbon finance unit found that fewer than 5 per cent of carbon traders were optimistic there'd be a multilateral agreement to cut emissions in operation by the end of 2015. About 70 per cent are pessimistic. Their optimism jumps to 20 per cent for a 2020 deadline.
What's possible is that a second commitment period under Kyoto will be agreed to by the end of the year covering developed countries. The caveat will be that only Europe and a few other countries will actually bind themselves to its emissions reduction targets.
When challenged publicly, Australian government ministers are non-committal about signing up to an extension of Kyoto. But Australia's negotiating position in international talks makes it clear there is no intention to do so.
On the record, the government's latest submission to international climate negotiations argues they have ''consistently maintained that a second commitment period of the Kyoto Protocol must be balanced by an agreement with legally binding mitigation commitments by all major economies''.
Considering we know the US, Canada, Russia and Japan won't be signing up, Australia's negotiating position to a second commitment period under Kyoto is mere bluster.
It's a spectacular turnaround for a party that rode into office in 2007 on Kyoto's ratification. It also spells trouble for international linking.
In international climate negotiations, Europe is pushing for countries to be able to use cheap international permits to meet their emissions targets after the end of this year only if they sign up to an extension of Kyoto. If successful, that means Australia may have a bilateral deal with Europe to allow business to buy cheap emissions permits to reduce costs, but multilateral rules will mean they cannot be counted.
If Europe gets its way in international negotiations it will have effectively forced Australia's hand into adopting an extension for Kyoto, even if the final deal is strongly against our national interests.
The alternative is that Combet and the Gillard government will have to explain to Australian business why forward-purchased European permits are worthless.
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